Litigation trends for 2023
The Metaverses – Tech’s Next Great Schism

The ‘metaverse’ is one of the most hyped, and simultaneously poorly defined, concepts of the ‘new age’ of the internet’s evolution. To a certain extent a result of the vision promoted by Mark Zuckerberg when announcing Facebook’s pivot and rebranding to become ‘Meta’, the term conjures up images of fantastical worlds populated by other-worldly avatars. A utopia, where users can work, create, socialise and play with anyone else from anywhere on the planet. However, looking past the ‘artist’s impression’ demos that seem, so far, to be the only visible return on the enormous sums that have reportedly been invested (£10-15bn a year by Meta alone), it is difficult to predict what the future of the metaverse may look like – particularly for lawyers, who currently have more questions than answers.

A defining feature of the metaverse is that it has a distinct economy (most often rooted in digital currencies) that is, nevertheless, connected to the IRL (“in real life”) economy. As an indication of how much the metaverse economy might come to flourish, current trends in the value of virtual goods are a benchmark that have led to some extremely optimistic predictions. For instance, JP Morgan valued the current virtual goods market at $54 billion annually, and endorsed a prediction (by a digital currency asset management firm) of $1 trillion in annual revenues from the metaverse. It is clear that the metaverse (even if it falls significantly short of current predictions) is likely to be a sizeable economic force that legislators, regulators and the courts are increasingly going to have to tackle.

However, the major difficulty is that there is not, and never will be, such a thing as the metaverse. Rather, there is likely to be a proliferation of metaverses. This is largely down to a fundamental schism as to what this new age of the internet should look like – Web2 or Web3.

Web2 denotes the current prevailing form of the internet – where large companies provide services and platforms, allowing users to access and create content, in return for the harvesting and monetisation of users’ personal data. Web3 refers to a future of the internet where its functionality and ownership is decentralised across open-data blockchains, and where there is no central authority dictating rules as to what constitutes permitted activity.

The key disagreement is that proponents of Web3 see the hoarding of control, personal data and content generation by a small oligopoly of companies as anathema to the ideal of a virtual universe where all users have equal rights, access to, and control over how it operates. Therefore, Web2 metaverses are likely to exist in a very distinct orbit to those based on Web3 principles – and may not interact with them at all.  In practice, this is likely to be the most fundamental difficulty with any attempt to predict, legislate for, or impose on the metaverses some semblance of the rules (and protections) that exist in the real world.

Web2 metaverses – the devil we (sort of) know

Web2 metaverses, of the kind operated by Meta, Microsoft etc., are probably going to take the form of more immersive forms of the platforms that we are all used to. Users will have a choice of online worlds, accessed and interacted with using virtual or augmented reality devices, where they can socialise, share content (according to terms and policies imposed by the company), work and attend virtual events (an early example is Epic Games’ Fortnite hosting three concerts by US rapper Travis Scott over three days, with 12 million people tuning into the first gig).

Web2 metaverses are likely to dominate, at least at first, given that they do not require the cognitive leap that Web3 demands. Agreeing to adhere to online terms of use (even if the vast majority never read them) is a familiar concept to users of social media – and they provide opportunities to enforce users’ limited rights against the metaverse providers themselves.

Also, the tech companies are (theoretically) relatively straightforward to regulate, when compared to a Web3 metaverse. Governments are already - albeit belatedly - grappling with the issues thrown up by the existing Web2 platforms. For instance, the UK’s Online Safety Bill (in its latest form) aims to pressure social media companies into more robustly tackling illegal content (although a more contentious proposal to police “legal but harmful” content has been dropped). Similarly, the EU’s new Digital Services Act intends to more clearly define illegal content and to strengthen requirements for such content to be removed. In terms of regulating market abuse, the EU’s sister Digital Markets Act prohibits behaviour like self-preferencing and the combining of data from different services offered by a tech company. All of these have obvious application to a Web2 metaverse - even the Web2 metaverse economy is not so alien, with in-platform currencies conceivably being considered significant enough to warrant direct regulation.

Since the operation of a Web2 metaverse will primarily be governed by its terms of use, issues around permitted content, processing of personal data, jurisdiction, governing law, etc. will likely be relatively straightforward to address. The recourse available for breaches of those terms (by provider or user) is familiar, as are the remedies – the only real difference is the complexity and scale of the systems in question, and of the possible harm that misuse or misadventure might cause.

Web3 metaverses – into the unknown

The realm of the Web3 metaverses arguably holds the most promise in terms of radical change - along with serious challenges in terms of having (let alone enforcing) any rights or protections.

A Web3 metaverse could outwardly resemble a Web2 ‘social media’ style metaverse, but how it functions would be utterly different. For instance, gaming in the metaverse (predicted to be a huge industry) could take the form of play-to-earn games, where players are rewarded with digital assets for playing that then can be used in the wider economy (a key example is the NFT-based Axie Infinity, worth $813 million). On the other hand, remote work and business in the metaverse would be reconfigured to take advantage of the (alleged) transparency and permanence that are the hallmarks of Web3. However, this raises questions around what can be done about ‘illegal’, ‘inappropriate’, ‘harmful’, ‘abusive’ content that is stored and replicated across the blockchain – those terms are in inverted commas because, in a metaverse where content moderation or censorship by an overarching authority runs contrary to the entire ethos, they may have no meaning at all.

Web3 is likely to have the most impact on the evolution of the metaverse in the form of decentralised finance (DeFi) – eliminating centralised banking and regulators, allowing for peer-to-peer transactions and encouraging ‘trustless’ interactions (‘trustless’ meaning without the need for a ‘trusted’ intermediary). This will form the heart of a Web3 economy, although recent upheaval and dysfunction in the crypto world suggests that a Web3 economy would face significant challenges. The catastrophic collapse of the crypto exchange FTX (which has triggered plummeting prices for key currencies, a crisis of confidence and mass lay-offs across the sector all over the world) is just the most eye-catching example, which risks masking the fact that the crypto has systemic weaknesses, as demonstrated by the theft of over $3 billion worth of crypto assets this year so far.

One argument to explain such instability is that DeFi has, ironically, become more centralised in the hands of exchanges like FTX; this is largely due to crypto being made ‘accessible’ to the casual investor by making it easier to invest via a single platform. This makes these centralised institutions vulnerable to the same issues that plague the traditional financial world – not least fraud and theft - and so one (arguably impractical) solution is to take DeFi back to its roots by making it truly peer-to-peer. On the other hand, there are growing calls for governments and regulators to take action to bring DeFi to heel – although this is no doubt partly motivated by the fact that the total crypto market is worth c. $907 billion.

The reality is, that for every aspect of the Web3 utopia, the offline world will increasingly loom large. Recent efforts to tax NFTs in the US, shoehorning them into existing sales tax legislation, will be replicated elsewhere. Similarly, the possible application of US securities legislation to the world’s second largest crypto blockchain, Ethereum, following its transition to a proof-of-stake infrastructure (the ‘merge’) would have seismic ramifications in terms of the requirement for registration, filings and disclosures to the SEC. Away from high finance, the blatant infringement of intellectual property rights in NFT-based digital art also shows that, too often, a ‘trustless’ system cannot be trusted.

And when things go wrong in Web3, investors, creators and consumers ultimately seem to resort to IRL legislation and the courts to vindicate their rights - but those institutions are invariably lagging behind. Issues around where, and how, you are able to sue someone or enforce a judgment in respect of crypto assets are only just being tackled by the courts – for instance, the location of the owner determining jurisdiction in crypto disputes, or the service of court documents by ‘airdropping’ them as an NFT to a crypto wallet. But where control and ownership of assets and the fundamental infrastructure is fragmented (by design) across a blockchain that is physically manifested in servers across the world, what law should even apply?

One answer to this may be a legal system built specifically for the metaverse, with distinct laws, courts and remedies. One can see the benefit of being able to enforce a virtual judgment in the metaverse without the need to find and identify the owner of the crypto wallet where stolen assets reside. However, even if some form of rules-based tribunal could be devised that could regulate a Web3 space, technological innovation would also be required. For instance, any metaverse legal system would require a means of enforcement – especially if the use of centralised exchanges diminishes. Taking stolen NFTs as an example, a new standard (in other words, template) would need to be developed to allow transactions to be reversed without necessarily having the fraudster wallet owner’s consent (perhaps building on the newer ERC-1155 standard’s ‘secure token transfer’ functionality). This would not be straightforward, and issues around the security and integrity of the smart contracts governing the operation of such functionality would be difficult to overcome.

At present, the prospect of such a metaverse legal system developing is some way off, and the extent to which a parallel legal system would (or could) interact with IRL legal systems is unclear. Web3 proponents would also need to arguably compromise their ethos to allow for the existence of a hypothetical tribunal in an otherwise decentralised space (although see the discussion on DAOs below for the seeds of a potential solution). But the overwhelming obstacle is that it would require cooperation and consent from all participants across all metaverses for it to succeed.

An alternative would be a form of self-regulation, with the partnership earlier this year between MetaMask (a major crypto wallet provider) and Asset Reality (a crypto asset recovery firm) to trace stolen assets providing a possible model – although actual recovery is currently still dependent on the traditional courts system. This form of the community policing itself could lead to the formation of consortiums of Web3 participants acting like a virtual police force (investigating bad actors) and virtual tribunal (deciding on culpability and sanctions). There is precedent for democratised decision-making like this in Web3 space; the concept of ‘decentralised autonomous organisations (DAOs), where members can submit and vote on proposals which, on the basis of a simple majority, are automatically executed via smart contract. However, applying a similar idea at scale to the regulation of participants across blockchains would be extremely challenging – and having every participant as judge and jury would probably be unworkable anyway. It raises the same issues around cooperation and consent between different metaverses, self-appointed regulators and users that constrain the formal metaverse legal system concept outlined above. It is more likely that smaller collaborations, such as the MetaMask / Asset Reality initiative, and voluntary associations of regular users would form to regulate pockets of the Web3 metaverses – but leaving the rest as a no-man’s land of unregulated space.

The near-future landscape of regulation and litigation in the metaverses, therefore, will look much the same as it does now - and will leave the courts grappling with how to keep up and ensure that orders and judgments are effective. Web2 metaverses will mostly likely be a continuation of their Web2 social media parents – operating at the fringes of the law, but ultimately sufficiently recognisable to the current legal system that rights and obligations will be enforced broadly as they are now. For Web3 metaverses, however, the ideas and innovations of their evangelical pioneers will continue to race ahead of existing rules and legislation, with injured parties trying to rely on (from a Web3 evangelist’s perspective) the antiquated traditional court system to impose antiquated ideas of property ownership, control and an institutional vision of ‘fairness’ on a Web3 world that is supposed to transcend those limitations.

FURTHER INFORMATION

If you have any questions or concerns about the content of this blog, please contact William Christopher or any member of the Dispute Resolution team.

ABOUT THE AUTHOR

William Christopher is a partner in Kingsley Napley’s Dispute Resolution team, based in London.  He deals mainly with civil fraud litigation and asset recovery.  He is recommended in the Who's Who Legal: Asset Recovery Global Guide 2022, Who's Who Legal: Investigations Global Guide 2022, and is listed as a Thought Leader in the Who's Who Legal: GIR - Asset Recovery 2022 Guide.