How to stay legal, safe and secure in the wild west of web3

This article was written by Futura Digital associates Valeria Gziryan and Alexey Kononov.

Web3 is changing the gaming world by using blockchain tech to make games more transparent, secure, and controlled by users. It introduces NFTs and smart contracts to games, changing how ownership and finance work in virtual worlds. Virtual assets like NFTs and Play-To-Earn model have made web3 gaming popular. For example, total funding for web3 games will reach $5.79 billion between 2021 and 2023, which makes gaming one of the most funded web3 sectors. 

At the same time, there are challenges for web3 games including scaling issues, getting new users onboard, environmental impact, and most importantly, legal questions arising from the business of providing web3 games, digital assets ownership, and privacy. Despite such problems, web3 work continues unabated. Developers making games are focusing more on being creative, investors remain focused on the long-term potential of these games, and players are simply looking for better experiences. 

As the web3 journey continues and the ecosystem develops it will be increasingly important for all parties to understand their roles and responsibilities. But in order to get to grips with what needs to be done, let’s first address some basics.  

What is web3?

The first question that many people ask is “What is web3? And if there’s a web3, what were web2 and web1?” Let’s address each in turn.

Web1 was the internet’s first iteration, effectively beginning in 1991 and running until around 2004. The main thing to think about here is “read only”. Web1 was a period when content (text, music, videos, etc.) was loaded on Internet pages for users to see. There was no authorization, registration, editing of content by users. All materials were stored centrally by the website owners with the legal requirements for privacy being at an initial level at best.

The foremost exponents of web1 during this period were the likes of MSN, Yahoo!, Intel, and Google while, in gaming, there were early multiplayer games such as Quake, Ultima Online and Zork.

Web2 marked the internet’s ability to both read and write. From around 2004 social networks appeared and now not only website owners but their users could post content on the internet. The services provide what users want, and in return they receive personal data, income from that audience (including via advertising) as well as the opportunity to decide the fate of user content. This is an era of targeted advertising and threats to privacy. 

The prominent representatives of web2 being LinkedIn, Facebook, YouTube, X, Pinterest, and Gmail, etc and while the internet has become a hotbed of gaming developers and publishers still control game ownership, monetization, data, community, and virtual assets which offer no true ownership for users. 

Games such as Minecraft, League of Legends, Counter-Strike, Grand Theft Auto, Dota2, etc. are impressive but interoperability between them remains low.

Before we get to web3 let’s also consider a halfway option which is currently in play. Web2.5 can be considered to be a bridge between web2 and web3. On the one hand, web2.5 games look familiar to web2 users, but on the other hand, they do include blockchain aspects including NFTs. In web2.5 games, the blockchain is mainly used for transactions, while game data is stored off-chain. However, there is a growing trend of web2.5 games transitioning to web3, where both transactions and game data are stored on the blockchain. But within web2.5 games, players obtain limited ownership rights, monetization is becoming more hybrid, some data sharing between games is becoming possible and the community is starting to play a more important role in the game development.

In today’s web2.5 we also see NFTs and tokenization and  there are better game features and gaming experience thanks to VR, AR, and AI. Prime exponents of web2.5. are such games as Deadrop, Illuvium, The Fabled, etc.

Web3: A future that is closer than it seems

OK. Time for the main event – web3. Web3’s mantra is read, write and own… There are a lot of web3 ingredients and it’s difficult to list everything in one place, but here are the most key aspects that set web3 projects, apps and platforms apart from what’s come before:

• Blockchain and advanced technologies like AI, IoT, VR/AR will be actively used.

• Decentralization is at the core. I.e. There will not be one control center or service administration.

• Users will be full owners of their content, data and digital assets through cryptography.

• Users will rent ownership rights to digital assets that are independent of platform changes or the switch to another platform.

• Cross-gaming will be everywhere.

• Monetization will deal with the player’s digital assets and player-driven economies.

• Transition from traditional companies to other corporate options including decentralized autonomous organizations (DAOs) will be inevitable. 

Examples of companies and services working in this current web3 period are MetaMask, Bitcoin, IPFS, Ethereum, Zcash, etc. And for games, approximately 72.5% of top gaming firms are actively integrating web3 technologies. And this is only the start.

The web3 legal world map

It’s clear therefore that new legal frameworks must exist and given the global nature of web3 and gaming that these laws are internationally recognised. However, currently, there is no consensus on the standard approach for web2.5/web3 businesses to organize their legal structures. Instead, the approach can vary depending on the country. Let’s take a look at the practice of some advanced jurisdictions.

Japan
It should be noted that the web2.5/3 climate in Japan is very positive. During the webX 2023 conference, Japan’s Prime Minister, Fumio Kishida, highlighted the government’s commitment to adopting web3 technology to drive economic growth and innovation. He envisions web3 as a key component in ushering a new era of capitalism in Japan, marked by startup growth and digital advancements, while ensuring user safety and boosting the content industry.

The Liberal Democratic Party’s web3 project team (web3PT) released a whitepaper in April 2023, which outlines crucial proposals, including changes to tax regulations and the standardization of accounting practices.

The key points that being proposed in this whitepaper are:

• To enhance legislation to allow the use of stablecoins: Implement regulations that permit the circulation and use of stablecoins.

• Facilitate the use of DAOs: Simplify the legal and regulatory framework for DAOs.

• Optimize the tax regime for cryptocurrencies: Streamline tax regulations to make them more favorable and clear for cryptocurrency transactions and holdings.

• Develop a licensing system for intermediaries: Establish a licensing regime for intermediaries that provide services between exchanges and payment providers.

Web3 is already popular among large and famous Japanese companies – including game developers. For example, Sony has partnered with Startale Labs (Astar Network), investing $3.5 million in a web3 incubation program. This initiative aims to leverage Sony’s resources and web3 technologies to create new entertainment experiences, including the use of NFTs to support creators and artists.

Bandai Namco launched the Bandai Namco Entertainment 021 Fund dedicated to investing in web3 and metaverse companies. They plan to allocate approximately $23.8 million over the next three years to foster innovation in these areas.

Square Enix has invested $2.01 million in “The Sandbox,” the web3 experience built on Ethereum. Additionally, they have announced a partnership with the PC gaming platform Elixir to enhance the accessibility of web3 games.

Right now it would seem that common Japanese web2.5/3 projects prefer to structure their business within Japan. This can be explained by the favorable atmosphere for web2.5/3 within the country and clear prospects for the development of this sphere.

Depending on the projects’ nuances they may be structured as a DAO or as “classic” companies. As examples, the following famous web3 projects are structured as a DAO:

• Ninja DAO is one of Japan’s largest DAOs. It serves as the official community for the NFT project CryptoNinja allowing members to participate in creating derivative works of CryptoNinja.

• Wagumi DAO aims to broaden the adoption of web3 technology in Japan, reaching a wider audience.

• Super Sapiens is a unique entertainment DAO. By acquiring tokens, members can actively engage in the creation of artistic projects and participate in voting processes.

The Japanese government continues to take steps towards improving and clarifying the legislation related to DAOs. For these purposes the Financial Services Agency (FSA) has put forth a proposed amendment that would grant regulatory status to “Limited Company Type DAO Member Rights Tokens”. The move aims to promote the development of DAOs by easing regulations on employee rights in tokenized LLCs that utilize DAO structure and governance.

All things considered, Japan would appear to be a very interesting jurisdiction that provides a wide range of possibilities to web3 projects and as such could be a comfortable hub for your business.

UAE
Based on available information, the developers of web2.5/3 games within the UAE prefer to open legal entities rather than operate without them. 

It can be assumed that this is primarily done to protect IP and reduce regulatory risks. The UAE offers a huge list of suitable business licenses for the gaming industry and web3 services (there is even a license for Offshore Gaming Operator) and it is not a problem to find the right one.

At the same time, the UAE gaming companies choose to outsource some of the functionality related to the generation and maintenance of virtual assets to other companies. This is because almost everything related to virtual assets, including NFTs, is subject to licensing by special local regulators. This requires huge financial, administrative and time costs from the business. Therefore, the UAE gaming companies either involve a third-party partner with the necessary license anywhere in the world, or a company from their group, but from another jurisdiction, where it is much easier to obtain permission to work with virtual assets. 

In this case, as a rule, the terms of use prescribe that the gaming company has nothing to do with virtual assets and is not responsible for the actions of third parties in terms of virtual assets. This approach helps to avoid problems with the UAE authorities and at the same time allows a business to demonstrate that it is located in a respected country.

Hong Kong
The situation in Hong Kong is less obvious than, for example, in the UAE. Some developers still create companies, and some, it seems, may act without creating them. Those who have established official companies prefer to emphasize that they do not provide financial services, but only offer some administrative opportunities through the platform. All relationships are formed between users as buyers and sellers or between users and third-party platforms.

Of course, the game developers do not bear any responsibility in terms of operations related to virtual assets. This approach may also be related to stricter licensing and legalization requirements in Hong Kong, as well as anti-money laundering rules, which some game owners may fall under.

Offshore
When structuring web2.5/3 projects in offshore jurisdictions, companies often seek environments with favorable regulatory frameworks, tax benefits, and business-friendly policies. It’s worth noting that in the dynamic world of virtual assets, offshore should not be associated with unregulated or grey areas and many popular offshore jurisdictions for web2.5/3 projects already have virtual asset regulations in place.

From the standpoint of structuring the business itself, offshore web2.5/3 projects often prefer to create several legal entities to which they delegate various functions or outsource some functions (e.g. KYC) to third parties. Additionally, various offshore jurisdictions offer interesting solutions for structuring. For instance, Foundation Companies provide unique benefits for web3 projects on the Cayman Islands.

By understanding these aspects, businesses can make informed decisions about where and how to structure their web2.5/3 projects to leverage the benefits offered by these offshore jurisdictions.

The state of digital asset ownership

Who owns virtual assets is a very important issue. It’s important that we make the distinction that owning digital assets and owning the IP are two different things. If a gamer has virtual assets, this does not mean that she or he is a right holder. Depending on the answer to the question of who is the owner, we can then know which era we are closer to – web2 or web3. Once again, let’s look at how the different territories treat the issue of ownership.

Japan
Ownership of virtual assets in Japan is primarily governed by Japan’s Civil Code and the terms of use set by the platform or project. Japan’s Civil Code recognizes virtual assets as property, allowing for their ownership and transfer, provided the terms of use grant these rights to the user. These terms of use are legally binding agreements that detail the rights and responsibilities of both the users and the platform regarding virtual assets. This framework ensures that virtual asset ownership is clear, secure, and enforceable within the legal system of Japan.

UAE
In the UAE, under the regulations within the region, virtual assets are classed as commodities, and the transfer of rights to them is real. However, in the UAE, the main problem is that the rules of the right holder of the game do not cover the issue related to the ownership of virtual assets, since third-party partners or group companies are actively involved. For this reason, players need to study the rules of a specific third party every time, who helps to perform actions with virtual assets, and see how such a third party looks at this issue.

Hong Kong
In Hong Kong, virtual assets are classed as property, and in the event of disputes, the courts primarily look at how the rights to virtual assets are reflected in terms of use. They can even compare different versions of this document that existed at different times, and how the ownership provisions changed over time. Plus, there are different classifications possible for who owns virtual assets.

In Hong Kong, there are games in which players do not receive full ownership, but rather a license. But also there are those companies that say that the owner of the asset is the user, but at the same time, he or she provides a fairly broad license to the company to use them. But even in this case, the ownership of the virtual assets of the players is not absolute. For instance, at this point in time, nothing can stop an amendment of the terms of use so a digital assets’ owner could change.

Plus further grey areas exist in games in which the rules regarding the ownership of virtual assets have not been properly developed. In such circumstances users act at their own risk.

Offshore
The choice of a specific offshore jurisdiction will depend on the particular needs of your business model. However, we can refer to the Cayman Islands, the British Virgin Islands (BVI), Seychelles, and Malta to illustrate how offshore jurisdictions approach virtual assets.

In all of these jurisdictions, virtual assets are considered property, and their ownership is primarily governed by the terms of use agreements set by the platforms or projects. These agreements are legally binding and must comply with local regulations to ensure the protection of users’ rights. The regulatory frameworks in these jurisdictions require that terms of use are clear and enforceable, providing legal certainty regarding the ownership of virtual assets.

The privacy issue

When it comes to web2.5/3 projects, privacy is a critical concern due to the inherent transparency and decentralized nature of blockchain technology. Web2.5/3 projects face unique challenges in safeguarding user privacy, as well as ensuring compliance with various international and local privacy laws.

There are a lot “privacy pitfalls” for business to deal with, but in our view the main challenges are the following:

1. Transparency vs. privacy: The public nature of blockchain can conflict with the need for user privacy. Transactions are visible to all participants, which can inadvertently expose user information.

2. Decentralization: Unlike centralized systems, decentralized platforms do not have a single point of control, making the enforcement of privacy policies and data protection measures more complex.

3. Regulatory compliance: Navigating the regulatory landscape is challenging, as different jurisdictions have varying requirements for data privacy and protection.

To ensure that a web2.5/3 project is compliant with privacy regulations, make sure you have essential documents like a privacy policy, terms of use, Data Protection Impact Assessment (DPIA), and consent management systems. 

Additionally, be aware of key regulations such as the GDPR, CCPA, Japan’s Personal Data Protection Law, etc., as these laws are stringent, have extraterritorial reach, and impose high penalties for non-compliance. Taking these steps will help protect user data and ensure that your project adheres to international standards.