By Rudy Takala at CoinTelegraph. For the original article, click here<\/a>.<\/p>\n Are cryptocurrency games innocent fun? Or are they Ponzi schemes facing an imminent crackdown by regulators in the United States?<\/p>\n Tokens related to cryptocurrency games \u2014 known colloquially as \u201cGameFi\u201d \u2014 were worth a cumulative total<\/a> of nearly $10 billion as of mid-August, give or take a few billion. (The number may vary depending on whether you want to include partially finished projects, how you count the number of tokens that projects technically have in circulation, and so on.) In that sense, whether the games are legal is a $10 billion question that few investors have considered. And that\u2019s an oversight they may soon regret.<\/p>\n That\u2019s because a bipartisan consensus appears to be forming among legislators in the U.S. that the industry needs to be shut down. They haven\u2019t addressed the issue specifically \u2014 good luck finding a member of Congress who has uttered the word \u201cGameFi\u201d \u2014 but there are at least two bipartisan proposals circulating among senators that would effectively eject these gaming projects from American soil.<\/p>\n The Responsible Financial Innovation Act, offered in June by Senators Cynthia Lummis (Republican from Wyoming) and Kirsten Gillibrand (Democrat from New York), would, in Lummis\u2019 words, classify a \u201cmajority\u201d of cryptocurrencies<\/a> as securities subject to regulation by the Securities and Exchange Commission (SEC). And this month, Senators John Boozman (Republican from Arkansas) and Debbie Stabenow (Democrat from Michigan) offered a second proposal \u2014 the Digital Commodities Consumer Protection Act. The effect would be similar, but with a stronger emphasis on classifying Ethereum as a commodity \u2014 putting it under the purview of the less heavy-handed Commodities Futures Trading Commission (CFTC).<\/p>\n Securities classification for Axie Infinity, DeFi Kingdoms and other games<\/strong><\/p>\n According to the SEC definition<\/a> that Congress is looking to affirm, any token in which users invest with \u201can expectation of profit\u201d is likely to be a security. Let\u2019s talk a bit about what that may mean for your favorite tokens.<\/p>\n For one, this definition is likely to include projects that incentivize liquidity pools. Examples of projects this would affect are Axie Infinity \u2014 which incentivizes liquidity pools with interest payouts provided through its native token, AXS \u2014 and DeFi Kingdoms (DFK), which incentivizes liquidity pools using its native tokens, JEWEL and CRYSTAL.<\/p>\n Why do liquidity pools matter? Because users are \u201ctreating it as an investment,\u201d blockchain expert and Rutgers Business School fintech professor Merav Ozair noted in an interview<\/a> last month. \u201cIf it\u2019s a token used to buy artifacts for the game, that\u2019s not a security. But if you can take the token and use it for investments in securities, then that token has a different use case,\u201d she said.<\/p>\n The definition is also likely to result in a problem for projects that have profited from initial coin offerings (ICOs), private token sales, or selling nonfungible tokens (NFTs). That includes Axie \u2014 which sold<\/a> 15% of the total AXS supply in pre-game or private token sales \u2014 as well as DFK, which sold more than 2,000 \u201cGeneration 0\u201d characters to kickstart its game last year.<\/p>\n \u201cOnce they\u2019re using [something] to generate capital, they fall under the definition of a security,\u201d Ozair said.<\/p>\n Beyond the obvious, precedent indicates that SEC prosecutors are likely to find a host of additional reasons to classify gaming tokens as securities. In a case filed last month, the agency argued that a number of tokens<\/a> listed on Coinbase constituted securities for reasons that ranged from developers referring to investors as \u201cshareholders\u201d to one project\u2019s decision to feature a photo of its CEO pointing at an advertisement that ridiculed Goldman Sachs.<\/p>\n Consequences: Fines, Registration & Disclosures<\/strong><\/p>\n Penalties that game developers could face may vary depending on how lenient SEC officials feel. At the very minimum, developers will be required to follow the same disclosure laws by which public companies in the U.S. abide. That means disclosing public officers, principal stockholders \u2014 or those who hold more than 10% of token supply \u2014 and an annual report that includes an audited balance sheet and cash flows.<\/p>\n Disclosure requirements alone could come as a rude awakening for many developers, who have become accustomed to running projects worth millions \u2014 and occasionally billions \u2014 without disclosing their names. But, more importantly, a securities classification would likely mean big fines for offending projects.<\/p>\n Related: <\/em><\/strong>Crypto Unicorns founder says P2E gaming is in a long \u2018maturation phase\u2019<\/em><\/strong><\/a><\/p>\n In one case that could serve as an indicator of how regulators might approach the issue, the SEC settled<\/a> this month with a project that engaged in an ICO while failing to register its offering as a security. In that case, developers agreed to file with the SEC \u2014 and compensate investors for their alleged losses \u2014 or face a penalty of up to $30.9 million.<\/p>\n \u201cIntent matters,\u201d Christos Makridis, a tokenomics expert and adjunct associate research scholar at Columbia Business School, noted in an interview with Cointelegraph. \u201cSome NFT and GameFi<\/a> projects are so convoluted that there\u2019s a clear evasion of the rules.\u201d<\/p>\n At the same time, he said, \u201cIf you think about the role tokens can play in gamifying education, an overly rigid and narrow definition is going to exclude a lot of value-creating projects and deter many inventors from building in the U.S.\u201d<\/p>\n Alabama, Hawaii, Utah, and 47 other states may want to have a word<\/strong><\/p>\n Regulation out of Washington, D.C. is just one challenge coming down the pike for embattled crypto gaming enthusiasts<\/a>. A less foreseeable issue stems from what the late U.S. Defense Secretary Donald Rumsfeld termed \u201cunknown unknowns.\u201d<\/p>\n In this case, an example comes from an unlikely triad of U.S. states \u2014 Alabama, Hawaii and Utah. (If anyone is counting, Canada is also on this list.) Each jurisdiction (mostly) prohibits gambling, including raffles \u2014 which have become exceedingly popular in the world of crypto gaming.<\/p>\n Axie, for instance, held a month-long raffle between January and February of this year promising users the chance to win a variety of NFTs if they \u201creleased\u201d \u2014 meaning burned or deleted \u2014 their characters. DFK quickly followed suit, asking users to gamble on potentially losing their characters in March in exchange for an opportunity to receive better (more expensive) \u201cGeneration 0\u201d characters. Smaller raffles have become ubiquitous in DFK in more recent months, with options to participate in both daily and weekly contests, among others.<\/p>\n Experts say the raffles pose a problem for U.S. authorities even outside of the three states where they\u2019re outright illegal.<\/p>\n \u201cWhat they need to do to be legal is set it up as a sweepstakes, which means there is an alternative free means of entry that has an equal opportunity to win as those that pay to play,\u201d David Klein, the managing partner at New York-based law firm Klein Moynihan Turco LLP, said in an interview with Cointelegraph.<\/p>\n \u201cIf you have to put a $200 item on the line \u2014 meaning you ruin it \u2014 to enter, then that is consideration,\u201d Klein added. \u201cUnless there is an alternative, 100% free method of entering, like mailing in a postcard, or calling a 1-800 number, or going to a website and filling out information.\u201d<\/p>\n Related: <\/em><\/strong>Coinbase hit with 2 fresh lawsuits amid SEC probe<\/em><\/strong><\/a><\/p>\n The list of problems didn\u2019t end there. Disgruntled players have long criticized aspects of DFK\u2019s raffle system \u2014 including a promise<\/a> to award 800 \u201camulets\u201d (an NFT representing a piece of equipment) randomly to players who held between approximately $1,000 and $50,000 in JEWEL tokens from Dec. 15 to Jan. 15. As of mid-August \u2014 seven months after the raffle ended \u2014 the amulets had yet to be awarded, with developers promising the equipment was still in the works.<\/p>\n \u201cThere are a lot of problems there,\u201d Klein said. \u201cWhen you have these contests, it\u2019s important to communicate. The start date [of the raffle] has to be announced in advance of the contest starting. The contest rules have to be drafted, and they cannot be meaningfully changed. You have to do what you say you\u2019re going to do by way of awarding prizes and when. You have to report to specific state jurisdictions who won and supply them with a list of winners within X amount of days. And if you don\u2019t do so, you violate those state statutes.\u201d<\/p>\n That\u2019s in addition to any other regulatory or legal hazards that developers may have instigated by taking their projects global before assembling legal teams to examine potential hazards.<\/p>\n Declining players, expanding token supplies, dropping prices<\/strong><\/p>\n Beyond unforeseen legal ramifications, developers face a more apparent problem: a rapidly diminishing user base. The number of users interacting with Axie Infinity fell from a peak of 744,190 on Nov. 26, according to blockchain data aggregated by DappRadar, to 35,420 on Aug. 20 \u2014 a decline of 95%. DFK players, meanwhile, declined by 85%, from a peak of 36,670 in December to 5,290 as of Aug. 19.<\/p>\n The decline comes amid a rapid expansion in circulating token supply, with DFK\u2019s JEWEL supply expanding from roughly 60 million to more than 100 million over the same period. The supply stands to increase by 500% \u2014 to 500 million \u2014 by mid-2024, not including a new token \u2014 CRYSTAL \u2014 the game launched on the Avalanche (AVAX) chain.<\/p>\n When asked how many years of hard prison time developers could be facing for improperly conducted raffles, Klein \u2014 who handles compliance for a slate of confidential, big-name NFT projects \u2014 demurred. \u201cI want to help the industry do it right,\u201d he said. But, regarding projects that haven\u2019t complied, he said, \u201cYou could be accused of violating state gambling laws by a regulator, which is criminal. You could be sued by a private litigant who is upset. Or a combination of the foregoing.\u201d<\/p>\n Axie Infinity appears to have 80 million tokens in circulation, with another 190 million scheduled for release over the next three-and-a-half years. It merits noting that developers appear to be tinkering with official circulation<\/a> figures, which may become another cause for scrutiny among securities regulators in the future.<\/p>\n Rapidly expanding token supplies \u2014 combined with a diminishing number of buyers \u2014 means unrelenting downward price pressure, an issue that could drain developers of legal funding when it\u2019s most needed.<\/p>\n Can devs do something?<\/strong><\/p>\n Lummis, Gillibrand and other lawmakers have indicated that Congress will likely pass legislation<\/a> clarifying securities law related to crypto by mid-2023. The impending sea change begs a question: Where are the developers behind these projects? Nary a peep has been heard from the $10 billion industry. (By the way, keep in mind that figure only counts the value of tokens related to gaming projects and not their characters, land, or other NFTs.)<\/p>\n Related: <\/em><\/strong>GameFi industry to see $2.8 billion valuation in six years<\/em><\/strong><\/a><\/p>\n Developers behind the top 16 play-to-earn projects \u2014 according to CoinGecko\u2019s list \u2014 have made their identities known. That obviously includes those associated with Axie Infinity developer Sky Mavis<\/a>. But the majority, like those behind DFK, have opted to remain anonymous, disclosing little about even the countries in which they reside. (In fairness, DFK did incorporate a legal entity \u2014 Kingdom Studios \u2014 in Delaware this year. That entity did not respond to a request for comment.)<\/p>\n Realistically, developers have fewer than 365 days to begin lobbying legislators if they would like to see congressional proposals amended. So far, they\u2019ve been radio silent. With each day that quietly passes, it seems increasingly likely that silence is going to result in GameFi investors getting wrecked.<\/p>\n<\/div>\n Klein\u00a0Moynihan Turco<\/a>\u00a0maintains an extensive practice in the fields of Internet and mobile marketing law, consumer data privacy law, sweepstakes and promotions law,\u00a0fantasy sports and gaming law,\u00a0intellectual property and general corporate law. If we can be of assistance, please visit\u00a0https:\/\/kleinmoynihan.com<\/a>\u00a0or call us at\u00a0(212) 246-0900.<\/em><\/p>\n