Regulating the Metaverse Economy

Front matter

SpringerBriefs in Law

Annelieke Mooij

Regulating

Contents

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6.3 Centralized Currency Issuers

Chapter 1 A) Governing the Meta-World Finances ms

Imagine that you live in London and are a fan of musicals. You have grown particularly fond of the musical Hamilton. As a special rendition the musical plays in New York with your favorite star singing the lead. It provides a great way for you to see the musical and catch up with your old classmate who moved to New York. Unfortunately, you live in Europe and you cannot find the time to travel to New York and back. Your option is to buy a ticket to a live screening and have a video call with your friend afterwards. Most people will agree that this is not a real alternative to seeing the musical in real life. Whilst streaming is less expensive and will save you the trouble of travelling, it does not offer the same experience. The videocall with your friend will provide you with some interaction but not on the same level as sitting next to each other at the theatre. In comes the Metaverse to provide you the immersive 3D alternative. Instead of sitting at home or in your local cinema watching the live screen in 2D, the Metaverse will allow you to buy a ticket to a virtual seat in the theatre. Your friend is sitting on the virtual seat next to you, so you both chat before the curtain call. In the break you both have a drink from your own kitchen but with the experience of being in the café of the theatre.

The development of technology is ever-continuing. The world between online and offline is getting blurred.' The Metaverse will bring many new experiences and increase the accessibility to these experiences. All that is needed to access the Metaverse is a device with internet access. The immersive 3D experience can be created using cardboard vr-glasses which are sold for around €15,-. In case of real deprivation, these glasses can even be fabricated at home from an old cardboard box. The possibilities of the Metaverse are endless but the Metaverse itself brings many regulatory challenges. The Metaverse can be accessed from anywhere on the planet which makes it difficult to determine which country or region has jurisdiction. The problem of jurisdiction is made even more difficult because the Metaverse is “[. . .Jan open source decentralized, interoperable platform for programmable digital assets

'Kalpokas (2019).

© The Author(s) 2024 1 A. Mooij, Regulating the Metaverse Economy, SpringerBriefs in Law, https://doi.org/10.1007/978-3-03 1-46417-1_1

2 1 Governing the Meta-World Finances and digital identities built on Substrate.”* In non-coding language, this means that it is free and open for everyone to use. Virtual realities can be connected to the Metaverse by anyone anywhere. The code of the Metaverse is like a building platform upon which many different worlds can be built by anyone who knows how to build blocks. These worlds form a network of virtual environments.

The environments can be created and hosted by different providers and they can then be accessed at any point by anyone. It can use the real world as a template for the shared virtual reality which can be used to facilitate daily interactions.° The Metaverse gained fame on the 28th of October 2021 when Meta, the parent of Facebook, announced their intentions for the Metaverse. Meta intends to create meta home and meta workplace. The aim is to provide the general public with virtual reality settings designed to replace face-to-face interaction.* One of the potential aims of this environment is to facilitate a virtual office space whereby day-to-day office interactions will take place through virtual reality. With this potential comes a new form of virtual existence. Whilst most previous virtual realities have been created to provide an alternative world, the Metaverse would provide a virtual real-life existence. The virtual experience could cheaply facilitate a feel of real-life luxury. The hype is therefore likely to stay.

The new form of virtual existence would open up a wide array of possibilities. One can tag into the virtual office and conduct 3D business meetings. An international meeting could take place within a single virtual location. Metaverse distinguishes itself from other meeting platforms by combining a wide array of services such as communication, payment and smart contract building. The Metaverse furthermore will be provided in 3D. Due to its open source, anyone can build a reality and connect it to the Metaverse, therefore allowing a network of providers to be attached. The Metaverse will allow its users to walk through a high-end retail street, take a walk through a rainforest and close by watching a 3D football match all from their own living room. Though the Metaverse will open up new possibilities vis-a-vis the use of the internet, it also raises a series of legal questions.

These legal questions include private law matters such as the applicable law and jurisdiction over virtual contracts. Criminal law questions such as what constitutes a virtual crime. But perhaps most importantly what authority can regulate the internet? Governments aim to promote public values within their society. Whilst promoting these values they are limited to their own borders and jurisdictions. The jurisdictions are defined by physical space. Some of this space is easy to grasp such as land and some of it is a little less tangible such as water and aerial territory. Nevertheless, even the sky can be identified as what does and does not fall within a government’s jurisdiction. Some of the challenges related to water and sky, such as climate change, require an international approach. Governments therefore participate in

? Metaverse (2022) Homepage. https://mvs.org/. 3 Ondrejka (2004).

+Meta Press Release: The Metaverse and How We’ll Build It Together — Connect 2021, 28 October 2021. Available at: https://www.youtube.com/watch?v—Uvufun6xer8.

1 Governing the Meta-World Finances 3 supranational organizations. The Metaverse, however, combines national and international with a new challenge: the virtual. Whose jurisdiction applies in a virtual space? It is intangible but unlike the sky, it cannot be measured or marked. The virtual reality therefore carries the risk of becoming the new wild west. A variety of journalists have entered the Metaverse and found (sexual)harassment, discrimination and child pornography to be the order of the day. This phenomenon is undesirable but has little effect in the real world and can be avoided by not entering that part of the Metaverse. The lawlessness of Metaverse also brings the risk of crimes with real-world effects such as money laundering.

Virtual reality and in particular virtual payments bring new risks with regard to money laundering and the financing of terrorism (MLFT). If left unregulated the Metaverse can provide terrorists and organized crime with new mechanisms to finance their activities. The easy solution would be to ban the Metaverse. To ban an internet product is near impossible and considering the possible advantages; is undesirable. This book will therefore consider how to regulate financial transactions through the Metaverse to prevent MLFT. It will analyze the legal framework and suggest improvements from a European Union (EU) perspective. The EU has regulated MLFT primarily through the Anti-Money Laundering Directive (AMLD). A directive requires national implementation, this book will therefore analyze national implementations for further detail.

To analyze the effectiveness and requirements of a new legal framework, Chap. 2 of this book will first describe the development of online realities and the Metaverse and the new types of transactions that can occur. Chapter 3 will discuss the different types of virtual currency schemes in relation to the physical economy. Chapter 4 will continue by examining the three phases of MLFT and the specific risks with regard to the Metaverse. This chapter will also demonstrate that there are three new risks to be added to the MLFT framework that are specific to the Metaverse. These risks are the rise of Non-Fungible Tokens, anonymity and the lack of jurisdiction. The book continues by first examining the three standard MLFT phases with regard to the Metaverse. Chapter 5 will discuss the placement phase. Chapter 6 will discuss the layering phase and Chap. 7 the integration phase. Each of these chapters will discuss the specific risks of the Metaverse and analyze whether the current EU legal framework is adept at preventing MLFT. Chapter 8 will discuss two of the new risks that are specific to the metaverse namely that of anonymity with regard to firms and the occurrence of Non-Fungible Tokens. Chapter 9 will provide a conclusion on the current legal framework and the improvements that need to be made in order to prevent MLFT through the Metaverse.

5Crawford and Smith (2022).

4 1 Governing the Meta-World Finances

Crawford A, Smith T (2022) Metaverse app allows kids into virtual strip clubs. BBC 23 february

Kalpokas I (2019) Algorithmic governance. Politics and law in the post-human era. Palgrave Macmillan, Cham

Ondrejka C (2004) Escaping the gilded cage: user created content and building the Metaverse. New York Law School Law Rev 49(1)

Metaverse (2022) Homepage. https://mvs.org/

Open Access This chapter is licensed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license and indicate if changes were made.

The images or other third party material in this chapter are included in the chapter's Creative Commons license, unless indicated otherwise in a credit line to the material. If material is not included in the chapter's Creative Commons license and your intended use is not permitted by statutory regulation or exceeds the permitted use, you will need to obtain permission directly from the copyright holder.

Chapter 2 A) What Is the Metaverse? Cheek fo 2.1 Introduction to Virtual Reality

This chapter will discuss the contours and aims of the Metaverse along with the development of virtual realities. Before discussing the legal difficulties concerning the meta-verse it is important to discuss its contours. In this discussion, an important distinction must be made between Meta and the Metaverse. The Metaverse is the 3D virtual reality that will be the central point of discussion. The Metaverse is an open-source, decentralized virtual reality that facilitates interoperability between different providers. It is the next step in the virtual reality saga, whereby virtual reality aims to take over large aspects of physical life. Meta on the other hand is the parent company of Facebook and other companies and aims to become a large provider of virtual realities connected to the Metaverse.

The discussion on how to regulate the meta-reality is not completely new. The Metaverse is in many ways comparable to other virtual realities. There are various developments of virtual worlds. The most popular and well-known virtual worlds are perhaps those offered through games. The development of games is complex. There are multiple layers and levels of development. ' For the purposes of regulating the economy of the Metaverse, it is only necessary to examine three earlier developments.

2.2 Development of Online Realities

The first is the offline virtual world. This world was developed through a variety of games, most famously, Super Mario. The user would buy the gaming software, install it on a device and the user could then experience a virtual reality. This reality

© The Author(s) 2024 5 A. Mooij, Regulating the Metaverse Economy, SpringerBriefs in Law, https://doi.org/10.1007/978-3-031-46417-1_2

6 2 What Is the Metaverse?

however was limited to one user who was alone in the virtual reality. A similar development was the Sims a virtual game whereby users would play in a simulated real-life world. This development is the first leading to virtual realities based upon a real-world environment. With the development of the internet, the same type of gaming content became available online. The online virtual worlds allowed multiple players to connect and play within the same virtual world. These are called the Massive Multi-player Online games (MMO).

The MMO games form the second development in the gaming development. Unlike offline games, the MMOs allow interaction and cooperation between different players. The first graphical MMO in existence was Neverwinter Nights” a roleplaying game based upon the board game Dungeons and Dragons. The MMOs currently include famous gaming worlds such as World of Warcraft (WoW) and Runescape. WoW at its height had an estimated amount of 7.2million users and currently has around 1.1million.* These games are characterized by an online virtual world in which the players emerge themselves. Unlike the offline games, users can interact in the virtual environment. The users can earn and buy gold from the platform provider and use it to buy virtual assets. This game is closely related to the third development that of MMOs with economies with a link to the real economy.

The third development is that of MMOs with a link to the economy outside the gaming industry. The most famous of these games was Second Life, a game based upon simulating the real world. Second Life in 2020 had an estimated user number of 600.000.* Whilst currently past its peak, the platform had 36 million accounts created and a daily transaction rate of 1.2 million dollars. There are two important differences between Second Life and the earlier MMOs. The first is the intention which is that of a simulation based upon the real world. The second is that of the economy in Second Life. Users can purchase coins with dollars but also earn them by working for another user or by operating a shop. They can furthermore exchange their virtual coins for fiat currency. This exchange created a link between the real economy and the virtual economy. There are several similarities between the Metaverse and Second Life.

Similar to Second Life users of the Metaverse can communicate and trade with each other. The platform allows the users to exchange virtual goods and services. The aim of the Metaverse, like Second Life, is to provide a reality based on real life. However, unlike Second Life the Metaverse will allow users to emerge in the environment using virtual reality glasses. Thus whilst walking through their own homes users can feel like they are in their work environments and meet other

3MMO Populations. World of Warcraft Stats. Available at: https://mmo-population.com/t/wow/ stats.

“Ibid.

Linden Lab Press Release: Infographic: 10 years of second life. Available at: https://www. lindenlab.com/releases/infographic-10-years-of-second-life.

2.3 Metaverse, the Future? 7 colleagues. The second large difference between Second Life and the Metaverse is interoperability. Due to its open-source code, the Metaverse will be able to connect to virtual environments provided by other companies. Second Life on the other hand was a Closed virtual environment provided by a single source. To explain it in less technical terms, consider Legos.

2.3 Metaverse, the Future?

Virtual reality such as Second Life can be compared to a world created by Legos. The world is provided by one company (Lego) which has created the world, decorations and characters. Whilst the same company can create different themes and different worlds, these are separated into different boxes. And whilst the Lego worlds are sold and offered throughout the world, the company is located in a small number of jurisdictions. Therefore the themes can be played throughout the world but in case there is an issue consumers can easily establish the applicable legal regime. The interesting thing about Legos is that you can connect the blocks. You could build one room and then build the next and attach it. Before Lego lost its patent only Lego created the specific blocks that could be connected, now these blocks are created by a number of providers. These worlds can be accessed from the Lego rooms or through their own door. When entering the other room, one leaves the world offered by Lego and enters one offered by a competitor. And whilst Lego used to create the entire universe, including decorations and characters, now these can be designed by competitors. This means that a company specialising in the creation of avatars might be providing the characters walking throughout the world. Another company can create the art hanging on the walls, or even individuals can make and hang up their own art. Thus creating a complex mix of different providers. Metaverse is like these Lego-built rooms but after Lego lost its patent. All environments are built upon the same baseplate (source code) but built by different providers. Adding to the mix of complexity is the strange jurisdiction. When Lego sells its products through a store, it generally falls under the jurisdiction of the store it sells through, there are fewer such clarities in virtual reality. Thus allowing for an almost infinite amount of jurisdictions to be part of the same virtual environment. Metaverse, however, is different from previous online environments in various ways.

The previous environments were purposed for a single function: entertainment. Whilst the gaming industry is a large business, only a few games remain successful for a long period of time. Virtual reality, however, is not the same as a game. Whilst virtual reality has its origins in gaming it has often different objectives. Second Life for example was not described as a game by its designers. It is a virtual environment where users can explore without gaming obstacles or objectives. Though its popularity decreased slightly, Second Life still had a $600 GDP in 2021.° A virtual reality

8 2 What Is the Metaverse?

that is not perse designed as a game whereby obstacles should be overcome can generate long-term revenue. The Metaverse is considered more likely to be successful. As it encompasses various objectives.

The Metaverse can offer entertainment such as attending virtual concerts, plays or festivals. Such as the musical example given in the introduction of this book. However, the Metaverse can offer a wider variety of services. Such as online shopping whereby an avatar that looks exactly like its user can try on various items of clothing. These virtual dressing rooms can mimic the experience of trying on clothing but without the hassle of having to physically change outfits.’ This experience is made possible by what is described as the three illusions of virtual reality. Virtual reality provides the user with three illusions: place, embodiment and plausibility.* The user will see the virtual surroundings of a dressing room through the mobile device. This illusion is strengthened by the ability of the Metaverse to respond interactively.” The clothing can furthermore be programmed to fall as it would in real life and respond to the behaviour of the user. A skirt could digitally swirl in response to the user spinning through its own physical environment. The Metaverse thus facilitates online shopping by mimicking the physical benefits of examining goods with the easy accessibility of virtual reality. In addition to facilitating the online purchase of physical goods, the Metaverse will generate its own economy. The ownership of digital goods is expected to increase. As seen in the previous section, in earlier game environments the ownership of virtual items generates real value. Previous virtual realities differ from the Metaverse in an important aspect: Non-Fungible Tokens (NFTs). These are digital certificates of ownership that digitally guarantee a sense of unique ownership. The NFTs are considered to be the fourth illusion. These NFTs provide the illusion of digital ownership.'° They are mined on a blockchain and cannot be replicated. Through the use of NFTs digital scarcity is created. Scarcity is the foundation of the economy, yet it was not present before the introduction of blockchain technology.'' The Metaverse therefore offers new opportunities to create a virtual economy. With virtual pieces of art that sell for high value. The most famous example of this is likely the Bored Ape virtual imagery which ranges in price from $63,000 to $13 million.’

In addition to generating a new type of economy, the Metaverse is also adaptable to generate new types of learning environments." The Metaverse can be used to provide a realistic type of training environment for vocational training. Such as providing a realistic environment for police officers or giving aspiring surgeons the

Ibid.

12 As on offer on OpenSea on 10 july 2023. 13 Hwang and Chien (2022).

possibility to practice in a realistic operating theatre. Metaverse applications can help students develop their soft skills in simulated environments.'* The Metaverse can furthermore be used in high school history classes to experience the Stone Age. Or to provide children with a classroom experience during a pandemic. Metaverse can facilitate attendance to training courses across the globe at low costs. A student from a developing nation could attend university lectures without having to travel. The university providing the course does not need additional physical space for the student. The additional costs of receiving that student are relatively low. In combination with AI, the Metaverse can be used to generate personal lesson plans for students. This could help provide a more tailored learning approach for the individual students. "° The potential educational opportunities of the Metaverse are large.

In addition to educational opportunities, the Metaverse can help provide tools for public bodies. Tools can be generated for urban planning.'° Whereby the designer, potential users and neighbours can virtually walk through the planned urban development. Similarly, tools can be generated for traffic planning. Or the design of a public facility such as a new sports centre or community building.

These are just a few of the potential applications of the Metaverse. The limitless opportunities make it that it is expected that VR and AR will increase global GDP by $1.5 trillion in 2030.'’ The Metaverse is a large part of the VR experience. The Metaverse market is expected to reach $1.35 billion by 2025.'* Thus demonstrating the big expectations of companies and their willingness to enter the Metaverse.

The combination of different virtual world providers makes the legal governing of Metaverse more complex. This complexity is enhanced when considering some of the latest developments in financial technology such as cryptocurrency. The legislation will therefore have to take into consideration that there are different structural designs of transactions. However, before analyzing the different legislative conundrums the next section will first describe the potential payment structures available in the Metaverse.

Galov N (2023) ‘18 second life facts in 2023: what it means to live in a Virtual World’, webtribunal (6 maart)

Hwang G-J, Chien S-Y (2022) Definition, roles and potential research issues of the metaverse in education: an artificial intelligence perspective. Comp Edu Artif Intelligence 3:100082

Ivory JD (2016) A brief history of video games. In: Kowert TQR (ed) The video game debate. Unravelling the psychological effects of digital games. Routledge, London

"Tid.

'8Walbank (2023). Top 10 companies investing in the metaverse in 2023. Mobile Magazine.

10 2 What Is the Metaverse?

Kemeg A (2023) Metaverse applications as a tool in urban policy design. In: Anshari M, Syafrudin U, Alfian G (eds) Metaverse applications for new business models and disruptive innovation. IGI Global, Hershey

Rijmenam M (2022) Step into the Metaverse. How the immersive internet will unlock a trilliondollar social economy. Wiley, Hoboken

Ruco A (2023) The fourth illusion: how a new economy of consumption is being created in the Metaverse. In: Lai PC (ed) Strategies and opportunities for technology in the metaverse world. IGI Global, Hershey

Sabtu M (2023) Metaverse and soft skills development through video games. In: Anshari M, Syafrudin U, Alfian G (eds) Metaverse applications for new business models and disruptive innovation. IGI Global, Hershey

Shams MY, Elzeki OM, Marie HS (2023) Towards 3D virtual dressing room based user-friendly metaverse strategy. In: Hassanien AE, Darwish A, Torky M (eds) The future of Metaverse in the virtual era and physical world. Springer, Cham

Walbank (2023) Top 10 companies investing in the metaverse in 2023. Mobile Magazine

Open Access This chapter is licensed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license and indicate if changes were made.

The images or other third party material in this chapter are included in the chapter's Creative Commons license, unless indicated otherwise in a credit line to the material. If material is not included in the chapter's Creative Commons license and your intended use is not permitted by statutory regulation or exceeds the permitted use, you will need to obtain permission directly from the copyright holder.

Chapter 3 A) The Virtual Currency Schemes is 3.1 Introduction

Due to its interoperability, the Metaverse will provide a different virtual economy than currently in existence. The Metaverse could combine the convenience of staying at home with daily (office) interactions.’ The potential applications of this type of virtual reality are therefore endless. In particular, it is likely the Metaverse will facilitate a variety of economic transactions. Before entering the debate on whether the current legislation can govern the Metaverse, it is important to distinguish between different virtual currency systems. The dissection of the different currency systems will enable the next chapter to analyze the risks and legal framework necessary. This dissection will be done according to the developments of the virtual worlds as described in the previous section. The systems will be described according to a virtual currency classification developed by the European Central Bank (ECB).

3.2 Virtual Currency Schemes

The ECB provides three different types of virtual currency definitions.” These definitions are established in the contours of examining monetary policy and do not form legal definitions. They are however practically useful in defining the different types of virtual currency and their respective MLFT risks. The first virtual currency scheme considered by the ECB is a “closed virtual currency”. This type of

! Meta Press Release: The Metaverse and How We’ll Build It Together — Connect 2021, 28 October 2021. Available at: https://www.youtube.com/watch?v—Uvufun6xer8.

European Central Bank (2012).

© The Author(s) 2024 11 A. Mooij, Regulating the Metaverse Economy, SpringerBriefs in Law, https://doi.org/10.1007/978-3-03 1-46417-1_3

12 3 The Virtual Currency Schemes

Game provider

Fig. 3.1 Uni-directional flow scheme does not have a connection to the real world.’ Under this type of scheme, the currency cannot be bought or sold and is given based on a game subscription or in-game reward. This type of currency is best compared to the offline games. These types of schemes have no risk of MLFT and will not be given any further attention.

The second scheme is described as a “uni-directional flow”. Within a virtual reality based upon a uni-directional flow, the virtual currency can be bought with fiat currency. The virtual currency can then only be spent within a single virtual reality.“ These schemes are often found in games whereby the player is able to purchase the in-game currency. This currency can then only be used to buy virtual in-game items and quests. Most MMO games are based on this concept.

Figure 3.1 shows a closed system currency and economy. The virtual currency cannot be used to purchase real-life goods, its redemption rate is therefore limited. The currency furthermore cannot be traded for fiat currency and there is only one provider of the virtual economy. The regulation of this economy can therefore be done by simply regulating the providers. This system is however the most simple

*Tbid, p. 15.

“Ibid.

3.2 Virtual Currency Schemes 13

Game provider

Fig. 3.2 Virtual currency with unintended ties to real economy virtual economy currently in existence. More complicated is the third scheme identified by the ECB.

This scheme provides a “bi-directional flow” meaning that the currency can be purchased and sold through the real economy." There are two different types of virtual currency schemes with a bi-directional flow. Staying with the example of WoW, officially the trade in WoW currency outside of the official platform is prohibited.° Users are not allowed to buy currency other than through the platform provider.

There is, however, a lively black market. The black market as indicated by Fig. 3.2 provides ties to the real economy. It is therefore possible for players to gather or buy virtual currency which they can transfer to other players or convert to fiat currency. This type of currency scheme creates a potential for conducting MLFT. The currency acquisition requires little effort as it can be bought from the gaming platform. It can then be transferred to another player and converted into fiat currency. It is furthermore difficult to regulate as it is not the virtual reality provider that created or supervises this market. This system should therefore be considered as a

STbid.

© Article C.iii of the Blizzard end-user license agreement.

14 3 The Virtual Currency Schemes

Game provider

D ERU

Fig. 3.3 Virtual currency with intended ties to real economy currency with an unintentional bi-directional flow. These systems are particularly vulnerable to MLFT because of the lack of supervision. Research found that the game Fortnite was used frequently for MLFT purposes.” Another research indicated that a two-month eBay surveillance had produced 53,000 signals of money laundering.® Black markets with MMO games should therefore be considered of high MLFT risk.” The black markets are furthermore more difficult to regulate than the intended bi-directional flow designs.

Figure 3.3 has an intended flow between the currency used on its platform and fiat currency. The users can buy and sell currency to the platform provider, trade with each other and buy virtual items in different shops. This virtual reality is more complex than that of most MMOs. Users can operate shops and earn currency through the platform. Thus making it more difficult to discover potential money laundering. However, as only the provider exchanges the currency it is easier to regulate. As it only requires the regulation of a single provider. However, a potential black market can still arise which would be a likely source of MLFT.