Metaverse markets are blurring the lines between ‘virtual’ and ‘reality’

Rooftop dance floor at The Fidelity Stack in Decentraland (Graphic: Business Wire)

Seemingly every week there’s another blockbuster transaction in the metaverse, like the Yuga Labs “land” grab from a few weeks ago that saw users spend the equivalent of more than $300 million on virtual real estate, nearly crashing the Ethereum network.

Even in its nascent form, the metaverse already has a robust economy for digital goods like such “deeds” to virtual property, or outfits for users’ avatars. In many spaces those sales are verified by NFT tokenization. That’s a crucial part of the trade in digital goods: The NFT serves as both an authenticating token and theoretically allows for “interconnectivity,” or the idea that digital items can be seamlessly and securely ported from one virtual world to another.

The next step might be a metaverse economy that crosses over into the real world of atoms, not bits, as they say. What if you could do your shopping not from an Amazon list, but in a sort of virtual supermarket, or shopping mall, without leaving your home? Is it possible that the metaverse could upend commerce in the same way current web titans like Amazon did? And, perhaps most importantly for both vendors and regulators, how are those transactions tracked and taxed?

“These marketplaces are new, small, and still evolving,” said Mark Jamison, an economist and a senior fellow at the American Enterprise Institute who has studied the metaverse. “You’re involved in trying to project into the future whether it’s going to be a viable product, and a viable place to engage in your transactions.”

We’ve yet to figure that out with purely digital goods and the role they play in the real-world economy. There’s been a great deal of hype, for example, around the metaverse in the fashion world, which just might have the potential to spark the kind of widespread adoption that would take metaverse commerce beyond just something for early adopters and hobbyists. McKinsey researchers note in a recent report that users spent $110 billion on digital goods in the metaverse in 2021, with roughly 30 percent of that on “virtual fashion.”

But there’s still no answer to the thorny question: How do we situate these transactions within the real-world economy when there’s no “physical” location to which your virtual Nikes, or Gucci handbag, are delivered?

This isn’t the first time the tech industry has forced the government to take notice of such issues. When Amazon first started to expand its e-commerce empire, for example, it took years for states to catch up and collect their share of sales tax from its transactions.

“With e-commerce, we’re thinking still in terms of a physical delivery of something,” Jamison said. “In the metaverse, how do you know if someone’s actually taken delivery of it, where do they take delivery of it, where did it come from?… we’re going to have to jump through some additional hoops before the states can get comfortable with how they might tax those transactions.”

The most common ties between virtual reality and the real-world market are so far in augmented reality, where various products help users make online purchases. Ikea and Amazon have allowed users to see what an item would look like in their home before they buy it; eyeglass company Warby Parker allows customers to try on glasses virtually; clothing companies allow users to try on outfits for both their virtual and real-life selves simultaneously.

Still, the authors of that McKinsey report note there’s still relatively little appetite to buy real-life goods from a marketplace in the metaverse, with virtual goods still presenting “the biggest short-term revenue potential.” More likely virtual fashion assets will serve as a sort of token of users’ loyalty to various brands like Nike or Gucci that have made early metaverse efforts. (Or, potentially, a token showing that they own that same pair of Nikes in both the digital and analog worlds.)

Which means that for now, the NFT and digital goods market is still the biggest game in town when it comes to the metaverse economy. As of now that space is largely unregulated — even lagging far behind crypto, as some critics have directly accused metaverse merchants of offering unregistered securities in high-profile cases like the Yuga metaverse land sale. Those cases might not remain unregulated for long, as the SEC has already opened a broad investigation into the NFT market.

“The feds have already stepped into this space,” Jamison said. “They say, ‘well, a lot of these look like securities. We know how to tax those.”

How do you tell whether or not something is a security? Believe it or not, what would seem to be a decades-old settled matter of law is the subject of heated debate in the digital world, as in the Yuga “real estate” case. Central to the complaint about that sale was that it satisfied the Howey test, the SEC’s official test for whether or not something qualifies as a security.

Appropriately enough, the Howey test was developed in 1946 after a dispute over the sale of… actual land. (Dirt, really; it was an orange grove.) The four legs of the test are as such, that the sale includes:

(i) an investment of money by a person;

(ii) in a common enterprise;

(iii) where the person is led to expect profits;

(iv) to be derived from the entrepreneurial or managerial efforts of the promoters of the project.

I am merely a humble technology reporter, and not a securities lawyer. But the speculative sale of virtual “land,” based on the idea that such land would be theoretically highly valuable in a future with a more developed metaverse, seems to fit the criteria. (For what it’s worth, the NFTs in question, which serve as an effective “deed” to that land, have already fallen below their initial price.)

I reached out to Duke Law professor Steven Schwarcz to ask for his take on the situation, who pointed me to his forthcoming paper in the Boston University Law Review that leaves no room for ambiguity. In it Schwarcz flatly characterizes such offerings as securities, writing that “because the interests are often referred to as tokens (or even coins), many investors fail to recognize they are even investing in securities.”

NFT peddlers hoping to avoid the heavy hand of government regulation might disagree. But regardless of which way the question is finally, definitively answered, they’re going to have to start answering these questions very soon.

Jeff Bezos’ Blue Origin has announced the passengers of its next civilian spaceflight, and it includes one extremely unusual résumé.

For the most part the crew is fairly standard as these things go, a mixture of aerospace enthusiasts, engineers, and wealthy hobbyists. And then there’s a 28-year-old named Victor Correa Hespanha, who identifies himself as “the world’s first cryptonaut.”

So… what is a cryptonaut? It’s somehow both a little bit more, and a little bit less, novel than it sounds: Hespanha is the winner of a lottery held by the Crypto Space Agency, which minted a proprietary NFT out of the holders of which one lucky enthusiast — Hespanha — was selected and screened at random to ride on Blue Origin’s vessel, on the CSA’s dime.

“I bought it thinking about the valuation potential,” Hespanha said in a CSA press release. “I never imagined that mine would be drawn. The CSA is making my childhood dream come true through an NFT.”

Like many Web3 projects, the CSA promotes itself via a combination of techno-optimism and business-world self-promotion, touting on its website their mission of “exploring ways in which web3 platforms could transform and expand demand for the space sector.” Add in the spectacle of a lottery and the gee-whiz-ness of consumer space travel, and it’s a perfect example of the confluence of new technologies and old-school salesmanship that powers the crypto world.

THE FUTURE IN 5 LINKS

Stay in touch with the whole team: Ben Schreckinger ([email protected]); Derek Robertson ([email protected]); Konstantin Kakaes ([email protected]);  and Heidi Vogt ([email protected]).

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The antitrust bills – S.2992 and H.R. 3816 – would cause economy-wide harm beyond just tech. A NERA economic study reveals that the use of broad language and arbitrary thresholds that rely on market capitalization will regulate 13 additional American companies in the next 5 to 10 years including Berkshire Hathaway, Visa, JPMorgan Chase, Walmart, Mastercard, PayPal, Home Depot, Walt Disney, Bank of America, Comcast, Netflix, Cisco, and AT&T. By the 2030s, over 100 American companies would be harmed by the bills. The bills would also jeopardize U.S. international competitiveness by applying U.S.-specific size thresholds that would cover U.S.-based online platforms and marketplaces long before they cover foreign competitors. The economic study concludes that there are “no quantifiable benefits from the bills for consumers or small businesses.” The bill sponsors have offered no quantitative economic analysis of the bills’ impacts.