French Insider Podcast Ep. 12
Navigating the Metaverse with Jim Gatto
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Listen to the original podcast released April 1, 2022 here:
https://www.sheppardmullin.com/multimedia-388
Joining host Sarah Aberg is Jim Gatto. Jim joins us today to discuss the metaverse, the technology and business models involved in these virtual worlds, the role of NFTs and cryptocurrency in the digital economy, and the legal, regulatory, and governance issues that can arise when companies seek to enter that space.
Guest:
Jim Gatto is a partner in Sheppard Mullin’s Washington, D.C. office, where he leads the Blockchain & Fintech Team, Social Media & Games Team, and Open Source Team. Jim’s practice focuses on blockchain, interactive entertainment, digital art, AI, and online gambling. He advises clients on IP strategies, development and publishing agreements, licensing and technology transaction agreements, and tech regulatory issues. Jim has been involved with blockchain since 2012 and has been recognized as a thought leader by leading organizations including as a Cryptocurrency, Blockchain and Fintech Trailblazer by the National Law Journal.
Host:
Sarah Aberg is special counsel in the White Collar Defense and Corporate Investigations Group in Sheppard Mullin’s New York office. Sarah's practice encompasses litigation, internal investigations and white collar defense. Her areas of focus include financial services and securities, as well as corporate fraud in a variety of industries, including technology, construction, and nonprofits. Sarah’s regulatory practice encompasses market regulation, foreign registration and disclosure requirements, supervisory procedures, and sales practices. Sarah represents corporations, financial services companies, and associated individuals in connection with investigations and regulatory matters before the U.S. Department of Justice, the Securities and Exchange Commission, the Commodity Futures Trading Commission, FINRA, the New York Stock Exchange, the New York State Department of Financial Services, and the New York Attorney General’s Office.
Transcript:
Sarah Aberg:
Welcome to the show. I'm Sarah Aberg. I'm an attorney at Sheppard Mullin. On today's episode, we will be discussing the metaverse, NFTs and DAO’s. Here with us today is Jim Gatto, partner in the firm's DC office. Jim is the leader of our blockchain and FinTech team and our social media and games team, and our open source team. Jim's practice focuses on blockchain, interactive entertainment, digital art, AI, and online gambling. And he advises clients on IP strategies, development and publishing agreements, licensing and technology, transaction agreements, and technology regulatory issues.
Sarah Aberg:
Jim, welcome to the show.
Jim Gatto:
Thank you, Sarah. It's great to be here.
Sarah Aberg:
So Jim, just to give our listeners a bit of background, what is the metaverse?
Jim Gatto:
Great question. I think if you ask 10 different people, you get 10 different answers. There really is not a single metaverse. Although there is this kind of concept of all the metaverses collectively, someday will be the metaverse, but in the near term, there really are a number of different metaverses and each will have different characteristics. So I like to think of metaverses as really kind of a combination of different technologies and business models and they can all vary, but these are some of the elements that I think are relevant and common among many of the metaverses that are there now, and that we'll see going forward.
Jim Gatto:
The first is that many of them, and I think this is one of the most defining characteristics is that they're primarily virtual worlds. And what virtual worlds are, are shared immersive social spaces where users typically represented by an avatar and their avatar interacts with the space and with other people through other's avatars. And if you think about the virtual world's been around for a while, Second Life and others, but that's really one of the core components of it.
Jim Gatto:
Another aspect of metaverses or many metaverses will be that they'll be based on blockchain technology. So in some of their early virtual worlds, there was a platform operator and they controlled a lot virtual world, a lot of the items in there, you had an account and there was a number of cases where people had their accounts terminated and they lost all the land and other virtual items they had bought because of that centralized control. And what blockchain brings is the level of decentralization and the use of NFTs to represent ownership of items. You can use them in the virtual world, in the metaverse and across other platforms.
Jim Gatto:
The one other kind of important concept, many metaverses will have some component of AR, VR or some combination of mixed reality. So you're not just going to see your avatar in a virtual space, on a 2D computer screen. In many cases, you'll see a much more enhanced version of that.
Jim Gatto:
Some of the other elements, just to kind of wrap up this kind of broad question of what are metaverses, is kind of some of the business models that we see. So with many metaverses, the platform operator will sell land and people buy land. And that's one of the things that's confusing to many people is, why would I buy virtual land? And the reason is in most metaverses is that in order to do things, whether it's have an entertainment venue or create a storefront where you're selling digital fashion for avatars, you need to have land to build things on, to be able to offer goods or services and that a big part of model. So people buy land.
Jim Gatto:
And then the vast majority of the metaverses are user-generated content. So users will build things on the land. There'll be concert venues, nightclubs, a lot of kind of service type stuff that is very social. Businesses will use land to see whether it's private or public business that they will engage in. Educational institutions will have people who will connect with friends and family. So there'll be different types of metaverses with different purposes and people may have different avatars that represent them for these different types of purposes.
Jim Gatto:
And so with the user generated content, there's typically going to be some digital economy. And this is kind of one of the last big pieces. Again, many of the items that are bought and sold in metaverses will be based on NFT recordation of ownership on a blockchain. And there typically will be a digital currency associated with the platform. It may be platform specific or it may be a more ubiquitous or universal digital currency that people use to buy NFTs and to engage in other services.
Jim Gatto:
They'll be virtual advertising just like there is in other virtual worlds. Lots of social media communications. You'll have music and movies. You'll have live concerts through a metaverse. You'll see movies and other types of entertainment as well. So those are some of the elements that will make up metaverses.
Sarah Aberg:
It sounds like a lot of these activities are already taking place on blockchains. We have dApps and we have the DeFi platforms where people are creating communities around a chain and a particular kind of asset. So is it fair to say that the metaverse is kind of the next iteration, taking that ecosystem another step further and expanding the experience into... A lot of dApps right now are financial based or based, and now you're saying, "All right, we can go from that kind of activity to basically exponentially increasing the kinds of activity that we can do on this blockchain."
Jim Gatto:
Yeah. So I think it's two ways to look at it. That's certainly one and as valid. I mean, I think this is an application, one of many applications of blockchain technology and dApps and DAOs and NFTs. And the other way to look at it is this is an extension of what the original virtual worlds were, right? A lot of people say that metaverses are just a rebranding of virtual worlds. To some extent they are, but there are significant differences.
Jim Gatto:
The technology has improved significantly. When virtual worlds were first introduced 12, 13, 14 years ago, whatever it was, the technology was clunky. And we had a very different ownership model because it was centralized control. So blockchain enables this decentralization, as I mentioned earlier, AR and VR has come a long way since then. So the visuals and the experience is much more robust. And we've seen a lot, lot more of the business models that I've talked about, user generated content and things like that, we've seen that become a much more pervasive model in games. Whether it's Minecraft, Roblox or just other aspects of digital media, we've seen more user generated content.
Jim Gatto:
And so I kind of look at it. I guess there's a couple of ways to look at this as an extension of blockchain technology or it really a confluence of technologies, right? Blockchain being one, that is finally ready for prime time and collectively they'll make the metaverse much better than virtual worlds ever were.
Sarah Aberg:
So, as you mentioned this earlier, NFTs are going to play a big role in denominating and designating ownership within the metaverse. And that it sounds like a lot of digital assets will be a part of that metaverse economy. What are, and I apologize, this is another broad question, but kind of how are those assets going to be utilized and is it going to be kind of different than how we're seeing them utilized now on the various dApps and platforms?
Jim Gatto:
I think it'll be similar to a lot of what we're seeing out there right now. So NFTs are really just a way of recording ownership on a blockchain of some asset or entitlement. And so the token part is really just there's a unique token ID associated with a wallet ID that creates an ownership of the NFT with whoever the wallet owner is. And then the NFT references some either asset or entitlement and they can reference physical assets. But in most contexts in the metaverse, it'll be digital assets, it'll be land. It could be an avatar.
Jim Gatto:
It could be represented by an NFT, if you want to trade avatars, like the way they look, fashion, all types of things, all types of digital assets, just like we're seeing with digital art and other types of NFTs right now. Some of them will be just aesthetic, like the fashion stuff. Some will actually have functionality within the metaverse depending on the nature of the metaverse and the digital asset.
Jim Gatto:
But the other category of thing that's represented by NFTs. And we're seeing this outside the metaverse, but I think very important in the metaverse is entitlements. And I use that term generally, but entitlements can be many different things, typically not a digital asset. So one big example is tickets, right? So you can have an NFT based ticket and that can entitle you to attend some event either in the real world or in a metaverse. And so, as I mentioned earlier, you'll have concerts and dance clubs and stuff. And so you can have an NFT of a ticket that gets you into an event. And there are many other examples of entitlement, but that's just one.
Sarah Aberg:
So for those of us who are ready to move into the metaverse such as it is, the way in, it sounds like you've got to start making some investments in these digital assets. That being the case, what are some of the key risks that users, but also corporations who want to start getting a foot in the door in the metaverse need to be aware of as they start purchasing land or purchasing these NFTs and other digital assets?
Jim Gatto:
Yeah. So the answer is a little bit of, it depends on what role you're playing in a metaverse. So at the lowest level, users can just show up with an avatar and just check out what's going on. You don't need to buy land, you don't need to experience stuff, but you may need to pay to go to someone's space. You'll have businesses and many brands are opening locations in a metaverse. Many of them will be free and it's really kind of an extension of their brand. They're trying to create community around their products or events or things like that. And so the brands, they may either purchase land or what we see a lot of, and just like in the real world, there are virtual landlords. There are people that will buy land and build stuff for people.
Jim Gatto:
So as a brand, you may not want to deal with all the purchasing and building and stuff. You may always have a venue and you may hire someone to create it for you and you have social media promoters and stuff that will create events for you. So there can be a whole range of activity, and in LA the range of legal issues vary significantly, depending on what role you're playing.
Jim Gatto:
But I think the single most important thing is that, as I mentioned earlier, there's going to be so many different metaverses and there's going to be so many different combinations of technologies and business models. I mean, the short answer is you really just need to sit down with a lawyer who understands these issues, depending on what you plan to do and get advice on your activities.
Jim Gatto:
Having said that, some of the big issues are with NFTs. If you are selling NFTs, if you are a brand or a company it's really important to make sure that you have an IP strategy around what you want the NFT to represent and how you market it. And what I mean by that is typically the token part users can own the token so they can sell it. They can resell it, but if the token represents a digital asset, you typically only want the users to have a license to the single instance of the asset associated with that NFT.
Jim Gatto:
So you don't want to give away copyright or trademark. You want them to be able to use it. So if it's a piece of digital fashion, they can wear it on their avatar. They can't go out and resell it to other people, unless that's your model. If you want that to be the model, that's fine. The key thing is you need to have clarity around the licensing of the digital assets associated with an NFT and/or the entitlement. So that's one of the issues.
Jim Gatto:
A second issue is as brands move into metaverses, especially if they're primarily dealing with physical goods, they need to extend their IP strategy to protect digital assets and the use of the trademark in metaverse related classes of the trademark registry, so that's another thing.
Jim Gatto:
And then there's a whole host of regulatory issues that can arise around, depending on how you structure the NFT. There can be securities issues. There can be money laundering issues. If you're operating a marketplace, for example, you need to assess whether you're subject to money transmitter laws, or whether an exemption applies, but there's a host of regulatory issues. There's tax issues that require you to set up different accounting systems for handling NFTs and cryptocurrency.
Jim Gatto:
If this is your first foray into that area, I'm not giving tax advice. I'm saying here's categories of things that you want to ask questions about. One is typically if you sell something just like in the real world, if you get paid, whether virtual currency, real currency that may be a taxable event. If you hold digital currency and it goes up in value, there may be tax implications there when you go to convert it.
Jim Gatto:
So unlike the dollar where it may fluctuate in value, but you still pay tax on a dollar there's, look really, unless you're trading typically there's not going to be gains. So there's tax issues associated with it.
Jim Gatto:
If you are either a platform operator or someone who buys land there's generally referred to as governance issues. So the platform operator typically will have a terms of service that everyone has to agree to. And it'll set typically minimum standards and compliance with laws. Typically one of those standards of how the platform will operate, but each land or space within a land can have its own terms that may apply, and they need to be consistent with law and with the platform terms of service, but they can address other things.
Jim Gatto:
So for example, kind of probably the most commonly sided example is in virtual worlds there are a lot of, let's say adult oriented or adult themed lands, where people went and did fun stuff, things that they thought was fun. You may want to exclude kids from that. That's probably a good idea to not have people under 18 in some of those areas, but it can also range across a whole variety of other areas within governance.
Jim Gatto:
So the governance of metaverses is much more complex because it's typically layered between real world law, platform terms of service, and land. You may have individual markets on a land, they may have their own terms of service. And so it gets a very kind of cascading effect.
Sarah Aberg:
Yeah, it kind of sounds like it gets complicated pretty fast. So, I mean, I think we touched on some of this, but as companies begin considering kind of moving into the metaverse and I think we're aware that some big accounting firms have opened up a virtual storefront on certain platforms. I think certain law firms have done the same thing. Are there any keys aside from some of the securities issues that we talked about, are there any other kinds of key regulatory issues that you should keep in mind if you want to open up a shop?
Jim Gatto:
Yeah. So the law firm you mentioned is interesting. So back in the early days of the virtual world, there were a couple people who tried to set up law practices in the virtual world. And one of the challenges due the ethical rules and the need to clear conflicts. I mean, there's both an issue of making sure you know who you're dealing with and also the confidentiality issues.
Jim Gatto:
In the early days, there was a lot of hacking of social media sites. So I think if you're a service provider, I think you want to think about all those types of things that you think about in the real world, but they may be more acute there as well.
Jim Gatto:
From a regulatory perspective. You know, I think we touched on some of the things there. I think if you are going to create a space, you need to think about what are the platform rules and what do you want? What, if any, additional protections maybe you want to provide to users?
Jim Gatto:
One of the things that's interesting with metaverses is because these are social and they're interactive, we see a lot of pranksters in something that's intended to be a serious, whether it's be business meeting or whatever, do all kinds of crazy stuff that interrupt the flow, let's just say. And so you want to have levels of protection depending on the nature of what your site or your space is. And so it may be that you have limited admission to more of a private site. So that's still kind of more of the governance side, but really, it depends on the nature of the business you're doing.
Jim Gatto:
I mean people look at the metaverse as this kind of really different thing. It is software running on a server, just like a website is, it just has different elements.
Sarah Aberg:
Right.
Jim Gatto:
And just like with eCommerce, it doesn't exempt you from worldwide laws. The same is true with metaverses. Despite the fact that some people are very focused on decentralization, they would like it to be that real world laws don't apply, but they do. That's just the reality. So IP laws, contract laws, criminal laws, all of the laws that apply to any, think about any other online service, there may be differences because of the nature of metaverses, but in general, you have to go through the checklist and see what's relevant to the business you're offering.
Sarah Aberg:
So it sounds like you can't just kind of open up a law firm on the metaverse without actually having a law license and start rendering legal advice.
Jim Gatto:
Rendering legal advice.
Sarah Aberg:
Yeah.
Jim Gatto:
Yeah. I mean, unauthorized practice of law, is unauthorized practice of law, so.
Sarah Aberg:
Right. Regardless of where it happened, so.
Jim Gatto:
Exactly. One of the interesting questions is, what jurisdiction applies? And that's true of many even just social media sites, right? I mean typically where the servers are there may be some jurisdictional issues, where the users are where the businesses are, similar tests apply, the facts may dictate different outcomes.
Sarah Aberg:
So here's that kind of interesting question that's appropriate for these days when we're talking about a virtual economy and an economy within the metaverse. What are your thoughts, if any, about the inflationary and deflationary aspects of that? And whether is it going to follow the brick and mortar markets? Is it going to be a hedge? Or is there an intelligent way to look at it or is it anyone's guess?
Jim Gatto:
No, I think it's definitely a very intelligent way to look at it. And look at any digital economy, right? So gaming companies hire economists to manage their economy, right? If you have too many of a particular type of good and it becomes too common, it becomes devalued, it becomes cheap, right? And so that at a very simple level.
Jim Gatto:
When you're dealing with cryptocurrencies, the same rules apply to any economy at a high level: supply and demand. The thing that's interesting is many people don't really dig into the details of cryptocurrencies, right? They look at what's happening. It's going up, it's down, I'm going to buy it or I'm going to sell it. But at the end of the day, they're very different, right? And so I think some of them it's unlimited supply. The issuer can send out as many of the coins as they want to.
Jim Gatto:
And you have others like Bitcoin, where there's a hard cap baked into the protocol. They'll only ever be 21.5 billion Bitcoin, unless there's some significant change, which is not likely. And so for Bitcoin, as long as people keep using it and mining it, it'll become scarcity over time, which is part of what drives the increase in value. And so if there's utility for the coin, increased utility, and a fixed number of coins, it's likely to go up in value. But not every crypto has that baked in some crypto they pre-mined, and there's billions and they can mine more if they want to, right? And so you have to look at the protocol and each one is different.
Sarah Aberg:
Yeah. A lot of them, they actively manage the prices through very deep economics and big algorithms to make sure that they... A lot of them have stated goals.
Jim Gatto:
There's also what's referred to as stable coins, which is a type of cryptocurrency that is designed not to go up or down. There's different types of stable coins. Some are backed by an asset. It could be dollars. It could be a commodity. It could be real estate, it could be anything, but typically the assets are designed to provide liquidity behind the coin so that there's not a great deal of fluctuation. It's typically pegged to the value of some asset. So even if it's pegged to the dollar, while the value of the dollar can change, the coin will track those changes. So it is not necessarily 100% stable, but it doesn't have the wild fluctuation that some of these cryptocurrencies do.
Jim Gatto:
But some of the state-able coins are algorithmically managed. And so basically, if you want to add more to the supply to bring the value down, you can just create more coins. If you want to remove some from the economy to remove the inflationary pressures and bring the price up, you can delete the coins or what's referred to as burning the coins, which basically often is just sending them to an address that they can't be transacted from. So it's essentially like wiping them out. So there's different ways to manage that for stable coins.
Jim Gatto:
Most of the cryptocurrencies are not, and this is where some of the securities laws come in is that people buy them with the hope that they're going to go up and value as there's more usage of the platform over time. And that's what in part can create potential securities issues.
Sarah Aberg:
Stable coins are really interesting. And I think particularly in the last week, when we've seen a certain country get cut off from the financial system. But one of the interesting uses for stable coins is trying to create an alternative to the international wire system through brick and mortar clearing the banks. And I have a number of clients who are kind of looking into that, the feasibility of those kinds of transactions in order to make international payments faster, more accurate, and less dependent on us institutions. And it seems like a lot of companies are kind of moving in that direction or have that goal in mind.
Sarah Aberg:
How, I mean, to the extent you know, I mean, how far out there is that on the horizon? Is SWIFT going to become outdated at some point?
Jim Gatto:
It's an interesting question. And I don't know that I know the answer. I think there are stable coins that exist right now. There Are some governments that have adopted Bitcoin as a Fiat currency. I think there's definitely a move towards. Even the US Central Bank has talked about potentially adopting a digital currency. In my mind I don't think they will replace dollars anytime soon or Fiat currency. I think they'll exist in parallel.
Jim Gatto:
I think one of the interesting things about cryptocurrencies and blockchain technology is that at a fundamental level blockchain, unlike the internet, which is an information TTvip is an information protocol, it's a way to move information around the world. Blockchain is a transaction protocol. It's a way to validate processes and record transactions. And what's interesting is beside the minors that are used to validate transactions, which is a kind of a decentralized approach to validation. You don't need all of the financial intermediaries that exist in the world today.
Jim Gatto:
You don't have the interchanges that process transactions, whether it's ACHs or credit cards or other financial transactions. And so one of the advantages over time of blockchain is that it should make transactions a lot cheaper. Right now one of the biggest uses of sending money is remittances, right? Sending money to third world countries or other countries where people may not have bank accounts, or if you are here and working and sending money back home, you may be paying a very significant percentage as a wire fee to one of the money services right now.
Jim Gatto:
It's not free to use blockchain, but it's a lot cheaper than what's in the existing infrastructure. So I think over time there's going to be a disintermediation of a lot of the key financial players, and that's going to make it kind of interesting. And so there's going to be tension there between the established guard and the DiFi companies, and we'll see how that plays out, but it's going to take a while for it to play out.
Sarah Aberg:
Yeah. But thinking about it in the current kind of global situation, it's really interesting to think that might be a piece of leverage that is maybe not as available in the future. Anyway, we're not going to solve that problem on the podcast, but.
Sarah Aberg:
Last question, there have been forecasts within the next 10 years Bitcoin is going to top a million dollars a coin, whether or not that's true, there does seem to be every year, we seem to see an increase in just the dollar value in cryptocurrency going up and up. Do you see this trend continuing? Are we kind of moving into a digital virtual economy?
Jim Gatto:
My personal belief is a strong yes. I think that blockchain technology is fundamentally very sound and there're many advantages to it. There Are issues in the short run. It is ahead of the regulatory capacity of many countries right now. There Are different ways to look at it.
Jim Gatto:
I mean, a lot of people focus on the price of Bitcoin or other cryptocurrencies. I think that's one thing. Can it get to a million dollars? Certainly, I think it can, I certainly hope it does for personal reasons, but whether it does or not. I think the important thing is that if you look at the activity, it continues to increase. And I think as long as the activity increases as the problems get worked out, I think it will absolutely just continue to expand the digital economy. And whether it's in metaverses or not I think that there will be increased activity as time goes on.
Sarah Aberg:
Cool. Well, thanks so much, Jim. I really appreciate the time, that we really appreciate your time.
Jim Gatto:
My pleasure, very fun as always, is to talk about these topics. I'm very passionate about it as you know, and happy to talk to anybody I'll listen to.
Sarah Aberg:
Great. Well, thanks Jim.
Contact Information:
Jim Gatto’s website bio: https://www.sheppardmullin.com/jgatto
Sarah Aberg’s website bio: https://www.sheppardmullin.com/saberg
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