Novel products
likely to mean greater calls for regulation. Although the platforms resemble those for trading regulated securities, it is an open question where regulation of digital-only assets should take place. Crypto currencies and NFTs are both essentially tokens to which a value may or may not be attributed (see sidebar) so they do represent a wager on an uncertain outcome. Their lack of linkage to fiat currencies or predictable real-world performance make them more akin to a betting product than a financial instrument. Regulating them via the financial services regulator would appear to confer on them greater respectability than they deserve. It seems likely that consumers would risk far less on such products and platforms if the true nature of the risks were better understood. The biggest risks of all The threat of being ruled illegal or regulated out of existence are not the only challenges to the growth of novel products. The market is young and the digital assets they are built upon are very volatile planting a seed of doubt as to the value developers and players may achieve. Perhaps the biggest risk, however, is in the way tokens are stored. Crypto currency proponents often point to the savings that come from cutting out the mediating role of banks, but it is in the lack of secure stores of value that problems have arisen. Many P2E developers create their own crypto currencies and NFTs storing them on their servers. Considering how much wealth can be accumulated in online accounts, these make an attractive target for criminals. Axie Infinity is just one example of online fraud costing players money. The company was the victim of a security breach which saw US$600 million stolen in March 2022. The threats are not all external, either. The location of NFTs on a game developer’s server also gives rise to another concern. Despite players apparently owning their NFTs, if the server where they are stored collapses for whatever reason, those NFTs disappear into thin air. This is not a remote possibility. F1 Delta Time was a popular car racing P2E game that recently went bust meaning that all the NFTs associated with the game are now worthless. Considering that some people paid extraordinary sums for their cars, the losses are likely to give players plenty of reasons to reflect. The nascent digital market has also witnessed the kinds of crimes more commonly associated with the regulated banking market. A former employee of OpenSeas, the largest marketplace for NFTs, was arrested in May 2022 by the FBI and charged with insider trading and wire fraud. Using his knowledge of assets which were about to be featured on the company’s website, he bought them and sold them immediately after the announcement pocketing the profits.
Thanks to the open nature of the NFT market, where all trades are written on to a blockchain database, observers had spotted that someone was purchasing digital assets with questionable timing in September 2021. However, in a worrying twist, OpenSea did not at the time have an explicit policy against such insider trading and acted only after the trades were brought to its attention. Some have questioned whether such practices are even illegal. In May, an apparent insider trading scheme was uncovered on a leading crypto exchange. The scheme saw a user build up large positions in small cryptocurrencies shortly before they were listed on major exchanges, selling them for a profit in the resulting surge of interest. The trade in so-called “shitcoins” – crypto assets created with no purpose other than to be traded in a speculative market – is openly acknowledged to be full of practices that would be illegal in a regulated market. The latest wheeze to boost the value of coins is to link them to famous celebrities/musicians in an attempt to convince consumers they are worth buying. This has led some to call into question the basis of digital assets. One influencer in the space is quoted as saying: “don’t’ ask ‘is this token a scam,’ because they all are. The question is: ‘Is this scam done well enough to convince other people to buy?’” The OpenSea case, then, is far from an isolated example, but it may prove pivotal to regulation of the sector. US attorney Damian Williams said: “NFTs might be new, but this type of criminal scheme is not … the charges demonstrate the commitment of this office to stamping out insider trading – whether it occurs on the stock market or the blockchain.” The FBI move coincided with a letter to US Congress signed by 1500 computer scientists, technologists and specialists in financial technology. They asked leaders of Congress to “take a truly responsible approach to technological innovation and ensure that individuals in the US and elsewhere are not left vulnerable to predatory finance fraud, and systemic economic risks.” Whatever their response, one thing seems sure: the future of these novel products will be one of more regulation rather than less giving rise to both opportunities and threats. Given that many of the developments in the space are likely to occur in the metaverse, it remains to be seen who will step up to try and regulate them and whether they are successful. At the end of June, the EU concluded a new regulatory framework to collect data from crypto transactions. The Transfer of Funds Regulation (ToFR) designed to regulate the “crypto wild west” will see every crypto transaction made via an unhosted wallet or at a crypto ATM provide data to a Crypto Asset Service Provider (CASP) transactions of €1,000+ will require an identity to be verified. The rules are part of the EU’s response to AML concerns surrounding crypto.
24 • IMGL Magazine • July 2022
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