legal impications on metaverse and NFT’S

Authors : divyanshi , Krishna Priya pk

Institution : Aligarh Muslim university Malappuram center , Kerala

Education details : 1st year law students (2nd semester)

Email : divyanshi1919@gmail.com

Contact : 7668111396

APRIL 10, 2023

 Legal implications of metaverse
and NFT’s
[T]he present agony of social isolation, the impersonality, structurelessness, and sense of
meaninglessness from which so many people suffer are symptoms of the breakdown of the past
rather than intimations of the future. —Alvin Toffler

"Metaverse isn't a thing a company builds. It's the next chapter of the internet
overall."- mark Zuckerber

Introduction

Metaverse and NFT’s (non-fungible tokens) are two advancing technological innovations that
are reshaping the manner in which people interact with digital assets. Both of these
technologies have significant legal implications that need to be considered in the industry.

The metaverse which is predicted as our next disruptive technology shift is the emerging 3-
D-enabled digital space that uses virtual reality, augmented reality, and other advanced
internet and semiconductor technology to allow people to have lifelike personal and
business experiences online. It is understood to be an immersive virtual world serving as the
locus for all forms of work, education, and entertainment experiences.

Depicted in books, movies, and games, the metaverse has the potential not just to
supplement real-world experiences but to substantially supplant them. The metaverse, as
highlighted by the recent corporate name change of Facebook to Meta Platforms, Inc.
(Meta), owes its literary origins to Neal Stephenson’s Snow Crash (1992) or to prior works by
Verner Vinge and William Gibson.

NFTs, moreover are quirky digital assets that portray ownership of a particular item, such as
a piece of art, music, or video. They are certificates of ownership powered by smart
contracts and protected by blockchain technology. Blockchain is a distributed database
where all kinds of data can be recorded securely thanks to cryptographic protocols, without
resorting to intermediaries like banks or other financial institutions.

Tokens are subjected to another distinction regarding their fungibility. There are fungible
tokens, a classic example being a payment token like the cryptocurrency Bitcoin or Ether.
The fungibility of a token refers to the fact that the token has the same content compared
to other fungible tokens.
Therefore, fungible tokens are interchangeable/replaceable/exchangeable with, or equal to,
another asset of the same category. Therefore, they are not unique. NFTs, on the contrary,
are unique or scarce (rare) and cannot be replaced; this is why they are valuable.

One of the primary legal issues concerning NFTs is the ownership of the underlying asset.
While NFTs represent ownership of a particular item, they do not necessarily provide
ownership of the underlying asset. For example, purchasing an NFT of a piece of music does
not provide the buyer with the rights to distribute or reproduce the music. Additionally,
there is a need for clear rules and regulations regarding the transfer and sale of NFTs.

Both Metaverse and NFTs have significant legal implications that need to be considered by
stakeholders in the industry. Clear rules and regulations regarding ownership, transfer, and
use of virtual assets and NFTs are essential to avoid potential legal disputes and ensure the
growth and development of these emerging technologies. Given the continued expansion
of the video gaming industry, the societal impact of social media, and the shift to
technology-mediated work and learning environments, however, it is a reasonable
expectation that some of these shifts will take place, creating new markets worth billions of
dollars and triggering significant legal, business, and regulatory issues.

Scope of NFT’s
In theory , the scope for NFTs is anything that is unique that needs provable ownership .
NFTs will play a huge role in development of the metaverse. The further developments of
NFTs blockchain and cryptocurrency will lead to increased employment opportunities and
transparency. NFTs are become increasingly handy and popular in different industries and
professions that deal in their trade.

Jacy Dorsey sold his first tweet as an NFT for $2.9 million, and the sale of a LeBron James
dunk fetched around $280,000 on the NBA Top Shots platform. Subsequently, the first NFT
project which was capable of receiving success was CryptoKitties. It was introduced in
October 2017. Cryptokitty owners could collect, purchase and sell distinct creators capable
of living forever on Ethereum blockchain .

just like the core blockchain technology, NFTs have the potential for different business use
cases. The business applications have to be relevant for each use case alongside supporting
the better digital transformation. For example, storage of documents securely is a promising
factor for boosting future NFT applications.
NFTs can prove valuable assets in dealing with data modification and duplication. NFTs do
not comply with just the fundamental functionalities of blockchain with robust encryption.
On the contrary, they can also facilitate promising safeguards against data forgery and
unverified exchanges.

Furthermore, the storage of all information regarding signatures and the individual in an
NFT provides the scope for paperless transactions. Enterprises are no longer interested in
following excessive paper-based documentation. In addition, NFTs can also be useful for
individuals with their ‘paper-less’ advantage. Individuals who don’t have the need to provide
documents for verification could carry them in digital formats. At the same time, they don’t
compromise with authenticity while ensuring verification in real-time.

Challenges for NFT (Non-Fungible Tokens)

One of the formidable NFT challenges comes in the form of the environmental impact
of minting NFTs The example of one of the most prominent crypto art transactions in recent
times points to the collection of short films by a Canadian music artist known as Grimes. The
artist produced the short films along with her brother. However, the NFT-based videos were
able to achieve a price tag of around $6 million. Although this is a good implication for the
future of NFTs, the event also showcases an important doubt about their environmental
impact.

Seller tax is also another prominent challenge of NFT, which could affect its growth in the
future. Buyers and sellers in the NFT landscape might discover the steep taxes as an
undermining factor for joining the NFT revolution. For example, Beeple is apparently
supposed to incur taxes in the amount of almost tens of millions of dollars.

The concerns of ownership rights are also prominently evident as NFT challenges for the
future The increasing number of disputes in the music industry with artists seeking legal
action against sale of their NFT-based music is a notable red flag for the future of NFTs.
Since NFT is a new technology, lawyers have a tough time navigating such cases to help
artists in resolving the issues. So, tighter regulations are definitely required for expanding
NFTs in the future.
Lets dive deep into the legal implications of NFTs.

Legal implications of NFTs

NFTs, like other tokens, create various legal issues. Since NFTs use smart contracts to
conduct transactions, some of these issues are the same as those that occur when utilising
smart contracts.
First, there is the usual question of how and where the legal disputes arising from the creation
and use of NFTs will be resolved 1. Due to the anonymity or pseudonymity of blockchain
and the lack of conflict of law provisions, it is challenging to determine where a lawsuit
would be filed and what the applicable law would be. When an NFT is created on a public
blockchain like Ethereum, everyone can see how it was developed and linked to the
underlying right or asset. Although it is possible to see the NFT owner’s/creator’s wallet
address and the metadata linked to it, it is not enough to match these with the real-life owner
or creator

Secondly, there might be some problems arising from form requirements. NFTs are operating
with smart contracts that verify their ownership and manage their transferability. Fulfilling
form requirements in smart contracts is a problematic issue, especially in cases where the law
foresees that a transaction be carried out in a written form that includes the signatures of the
parties. The problems associated with NFTs are quite similar to the problems on form
requirements arising from the use of smart contracts. It should not be forgotten that people
carrying out transactions on blockchains via smart contracts must also abide by legal norms;
smart contracts are not above the legal systems and need to comply with the rules of contract
law 2

Thirdly, not everything about the NFT can be coded in the smart contract. For instance, if the
seller of an NFT wants to introduce a contractual term, which prohibits buyers from using the
underlying work of art for commercial purposes, such a term cannot be enforced by smart
contracts. Although smart contracts are smart to an extent that makes them self-enforcing,
these kinds of clauses cannot be evaluated, and therefore, operated by the smart contract.
Therefore, if the seller would like to impose such an obligation on the buyer, traditional
methods like demand letters and litigation have to be used.3

The fourth problem is about the possibility of classifying NFTs as security tokens.42
Although NFTs are non-fungible and generally associated with art or digital work (which are
not regarded as securities), some authors claim that there is a potential for them to be
considered a security, such as an investment contract. For instance, in cases where a company
issues NFT that represent different percentages of stake in the company but none of the
stakes are the same, the NFTs will most likely pass the Howey test applied by the SEC in the
USA.43 The decisive factor here would be the bundle of rights associated with the NFT and
its sales and promotion.

Fifth and most important, since we are dealing with ‘unique’ and ‘authentic’ items such as
digital art and music when we are transacting with NFTs, a variety of copyright law questions
also come to mind.

Copyright law issues

The technical features of the standard used in NFTs, namely ERC-721 standard, should be
mentioned in greater detail in order to understand the copyright issues more clearly. This
standard only provides mapping of the digital content to the creator of NFT and the digital
content to be transferred.

The digital content is represented in the NFT as for example token ID . So, where is the
digital content? At this point, one needs to make the distinction between on-chain and off-
chain NFTs.

The underlying content and the metadata are uploaded directly into the blockchain in on-
chain NFTs. Therefore, both are stored on the blockchain. They are not stored in other hosts
so there isn’t any risk of not being able to access it due to problems arising from the host
(such as blocking of the hosting website or deleting the content by the host or the creator).
Sometimes only the metadata is uploaded on the blockchain. There are not sufficient
advantages of on-chain NFTs for them to become popular and common because of the one
huge obstacle, namely, storage limitations and costs of uploading. Due to these obstacles, off-
chain NFTs are preferred. Contrary to the on-chain, in this type of NFTs neither digital
content nor the metadata is stored on the blockchain. How, then, is this content and the
metadata represented in the NFT? A method used to eliminate this problem is the ‘token URI
method’, which returns a public URL. There are some ways to store data of content through
both centralized servers (such as clouds or interplanetary file system (IPFS), which is a
system similar to P2P). If data are kept on a centralized server, the developer can always
change the metadata or the content. Furthermore, there is always the risk of not being able to
access the content due to either the creator of content or the server.49 In that aspect,
decentralized systems like IPFS seem more trustworthy. After clarifying the difference
between on-chain NFTs and off-chain NFTs, copyright law issues can be introduced.

A world Full of endless possibilities

The NFT craze is snowballing day by day. While it is not known whether it will remain this
insane or be permanent, it is beyond dispute that it has accelerated the creation of digital art
and carried digital art to another dimension. However, NFTs should not be limited to digital
art or even the art world. They will have some impact on real-life assets and result in their
tokenization. Certainly, like every technological development, many questions and
uncertainties arise from NFTs. The examples of minting protectable artistic works and selling
them have led to copyright issues that need to be tackled. It is possible to clarify many of
these uncertainties regarding copyright law with license agreements. However, the issue of
whether minting, especially an off-chain NFT, falls within the scope of the right of
reproduction or communication to the public remains controversial. It is also important to
clarify some other copyright law issues related to the NFTs. Time will show us how these
issues will be resolved and if the existing rules will be enough.

Scope of metaverse
internet has evolved so far and the very recent outcome of this evolution is ‘Metaverse’. Even
though the word metaverse was coined in 1992 by Neal Stephenson in his fiction novel
’Snow crash’ ,it takes more years to get ‘meta' into worlds recognition through when
Facebook’s parent company rebranded its name. When google definition of metaverse is little
perplexing as it defines metaverse as a hypothetical iteration of the internet as a
single ,universal ,and immersive virtual world that is facilitated by the use of virtual reality
(VR) and augmented reality (AR), don’t think it is insurmountable to get what it is. Let us
don’t make it too hard ,just imagine virtual world where billions of people are interacting
which each other ,are you getting a picture of the Instagram, Facebook WhatsApp or any
other social media. What if we can get the immersive experience in that virtual world, the
avatar version of us are moving freely with our identity, connecting with the avatar version of
our beloved ones, the computer screens we use today to connect to a World wide web have
become the portals to the virtual world of reality. isn’t that sounds like cool?. But it’s not that
cool actually when there the crimes happening in the real world can happen in the virtual
world too with more or less impactful. This what is metaverse for the simple understanding.
Why should we be concerned about this metaverse thing? The answer is very simple as it is
the next iteration of the internet. As the popularity of the metaverse is continuing to grow,
there arise a pressing need for reasonable regulations.

The future of metaverse is unpredictable. we have moved so far when we take a look back
upon the technological innovations. From the read only internet of version of Web 1.0 to the
process of entering into web3 indicates the scope of metaverse is increasing day by day as
new firms and new individuals are coming to the sector. Metaverse can emerge as a enhancer
in our home activities that actually we are struggling to deal with today. Post pandemic
period taught us to be in the work from home culture. Metaverse is a key to access that techy
home environment. Tourism sector is experimenting with metaverse to promote the actual
feel of travelling. As the Technology facilitates the immersive experience of exploring the
world without actual physical efforts and other common restraints when it comes to the actual
reality. South Korea has planned to become its capital Seoul to be the first city to be in the
metaverse as a venture for tourism development in the platform of metaverse. Besides
tourism entertainment industry will be the most profitable fields out of all. Digital concerts,
events, online gaming, the ads form a part of all will take advent of the metaverse. In the
education sector also metaverse can be a revolutionary step to impart distance learning
courses and online training teaching experiences. Metaverse really can be a place of
perfection that every individual needs to be his own and to get patch over his worldly
imperfections.

Legal implications of metaverse

A single metaverse will not provide a common global experience as there are unique set of
positive law and social norms in each country or region. The governance of the internet and
operation of domestic law varies considerably from country to country, and the metaverse
will exacerbate rather than flatten this trend. Freedom House reports, “Authorities in at least
48 countries pursued new rules for tech companies on content, data, or competition

A GLIMPSE OF THE U.S. LEGAL ROADMAP

The expansion of virtual worlds will take place within an environment largely defined by
intellectual property rights of copyright, trademark, patent, trade secret, and publicity rights,
rights of copyright, trademark, patent, trade secret, and publicity rights, as well as the digital
property rights associated with NFTs and their smart contracts. Other than for the NFTs, each
of these doctrines is well established, making it likely that the application of these intellectual
property rights will be generally predictable within the metaverse environment. Beyond the
intellectual property regime, however, there may be some areas where the expansion of
virtual worlds to large-scale adoption of a metaverse will have unanticipated implications and
complications.

As the metaverse grows more robust in user experience and the Web3 expectations of
participatory creative ownership, it must serve as a marketplace for commercial transactions.
Transactions involving only in-world digital assets will be predominantly regulated with
reference to the terms of service required of all metaverse participants. If the world uses in-
game currency, then transactions are unlikely to trigger significant regulatory scrutiny. Even
here, however, there are variations among different state laws.

In Kater v. Churchill Downs, Inc.,5 the Ninth Circuit recently interpreted Washington State’s
Recovery of Money Lost at Gambling Act (RMLGA) very broadly. The court explained:
[Virtual chips] permit a user to play the casino games inside the virtual Big Fish Casino. . . .
Without virtual chips, a user is unable to play Big Fish Casino’s various games. Thus, if a
user runs out of virtual chips and wants to continue playing Big Fish Casino, she must buy
more chips to have “the privilege of playing the game.”6 As a result, the plaintiff—and the
50,000 others who later joined the class action—had the right to recover their losses in the
game

Federal Regulation Through Money Transfer, Securities

and Foreign Investment Laws

Transferring funds or fungible assets within the game or world will be subject to money transfer laws
if the funds can be converted to currency, assets, or crypto. To the extent that virtual worlds are in
the money-services business as a function of the platform’s ability to exchange in-world digital assets
for fiat currency or cryptocurrency, then the platform will need to register as a money-services
business. Second Life has taken that step for its own operations and more recently for its users. In-
game banking and investment services will likely be subject to the regulations governing real-world
activities. Depending on the financial transactions that can occur within the game or virtual world,
potentially every financial regulatory body could claim jurisdiction over some aspect of these
financial transactions.

Given the long list of potential issues, it is not surprising that each of the U.S. financial regulatory
bodies is seeking to be part of the regulatory solution. There are four key regulatory regimes:

[1] Financial Crimes Enforcement Network (FinCEN): Regulates all crypto assets for [anti-money
laundering (AML) and combating the financing of terrorism (CFT)] purposes. 7

[2] US Securities and Exchange Commission (SEC): Regulates crypto assets considered securities by
applying the Howey test. 8

[3] Commodity Futures Trading Commission (CFTC): Regulates virtual currencies which are
considered commodities (Bitcoin and Ethereum). 9
[4] Officer of the Comptroller of Currency (OCC): For banks participating in the crypto ecosystem 10

What lies beyond ?

The leaders of the Web3 movement are decidedly focused on reclaiming the property rights lost to
Web 2.0. Using NFTs to enforce property and direct user control to discourage corporate overreach,
the Web3 movement has the potential to rectify the imbalances of the past. At the moment, many of
the promises may be loose predictions, but hopefully, this roadmap will help those building,
investing, and regulating in these future technologies see where an optimal mix of private
contracting, innovation, and government regulation. Since the movement will bring even more of our
daily lives onto the internet, courts and regulators must also anticipate how that will affect our
constitutional rights and civil liberties.

Legal scenario in India

There are no specific regulations in India that can control and monitor the working of metaverse and
NFTs . It is still a very new technology for India hence it leaves a big scope for new and effective
control polices.

The existing data protection system is governed by a set of rules titled the Information
Technology Rules, 2011 under the Information Technology Act, 2000. According to these
guidelines, a company must demonstrate code compliance by having documented
security plans, and information security policies which must include technological,
operational, and physical security measures.

The Information Technology (Intermediary Guidelines and Digital Media Ethics Code)
Rules, 2021 (IT Rules), were published by the government in a notification dated
February 25th 2021, with the primary goal of regulating and protecting consumers from
various potentially hazardous contents. To comply with the standards for data accuracy,
choice, consent, disclosure, portability, and security, the organization must follow
precise technical and design criteria. Furthermore, the organization must put in place
management systems to enforce privacy standards, out-of-date policies, and make
recommendations that are compatible with the quantity of information required.

The legal and regulatory concerns are five-fold:

 Security & Privacy Concerns

 Application of Anti-Trust & Competition Laws
 IPR Infringements
 Enforcement of Liability
 Jurisdictional Concerns

There are no specific regulations in India that currently oversee Metaverse

appropriately, which increases the risk to its users. There is a legal void yawning before
us when it comes to overseeing the safe execution of this new platform. Since
Metaverse is still in its infancy, regulators must intervene now before the technology
matures; otherwise, it will be harder to supervise once there is a higher level of user
dependency. While disruptive developments in technologies such as VR, AR, blockchain,
etc. have immense potential in their applications, their impact on established legal
systems gives rise to a certain spekticism It is obvious that governing new technology
would be difficult and would necessitate a reworking of existing legal systems.

Conclusion

Metaverse and the use of nfts is a hotly debated topic in legal world. Many countries are finding
themselves unarmed with relevant laws and regulations that can be imposed on metaverse. India has
no specific regulation which is creating a void . Time will show us how these issues will be resolved
and if the existing rules will be enough. The rest is already been discussed.

References

1 See Biden v. Knight First Amend. Inst. at Columbia Univ., 141 S. Ct. 1220, 1220 (2021)
(granting cert. and vacating lower court decision as moot).
2 See G Ru¨hl, ‘Smart (Legal) Contracts, or: Which (Contract) Law for Smart Contracts?’ in B
Cappielo and G Carullo (eds), Blockchain, Law and Governance (Springer 2020) 159ff.
3 C Poncibo and LA DiMatteo, ‘Smart Contracts, Contractual and NonContractual Remedies’ in
LA DiMatteo, M Cannarsa and C Poncibo (eds)
4 Koonce and Sullivan (n 19)
5 see Kaulartz and Schmid (n 16).
6 Kater, 886 F.3d at 787; see James Gatto & Mark Patrick, How the Evolution of Games Has Led
to a Rise in Gambling Concerns: All Bets are On! Gambling and Video Games, NAT. L. REV.
(Sept. 16, 2018), https://www.natlawreview.com/article/how-evolution-games-has-led-to-
risegambling-concerns-all-bets-are-gambling-and [https://perma.cc/R4MX-SW2R].
7 See Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT), INT’L
MONETARY FUND, https://www.imf.org/external/np/leg/amlcft/eng/ (last visited Nov. 18,
2022) (“Money laundering and the financing of terrorism are financial crimes with economic
effects. Money laundering requires an underlying, primary, profit-making crime (such as
corruption, drug trafficking, market manipulation, fraud, tax evasion), along with the intent
to conceal the proceeds of the crime or to further the criminal enterprise.”).
8 . Paul Kim, The Howey Test: A Set of Rules That Determine if an Investment is a Security, Bus.
INSIDER (May 31, 2022)
9 Customer Advisory: Understand the Risks of Virtual Currency Trading, CFTC,
https://www.cftc.gov/LearnAndProtect/AdvisoriesAndArticles/understand_risks_of_virtual_c
urrency .html [https://perma.cc/3YGM-WQ2V].
10 . Crypto Travel Rule in United States by FinCEN, NOTABENE , https://notabene.id/world/usa
[https://perma.cc/LN22-79WT] (“[W]here [the Financial Action Task Force (FATF)] uses
‘virtual assets’ and ‘VASPs,’ FinCEN’s guidance uses money services businesses (MSBs.) and
convertible virtual currencies (CVCs).”).