Models dress up as anime characters at the Thailand Crypto Expo on May 14, 2022 in Bangkok. Visitors ... [+] learn about blockchain and gamefi projects, among other things. (Photo by Lauren DeCicca/Getty Images)

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The House Financial Services committee held a hearing on FTX’s collapse on Tuesday, and its once-celebrated and now much-aligned founder Sam Bankman-Fried is now under arrest. Cryptocurrency investors and project executives will all say that more regulation is good for the industry. But there is one sector of the crypto world that’s up for debate on the regulatory side of things. That’s GameFi. The blockchain gaming segment was a gambling chip darling for crypto until this year, when the likes of Axie Infinity have flamed out, down over 90%. Late investors lost almost everything. Why not regulate the GameFi guys, too?

The consensus from every market participant I spoke to is regulation is not coming for the GameFi coins in 2023. But the investor risk to buying into GameFi plays is high, and not much different than giving all your crypto capital to the likes of FTX.

“I say a hard no to regulation right now,” says Mat Paul, head of strategy for Unix Gaming in Bali, Indonesia. “A security has the expectation of profits based on the effort of others. When a game is designed properly, in-game assets are difficult to acquire without actually playing the game. Since you need to put in the effort yourself to acquire those game assets, the majority of them are going to be just held by actual players of the game and not by speculators buying coins,” he says. “Players will be playing the game for the game, not because of financial benefits. Actual digital asset ownership and the ability to monetize them are game bonuses, but the core attraction (to playing or investing in GameFi protocols) has to be the game itself.”

GameFi allows game developers to monetize their games in new ways. Monetizing games through tokens and in-game assets sometimes gets more players involved in the game. But, just as XBox is owned by Microsoft, a tradable security, blockchain games are owned by young start-ups, maybe five to 10 years old on the high end, who sell their tokens to investors who – more often than not – never played the game, or saw the game in the first place.

If publishers of video games for the Xbox go public, like Activision Blizzard ATVI , these companies are all regulated, and investors are protected. No one is protected from mishaps inside companies like venture capital backed Axie Infinity based in Vietnam. The company launched only in 2018. Anyone can buy Axie tokens on Coinbase. Imagine buying stocks in a four-year-old start-up from Vietnam with no investor rights? That’s not just a GameFi problem. That’s a crypto problem at this point.

“When finance hits any new market, there will always be a need to establish clear, fair, and protective guarantees for investors,” says Borja Villalobos, CEO of Banger Games in Madrid. “A cooperative framework needs to emerge first between online safety, trade and financial regulators to understand the nuances of how finance is intersecting with the (blockchain) gaming community and the kinds of risks that create for investors.”

GameFi is blockchain gaming and decentralized finance rolled into one. Investors who don't play the ... [+] games still invest in the game developers cryptocurrency anyway, putting them at risk of fraud.

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GameFi: The Changing Nature of Gaming Investing in Game Creators

In the 1990’s to early 2000’s, gamers bought console games from the big Asian players – Nintendo, Sony and Sega. There were numerous game publishers and a long supply chain of stores sold the game.

By the early 2010’s, gamers could then download games directly to their Xbox or mobile device. Some games were less sophisticated. Those were free. For harder versions, consumers had to pay. It was like playing up to level 9 in the Legend of Zelda for free, but if you really wanted to save the princess and beat the boss, you needed to pay up. A new gaming model developed.

By the late 20-teens, more sophisticated games allowed for players to make in-game purchases of items – whether it was a new golf bag, or a new gun.

Enter the blockchain games, and gamers can now own those in-game assets. If the game becomes really popular, those asset values rise. Web3 game developers can create, sell and receive royalties from those assets – often in the form of non-fungible tokens. These assets only have use in the game, but if the game is popular and gamers are spending money on those things, then investors will come in and want a part of that action by buying tokens to the game in hopes they can reap the rewards of the game’s popularity.

“Considering that those in-game assets can be traded in a free secondary market, they are naturally born with price fluctuations and volatility. However, they are probably far from failing the Howey Test,” says Deng Chao, managing director of HashKey Capital in Singapore. The Howey Test stems from a U.S. Supreme Court case that is used for determining whether a transaction qualifies as an "investment contract”. If so, then it would be considered a security and subject to disclosure and registration requirements under the Securities Exchange Act of 1934.

The in-game NFT might not be a security. But if it is listed on Coinbase and someone can drop a grand into owning it, then it probably should be.

“If a player is using a token to generate an income it should fall under the purview of financial regulators,” says Stefano Riff, co-founder of Pooky, a gamified Web3 sports prediction platform in Milan. “By contrast, if a token is purchased to carry an action in a game then it can’t be considered an investment and can’t be regulated. An in-game asset can increase in value due to rising demand and limited supply, but there is no expectation it will generate a profit. The only difference is if a game creator advertises or mentions a financial incentive in holding the asset, then I think you have to consider that a security,” Riff says.

GameFi tokens are popular among cryptocurrency investors. They are down over 80% this year, worse ... [+] than bitcoin.

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Crypto Regulation Will Affect GameFi

Web3 gaming lies at the intersection of gaming and finance. It relies on the same blockchain technology and smart contracts as the broader crypto ecosystem that is at the heart of decentralized finance.

Currently, there are no regulations around GameFi in particular. But authorities around the world have stepped up the efforts to regulate crypto. GameFi will not escape that. The in-game tokens will be fine. The company that makes them, however, will feel not only the wrath of venture capital backers and retail investors, but also the U.S. government if there are more Luna coin and FTX-type blowups next year.

“There will always be those that exploit and use a lack of regulation to their advantage,” says Andreas Christensen, CEO and founder of SuperOne, an entertainment gaming app based on a blockchain network in Oslo, Norway. “This is the principal reason why regulation is positive for the industry; it will weed out the bad actors and give room and credibility to the good actors. We warmly welcome it.”

Given this year’s crypto crises, the current regulatory trend is pointing to more transparency, more investor protection for all crypto securities, whether investors are holding GameFi coins or investing in blockchain alternatives to Ethereum ETH .

“I even think in-game assets can be securities, so gameFi companies need to be prepared for that,” says Villalobos. “It’ll all depend on the nature, function, and engagement of those in-game assets. GameFi needs to be about safety, enabling relationships between finance and gaming, rather than the sheer gamification of finance or the financialization of all gaming. Regulation won’t cripple it, but it will definitely reshape the sector,” he says. “The aim should be to make any intersection between gaming and finance safe, transparent and not be a source of new systemic risk for crypto markets.”

Gaming is “eating the entertainment industry alive,” says Paul from Unix Gaming. Mobile gaming surpassed box office movie sales and music in total revenue combined. It is a huge market. It’s why all the crypto bros are involved in blockchain gaming. It’s a growth story.

“Premature regulation will likely just incentivizes ways to skirt the rules,” Paul warns. “It will be a temporary momentum stopper for the sector but not a crippling blow.”