It may be too soon to make predictions for Merriam-Webster’s 2022 word of the year, but “metaverse” is certainly a contender.
While still a nebulous concept for many mainstream consumers, the opportunities for entertainment, sports and consumer brands in the metaverse (virtual simulations of reality rendered at mass scale) are undeniable. How will commerce work in the virtual world?
Many think that NFTs (non-fungible tokens), another buzzword of the moment, may power the backend of content and digital product monetization for companies in the metaverse and the broader space of a more interactive, participatory internet that would support metaverse platforms and applications, a potential future that’s been dubbed Web3 by its advocates.
For more on NFTs and the metaverse’s expected role in Web3, check out Variety Intelligence Platform’s latest data-driven special report, “Web3 Demystified,” available only to subscribers.
While NFTs can be assets unto themselves, they may serve an important utility function for metaverse asset monetization in their role as “certificates of ownership,” so to speak.
Now is the time for content owners and brands to face (virtual) reality and prepare for the challenges they may encounter as they look to monetize the metaverse. Below are three topics companies ought to consider as they navigate this space.
1. Why might NFTs power monetization of the metaverse?
NFTs are comprised of a digital token recorded on a blockchain and the content associated with that token. A purchaser of an NFT acquires ownership of the token but often only a license to the associated content, the copyright of which is retained by the content owner.
One of the benefits of blockchain technology is the certainty it can provide regarding chain of title. For example, if your avatar purchases a branded shirt to wear in the metaverse and ownership of that shirt is represented by an NFT, you can then verify any prior owners of the token, all the way back to whomever originally minted the NFT (presumably the brand itself or its tech partner). This presents a level of certainty in provenance that you might not get in the “real world.”
Much like in reality, when you buy that virtual shirt, you aren’t buying any IP rights in the shirt (e.g. the logos), except perhaps a limited license for your avatar to wear the shirt.
Another benefit of using NFTs for digital-asset-rights tracking is that, if different metaverse platforms can connect with a common blockchain with which the NFTs are compatible, it will make cross-platform digital-asset use and sales much easier.
Time will tell what level of coordination will happen in the tech world, but keep in mind that NFTs are distinct from the content associated with them — the content is still likely to be hosted on a separate server, so digital rights management to protect IP remains critical. And if you are relying on NFTs to provide that certainty for digital asset sales, it is important to understand how the NFT and the related content correlate from a tech standpoint. Knowing the NFT and its applicable content remain linked is key for NFTs to have this kind of utility.
2. Aspects of Web3 may be in tension with traditional regulatory regimes but companies remain subject to real-world rules and regulations.
While opportunities abound in the metaverse and NFT space, concerns of fraud, manipulation, and money laundering are well founded when it comes to digital trading.
It is not a given that metaverse or NFT platforms perform anti-money laundering (AML) and Know Your Customer (KYC) processes on their users. These processes were originally designed to prevent nefarious transactions like money laundering and the financing of terrorism through traditional financial institutions, such as banks.
It remains important for entertainment companies and brands entering Web3 to understand to what extent their platform partners have AML and KYC procedures in place, especially as industry practices continue to change and evolve.
The challenge with these compliance regimes is that they typically require users to provide personal information, which is contrary to the flexibility and anonymity that tends to characterize Web3 activities.
Still, there are ways for companies looking to pursue digital asset sales in the metaverse to lower risk while limiting the intrusion on a potentially government-wary user base.
Companies can work with their developers and platform partners to implement geocoding and IP address filtering to prevent users in sanctioned countries (e.g. North Korea, Iran) from buying digital assets and the associated NFTs. They can also screen potential purchasers against the Specially Designated Nationals and Blocked Persons List (SDN) as operated by the Office of Foreign Assets Control (OFAC), which has included sanctioned digital wallet addresses in its database since 2018.
A benefit of relying on NFTs to support digital commerce in metaverse environments is the ability to obtain digital wallet addresses at minimum, which are usually necessary to hold NFTs. Companies entering Web3 will have to delicately balance a business model that keeps with the expectations of metaverse users who harbor “real world” regulatory concerns and legal risk.
3. Entering the metaverse and utilizing NFTs may mean entering the world of crypto.
A key decision companies must make when entering into digital commerce is whether to accept fiat currency (e.g. U.S. Dollars), cryptocurrency or both. If they choose to accept cryptocurrency, they need to further decide which coin(s) and which digital wallet(s) to accept.
Different users utilize different wallet providers, with such wallets often holding a variety of cryptocurrencies — the permutations of this digital transaction infrastructure are virtually endless.
As a result, companies must weigh the benefits of limiting their exposure to and potential diligence of an array of third parties against the risk of alienating portions of their consumer base. Companies may find this dilemma useful to discuss with their partner platforms and conduct market research on the digital wallets and currencies popular amongst their target audience to find the right balance.
To state the obvious, cryptocurrency is volatile. If companies transact in the metaverse and rely on selling NFTs for cryptocurrency, both sellers and buyers will be exposed to at least some financial risk.
The inherent volatility of cryptocurrencies means that it can be difficult to predict the tax liabilities associated with crypto-based transactions. One thing is clear, though: Any currency in which a company elects to conduct business ought to be usable outside of the metaverse and retain real-world value. Companies would do well to consider this when deciding which cryptocurrencies and related wallets to accept, as well as how and when currency conversions occur.
Many video game platforms have already proven that selling in-game digital assets is big business — that is just a preview of what is possible as metaverse platforms develop.
In this largely unlitigated and unregulated frontier of metaverse commerce and NFTs, companies have virtually unlimited potential to capitalize on revenue-generating opportunities in an exciting, consumer-focused environment with tremendous user engagement opportunities.
Traversing this constantly evolving landscape inevitably invites risk, but strategic decision-making coupled with a balance of caution and innovation can help ensure enterprising companies survive and thrive in the wild west of Web3.
Adrian Perry is a partner in the New York office of global law firm Covington & Burling, co-chair of its music industry practice as well as one leader of the firm's metaverse, NFT and Web3 practice. His work focuses on the intersection of technology and entertainment, representing record labels, film studios, TV programmers, video game publishers, sports leagues and global brands in their most complex, cutting-edge deals.
Ana Rosic is an associate in the New York office of Covington & Burling in its technology and IP transactions practice. She specializes in commercial transactions relating to IP licensing, content distribution, metaverse platform content licensing and NFTs, along with data use and commercialization.