Right now, there is no single metaverse. In fact, there are hundreds, if not thousands, of different metaverses you can become part of, or which are being developed, right now. We define these metaverses as virtual extensions of the real world or, a world that’s part of your imagination. They can include virtual reality characterized by persistent virtual worlds that continue to exist even when you’re not in the spaces, as well as augmented reality that combines aspects of the digital and physical worlds.
Web3 is a new iteration of the Internet which incorporates concepts such as decentralization, blockchains, smart contracts, and token-based economics. There are two views about Web3. The first is that Web3 will provide increased data security, scalability, efficiency, and privacy for users and combat the influence of large technology companies. The other view is that a decentralized web may lead to low moderation, accountability, the proliferation of harmful content. We tend to agree with the former rather than the later.
Decentralization, as it applies to Web3, is the process by which the activities of an individual or organization, including the foundational technology supporting these activities, are distributed away from a central authoritative entity or group. This approach can apply to planning and decision making.
A blockchain is a shared, immutable ledger that facilitates the process of recording transactions and tracking assets in a business network. Anything of value can be tracked and traded on a blockchain network, reducing risk and cutting costs for all involved.
Smart contracts are programs stored on a blockchain that run when predetermined conditions are met. They typically are used to automate the execution of an agreement so that all participants can be immediately certain of the outcome, without any intermediary’s involvement or time loss. They can also automate a workflow, triggering the next action when conditions are met.
Token economics refer to a system or process of goods and services that have been tokenized. Blockchain technology enables these economies to function without the need for intermediaries and third parties. In a token economy, blockchain technology is used to take tangible and intangible assets, digitize them, prove their ownership, and potentially allow for investment or transactions.
Non-Fungible Tokens (NFTs)
A NFT is a record on a blockchain which is associated with a particular digital or physical tangible or intangible asset. Ownership is recorded on the blockchain. NFTs may be bought, sold, gifted, used as collateral or as a business tool to facilitate a transaction. Tokens may Unlockable content and other utility. Factional NFTs are tokens that represent an interest or fractional ownership of an NFT.
A DAO is a decentralized autonomous organization constructed by rules encoded as a computer program that is often transparent, controlled by the organization’s members and not influenced, managed or controlled by any one central entity. DAOs are member-owned communities without centralized leadership with decisions and voting rights usually decided by digital tokens. A DAO’s financial transaction records and program rules are maintained on a blockchain. The precise legal status of this type of business organization is unclear.
Decentralized finance (DeFi) offers financial instruments without relying on intermediaries such as brokerages, exchanges, or banks by using smart contracts on a blockchain. DeFi platforms allow people to lend or borrow funds from others, speculate on price movements on assets using derivatives, trade cryptocurrencies, insure against risks, and earn interest in savings-like accounts.
Cryptocurrency is a digital currency that does not rely on any central authority to uphold or maintain it. Instead, transaction and ownership data is stored in a digital ledger using distributed ledger technology such as a blockchain.
Digital wallets are applications that allow you to store cryptocurrency funds, make transactions, track payments, and store digital assets on devices like phones, tablets, laptops and desktops. A cold digital wallet can be disconnected from an internet connection.
The blockchains and NFTs provide absolute proof of ownership along with provenance (a record of ownership of a work of art or an antique, used as a guide to authenticity or quality). Moving forward, we believe that every tangible and intangible digital asset will have an NFT or NFT type technology attached to it.
Intellectual property (IP) is a category of property that includes intangible creations of the human intellect. The best-known types of IP are copyrights, patents, trademarks, and trade secrets. The main purpose of intellectual property law is to encourage the creation of a wide variety of intellectual goods. To achieve this, the law gives people and businesses property rights to the information and intellectual goods they create, usually for a limited period of time. This gives economic incentive for their creation, because it allows people and companies to benefit from the information and intellectual goods they create, and allows them to protect their ideas and prevent copying. Watch this four-minute overview, “Who owns the copyright to your NFT?”
A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In the Web3 space, the question sometimes exists, “Is my NFT a security?” Watch this two-minute overview.
The Ethereum Merge
The current Ethereum Mainnet will merge with the Beacon Chain proof-of-stake system. This will mark the end of proof-of-work for Ethereum, and the full transition to proof-of-stake. It’s being reported that the Merge will reduce Ethereum’s energy consumption by about 99.95%
The Howey Case and Test
If your NFT is a security, then absent specific exceptions, the offering of your NFT must adhere to the U.S. Securities and Exchange Commission (SEC) rules, regulations and registration requirements. This applies to sellers and exchanges.
Under the U.S. Supreme Court case SEC v. Howey Co., 328 U.S. 293 (1946), the court gave four factors for determining whether an investment is a security:
- Is there an investment in money?
2. In a common enterprise?
3. Is there an expectation of profit?
4. Is the profit expected to be derived from the efforts of a promoter or third party?
The sale of a single NFT sale may take on the form of a work of art or collectible rather than a security. It depends on the facts.
Factional NFTs are tokens that represent an interest or fractional ownership of an NFT. The four factors of the Howey test seem to be present in fractional NFTs more so than the sale of a single NFT work of art or collectible.
For these reasons, most companies dealing with fractionalized art ownership of traditional physical art (yes, this is a thing) comply with SEC rules, regulations and requirements. With this in mind, the safe bet is that many, if not most, fractional NFTs may also be determined to be investments in securities.