ARTICLE
5 December 2023

Digital Assets In The Metaverse Of Madness

Increasing amounts of money are being poured into the development, propagation, and trading of digital assets.
Singapore Technology
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Cryptocurrencies, digital payment tokens, security tokens, Non-Fungible Tokens ("NFTs"), blockchain technology, virtual land, metaverse – these "buzz words" (to name a few) have become commonplace in our world today – whether in the news or in our social circles.

Increasing amounts of money are being poured into the development, propagation, and trading of digital assets. For example, Animoca Brands, the company behind The Sandbox metaverse platform recently reported it is now worth $5 billion up from a valuation of just over $2 billion in 2021.

With such vast amounts of money being pumped into the digital asset landscape, it is no wonder why more and more people are considering investments in digital assets. This however makes the question of the legal implications and intricacies regarding digital asset ownership all the more important to examine.

In this short article, we canvass some of the legal issues and misconceptions relating to digital asset ownership that investors should have in mind when deciding to embark on or explore investments in the digital asset universe.

What rights are attached to my digital assets?

So you've purchased digital tokens, a few parcels of 'land' on a metaverse platform, or an NFT. You would assume you are now the legal owner of these "digital assets". And rightly so – but what are your rights as the asset owner?

For a start, rights and obligations that ordinarily apply to bank and investment accounts, to tangible property, or even to shares may not similarly apply to digital assets. Indeed, digital assets present unique legal risks and implications, which we turn to explore below.

My digital wallet = my bank account

A common misconception is that a digital wallet used for cryptocurrency operates in a similar manner to a bank account. The "money" or "currency" which you own is "stored" in your bank account until you want to make a withdrawal. Such an understanding stems from a misunderstanding of both how bank accounts and digital wallets operate in the law and fails to account for the differing legal relationship between customers and wallet providers on the one hand, and banks on the other.

Simply put, when you set up an account with a bank, you enter a financial contract with the bank, through which the balance of all financial movements in your accounts is tracked. The rights that you enjoy in respect of your money are therefore, a chose in action against the bank (i.e. a right to claim) for the monies recorded to be remaining in your accounts. In this way, you do not "own" the money in your account, but have a "right to claim" from the bank the money recorded as credited in your account.

On the other hand, when you set up a digital wallet with a wallet service provider or an account with a cryptocurrency exchange, what you are obtaining is the right to use the provider's software for the purpose of performing certain actions with your cryptocurrency, such as the storing of keys, and the sending and receiving of cryptocurrencies on the blockchain network.

It is thus arguable that in this context, a similar chose in action does not arise in respect of the value of cryptocurrencies held in your wallet. Instead, conversion of your digital assets into fiat currency is done by way of direct / indirect trading on a cryptocurrency exchange, not by a direct claim from the wallet provider/exchange itself. This is the natural consequence of the decentralized nature of crypto assets, where there is no bank or financial institution working as a middleman to record transactions or ownership on your behalf. Instead, the relevant blockchain network independently records and verifies transactions in a decentralized manner across nodes located all over the world.

Accordingly, what is actually stored in any digital asset wallet (or account on a cryptocurrency exchange) is not the digital asset itself, but rather the public and private cryptographic keys required for the control of your digital assets as well as for accessing proof of ownership of the same.

It is thus possible that you, as the owner of a digital currency, do not have any legal rights as against the wallet provider or exchange on which you have chosen to "store" and/or trade your digital currencies. Much of this will turn on the platforms' own terms of use and the rights and obligations conferred and undertaken thereunder. It is thus crucial that as an investor you read these terms to understand the implications of having your assets held on a digital asset platform.

Consider, e.g. the following clauses in the terms of use of Binance (the largest cryptocurrency exchange by volume) which would warrant serious consideration:

"You agree that Binance shall have the right to immediately suspend your Binance Account (and any accounts beneficially owned by related entities or affiliates), freeze or lock the Digital Assets or funds in all such accounts, and suspend your access to Binance for any reason...

In case of any of the following events, Binance shall have the right to directly terminate these Terms by cancelling your Binance Account ...

- after Binance terminates services to you;

- you allegedly register or register in any other person's name as a Binance User again, directly or indirectly;

- the information that you have provided is untruthful, inaccurate, outdated or incomplete; ...

... once a Binance Account is closed/withdrawn, all remaining account balance (which includes charges and liabilities owed to Binance) will be payable immediately to Binance. Upon payment of all outstanding charges to Binance (if any), Users will have 5 business days to withdraw all Digital Assets or funds from the account."

The above terms, which are similarly found in various other exchanges' terms, suggest that cryptocurrency exchange operators have significant discretion which, if exercised, could severely affect your control of your digital assets.

Careful analysis of the applicable terms of use becomes all the more important in a situation where your digital currencies (or more accurately the keys to such assets) have been lost as a result of hacking, scams and/or failures of your digital wallet.

If, as above, you do not have any specific right to claim from the platform/wallet provider itself, your right to reclaim your misappropriated digital currencies becomes restricted to the persons who have so misappropriated them (subject to claims for breach of contract or tort against your platform/wallet provider – which are subject to proof and to the agreed terms between parties).

However, identifying such entities in time to take action is by no means an easy feat: in decentralized, self-authenticating financial systems characteristic of digital tokens, where user identities are often anonymous and no middleman exists to verify and/or authenticate transactions, early intervention in such instances of malfeasance is nearly impossible. Further, it is often the modus operandi of such wrongdoers to trade away stolen digital assets for fair value with innocent third parties, making the tracing of your stolen assets even more challenging.

In a recent landmark case in the Singapore High Court, the Court granted a freezing injunction (court order) against "persons unknown" for S$9.6 million worth of digital assets which were allegedly stolen from the claimant. The court also ordered the relevant cryptocurrency exchanges to disclose information necessary to assist the claimant's efforts to trace and recover the digital assets. This is therefore a welcome decision and legal option. However, it is also a costly course of action.

Digital asset ownership in the metaverse

Next, we consider the legal status of owners of digital items/assets in the metaverse (e.g. parcels of virtual land or other objects offered for sale in the metaverse). The prevailing narrative out there is that blockchain technology has created a new and indisputable method of proving the ownership of digital assets.

This however is not entirely true – as a matter of law, the type of 'ownership' offered by platform providers is often something very different from the traditional notion of ownership that applies to property in the real world, such as the ownership of intellectual property, immovable property (such as a house) or movable property (such as a car or jewellery).

Similar to what has been described above regarding digital currencies, when you buy an item in the metaverse, the purchase is recorded on the ledger on the blockchain which is under nobody's control (generally, not even the platform provider).

Your purchase assigns you a digital token known as an NFT, on which code is written and recorded on the blockchain network. This code is unique and is not directly replaceable, and is stored in your digital wallet.

Each NFT is linked to a particular virtual item in the metaverse platform in question. However, it must be noted that the NFT and the virtual item are not one and the same. Again, the rights you enjoy as the "owner" of the digital asset are determined by the platform's terms of service and purchase and/or other agreements or terms you consent to when joining the platform. Unlike the blockchain itself, these terms are centralized and under the control of a single entity i.e. the platform provider.

Thus, while the NFT does provide you with proof of ownership of the digital asset in the metaverse, the rights in respect of the digital asset are dependent on the terms of use and what the platform provider permits. In short, while the blockchain may be certain as to digital records, the rights granted in respect of your digital assets are a question of agreed terms.

Three simple examples illustrate why this is important to remember when considering an investment in digital assets:

- First, if you were to buy virtual real estate on a metaverse platform, whether or not you have the right to prevent others from accessing that 'parcel of land' entirely depends on the terms of purchase with the platform provider. For example, the terms of purchase could state that while you own the "land" (and can build structures on it etc.), other users are free to access it without the need for your permission. This is to be contrasted with the general law of ownership of immovable property, which generally gives the owner the right to prevent any unauthorized access by third parties as long as proof of ownership is established.

- Second, all the visual and functional aspects of your digital asset (which is precisely what gives them value) are in no way stored on the blockchain at all (which only captures the unique code assigned to the asset, and the history of transfers of the same i.e. the digital token). So for example, if the platform were to shut down, all you could be left with is the digital token itself, which would no longer be linked to any virtual asset on the metaverse as it were.

- Finally, all the features of your digital asset are within the complete control of the metaverse platform and subject again to the terms and conditions on which they were offered. For example, if the terms of service allow the platform to remove, modify, delete or give away your digital assets, then such acts by the platform will indeed be legal, regardless of any "ownership status" you might think you have over the item. Such terms of use have in fact been found in those of well-known metaverse platforms, and this is not therefore a far-fetched scenario. Consider e.g., the following extracts from the terms of use of The Sandbox metaverse, which reveal the true extent of control that a platform may exercise of the digital assets that you allegedly "own":

"We reserve the right to remove Assets and Games from the Services, in whole or in part, without prior notice, for any reason or for no reason at all. ... We also reserve the right to decide whether Assets and/or Games are appropriate and comply with these Terms for violations other than violations of intellectual property law. This shall extend to the right of TSB to edit, modify, moderate, re-format, change or otherwise remove all or part of the descriptions, comments and/or annotations that you and/or third parties add and/or make in relation to your Assets and/or Games in any manner that we may determine, whenever we deem it appropriate."

As is evident from the above, ownership of digital assets in the metaverse is not a clear-cut matter, and there are specific legal risks and considerations that ordinarily do not present themselves when it comes to real property. You should therefore keep these in mind when contemplating investment in such digital assets.

Buying an NFT = obtaining exclusive rights to an image

Another rising trend in the realm of digital assets is the sale of NFTs linked to pieces of digital artwork or media such as photographs, gifs, paintings, tweets, or graphic designs. However, similar issues can arise in purchasing such NFTs as do with the purchasing of virtual assets in the metaverse.

As with virtual assets, what you receive when purchasing an NFT is a piece of code written into the blockchain. The NFT is thus not the artwork itself, but a unique digital code linked to the original artwork. The NFT purchaser or holder is not the owner of the artwork or media.

Accordingly, the fact that an image is supposedly sold as an NFT does not mean that you have been granted copyrights to the image or licence to use, publicize or sell the image for commercial value. If the NFT is not sold with a valid licence to use or publish the copyrights in question, it is possible that the creator of the work may pursue action to restrain or prevent the use or publication of the work, or to claim royalties for any profits earned from the use of the work in connection with the NFT.

A purchaser should, therefore (a) ensure that the NFT seller has a valid title or the rights to commercialize the work being 'sold' as an NFT; and (b) analyse the terms of sale to see what kind of rights are being conferred in the sale of the NFT in order to know what exactly is being purchased with the NFT, and how the work can be used.

What can you do?

What is clear therefore is that as an investor, precautions must be taken to protect your assets and be apprised of your legal rights when taking up a digital asset investment – be it in NFTs, virtual assets in the metaverse or cryptocurrencies.

Here are some practical tips to keep in mind:

- First and always, analyse the applicable terms of use or sale: as tedious as it may seem, this is crucial to ensuring that you understand what kind of rights you enjoy.

- Second, protect access to your public and private keys to protect your digital assets. This can be done for example by using a combination of "Hot" and "Cold" wallets, especially where you are holding a large amount of digital assets. A hot wallet is one that is connected to the internet (and is generally more susceptible to online attacks) but helps to facilitate easier trading and spending of digital currencies, e.g. Metamask and Trust Wallet. A cold wallet, on the other hand, is one utilizing hardware which exists offline, which is generally less convenient to trade from and would cost some money to obtain, but which is generally less prone to external attacks, e.g. Trezor and Ledger. Even if you lose your hardware device, you may generally still access your wallet with a replacement device if you have recorded and retained your 'seed phrase'.

- Third, do your due diligence on platforms you use to hold and trade your digital assets: avoid platforms with a history of data breaches, hacks or misappropriated digital assets (even if they may have lower transaction fees), and check for the level of security protocols adopted by the platform (remember, your asset is only as secure as the platform you are using). In Singapore, you can look out for whether your platform has been granted a Major Payment Institution or Standard Payment Institution Licence by the Monetary Authority of Singapore and the scope of the licence so granted.

Other legal considerations

Tax

You may need to also consider tax implications in your trading of digital tokens. E.g. Singapore's Finance Minister Mr. Lawrence Wong has recently stated that income tax will apply to NFT trading. Briefly, income tax will apply to profit from the trading of digital tokens. However, as Singapore does not tax capital gains, the gains from the sale of digital tokens (which are not the result of 'trading') are not taxable. The distinction is a fine one and would depend on various non-exhaustive factors, including: 1

  • Motive;
  • Nature of the subject matter;
  • Method of financing;
  • Multiplicity & frequency of similar transactions;
  • Duration of ownership;
  • Application of special skill or supplementary work;
  • Circumstances for realisation.

Market Misconduct

Unlike traditional securities where tight regulations exist to govern market misconduct e.g. market rigging, market manipulation, false or misleading statements, there are currently no regulations governing such conduct in respect of the markets of digital tokens insofar as they are not deemed capital market services products. For more information, see Ronald's article on this issue in the Singapore Law Gazette, "Digital Tokens and Market Conduct Laws".

Currently, there is a widespread phenomenon of "shilling" or pumping. This refers to someone actively promoting a cryptocurrency or digital token to lure investors to invest or buy the token by any means in order to pump its value to increase their own profits. They may then sell off their entire holding of the tokens or do a 'rug pull'. Such conduct could significantly affect the value of your digital asset investments, and you would not be able to foresee or anticipate the same in time to respond and/or protect yourself in such an event. Unfortunately, given the lack of regulations, legal action to claim for losses arising from such conduct may be difficult. Apart from regulations, one may possibly claim in the tort of misrepresentation, although the precise facts and evidence will need to be considered carefully. It is therefore important that you conduct due diligence with critical scepticism before investing.

Conclusion

The purpose of this article is not to dissuade anyone from investing in digital assets. Indeed, recent years have seen many making remarkable profits and income from the investment in and exploitation of such technologies. However, many overlook or are uninformed of the specific legal risks and implications that digital asset investments carry with them, especially where the popular perception lauds them as the future of finance, promising massive returns for those who get in on the game early. We, therefore, hope that this article has gone some way in bridging the gaps in understanding when it comes to the legal intricacies of digital asset investments as the landscape continues to evolve and grow.

Footnote

1. See e.g. GCH v The Comptroller of Income Tax [2018] SGITBR 1; BQY & Anor v Comptroller of Income Tax [2018] SGHC 75; NP v Comptroller of Income Tax [2007] 4 SLR(R) 599.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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