Gold Rush-Era Policy Surprisingly Relevant To NFT Regulation

US Regulators Bring Down The Hammer On Crypto Casinos

Earlier last month, state securities regulators in Alabama and Texas issued cease-and-desist orders against a Cyprus-based company that’s been hawking non-fungible tokens (NFTs). It was doing so to operate crypto casinos in the metaverse. The enforcement actions are both the first of their kind and likely not the last.

In a particularly gray (market) area that’s becoming a kind of “Whack-A-Mole” phenomenon.

“The ubiquity of crypto casinos is likely going to continue to expand,” says John Holden, an assistant professor at Oklahoma State University who studies gambling regulation. “It is difficult for governments to stay on top of them, because they are able to repopulate quite easily. The barriers to entry are quite low for those who are unconcerned with the risks of operating an unregulated casino.”

Sand Vegas Casino Club, the online casino cited by authorities, and its cofounders Martin Schwarzberger and Finn Ruben Warnke, allegedly offered 11,111 NFTs in an unregistered and allegedly fraudulent securities offering.

Their reported goal is to raise funds for the development of virtual casinos. Specifically, these casinos would exist in the popular metaverse worlds of Sandbox, Decentraland, Infinity Void and NFT Worlds. It seems to be Schwarzberger and Warnke’s dream to build and operate a casino run solely on cryptocurrency.

The problem is, they’ve allegedly been offering their NFTs as if they’re not securities.

TSSB nixes NFTs

According to the Texas State Securities Board (TSSB), the Sand and its cofounders marketed their “Gambler” and “Golden Gambler” NFTs as investment opportunities. They also allegedly promised potential buyers a share in the Sand’s future profits, and all but guaranteed investors a return of up to $81,000 annually.

“The key is, is this legal? Is selling NFTs with the promise to make a profit legal?” asks Joseph Borg, director of the Alabama Securities Commission.

Rhetorically: No.

Borg continues:

“It doesn’t matter if it’s a catfish farm or a metaverse casino, this is really a securities registration issue. If I sell you a gold mine in New Mexico or you buy a share in that, and I guarantee you a profit, then it’s a securities issue.”

Still under construction in the metaverse, the Sand Vegas casino, according to its YouTube channel, will feature bright lights, slot machines, card games, drinks — basically all of the perks and amenities available in a real casino. (Most online casinos still use US dollars to gamble. Plus, more importantly, in states where they operate legally, they’re regulated.)

Although Borg and his securities peers see the Sand Vegas scheme as an age-old scam (along the lines of selling bridges to noobs), the case raises myriad other issues.

What is money, really?

For one, Schwarzberger and Warnke may honestly believe what they’ve been telling potential buyers: that its NFTs are not regulated as securities, because securities laws do not apply to NFTs.

It’s a rather circular and perhaps self-servingly faux-naïve argument. Even so, when it comes to NFTs, or Bitcoin, or any other blockchain-based cryptocurrency, few people are crypto-literate enough to define an NFT, much less determine its legality or illegality. (Or when it comes to the metaverse, or the difference between mining and minting, etc.)

As of now, for example, the US Securities and Exchange Commission (SEC) has yet to pony up any sort of formal guidance on where and when NFTs would be considered securities.

Adding to the confusion is the ongoing debate over cryptocurrency: Is it money? Not money? Or “money”?

The IRS declared it “virtual currency” back in 2014, and still classifies it as “property,” not currency. But then in 2020, a federal court ruled that, in the District of Columbia, Bitcoin qualifies as “money.”

What is cryptocurrency, actually?

The main reason crypto casinos aren’t yet definitively legal or illegal hinges on the issues raised by cryptocurrency.

If cryptocurrency is legal, then unregulated crypto casinos would clearly become illegal, as would any third-party company facilitating the transfer of currency on and off them. It’s defined under the Unlawful Internet Gambling Enforcement Act of 2006 (UIGEA). That’s one law used to regulate online gambling.

Holden said:

“I think the US Government would pretty likely consider crypto casinos serving American customers to be operating illegally. The question about whether cryptocurrency is money is really an old question about UIGEA, but … there are various other federal laws, like the Illegal Gambling Business Act, that make no reference to money that relies on a predicate violation of state gambling, which only requires consideration, or something of value, which crypto almost certainly satisfies.”

Clear as mud, right?

“While many will say, ‘Meta-what?’ Metaverses — and the concept of a singular metaverse — present exciting new commercial and social opportunities,” stated Travis J. Iles, the Texas State Securities Board commissioner.

Iles further wrote in his What Happens in the Metaverse Does Not Stay in the Metaverse blog post on the TSSB site:

“Unfortunately, bad actors often attempt to capitalize on hype to defraud the public.”

Gambling in the metaverse

Science fiction author Neal Stephenson first coined the term metaverse in 1992. His novel Snow Crash detailed a meld of virtual reality (VR) and augmented reality (AR). The metaverse consists of a network of ostensibly three-dimensional worlds, in which users create avatars of themselves to interact with the virtual world.

Fast-forward 30 years, and metaverse casinos function pretty much like real casinos. Only, they exist in these virtual worlds, where players use avatars and cryptocurrencies to navigate the environment and play the games. (The first crypto casino launched from Malta way back in 2013. Today, there are several hundred that accept cryptocurrency as a payment method.)

The problem with Schwarzberger and Warnke’s plan, according to the TSSB, centers not on NFTs or crypto casinos themselves, but in how they want to fund the development and operation of their metaverse casino.

As stated on the TSSB site:

“Purchasers of the Gambler NFTs profit from these operations. Not only do they become owners of the metaverse casinos, but they also purportedly share in half of the profits generated from the metaverse casinos— including profits from gambling and profits from the sale of digital assets representing drinks and cigarettes.”

Jumping on the NFT metawagon

As TSSB Enforcement Division Director Joe Rotunda says:

“Our division opened an investigation into Sand Vegas Casino Club after uncovering information showing it was offering NFTs to the public, including Texas residents. The NFTs were very similar to a high-tech version of traditional stock. The NFTs conveyed ownership of metaverse casinos and the right to share in profits generated by the metaverse casinos.”

In other words, NFTs in this case could have been real dollar bills, or bananas, or Thor’s teeth. What matters to Rotunda is how they’re being used.

As Rotunda explains:

“My key goal is to make sure the public has the material information necessary to make a meaningful decision; regardless of whether that decision relates to digital asset investing or traditional products, like notes, bonds, or shares.”

However, because NFTs and Bitcoin have become the currency du jour, people see these new currencies as a way to cash in fast.

While they’re barely five years old, NFTs leaped from obscurity to worldwide sensation during that time.

According to NFTGO.io, the total market cap for NFTs went from $55 million several years ago to more than $7 billion in 2021. Plus, 90% of this increase came during just the last four months of 2021.

OpenSea, for instance, reportedly did around $10 billion in sales last year. It calls itself “the world’s first and largest digital marketplace for crypto collectibles and non-fungible tokens (NFTs).”

GameFi (game times finance), the play-to-earn ecosystem of virtual gaming environments based on blockchain technology, have become key to its business model.

Even so, after news of the cease-and-desist orders came down, OpenSea decided to bail on Sand Vegas. Almost immediately, it disabled buying, selling and transferring Sand Vegas tokens, saying the collections violated the platform’s service terms.

What do we want? Decentralization!

If NFTs and crypto casinos operated along traditional lines, being cut off from a forum like OpenSea might’ve spelled the end for a venture like Sand Vegas.

However, the whole point of NFTs and cryptocurrency is decentralization.

Alex Costello, the vice president of government relations at the American Gaming Association, said as much to NBC News in mid-April.

She says:

“This segment has exploded in a very short amount of time. And as a decentralized system, it makes it even more difficult to figure out how to go after them.”

Again, Whack-A-Mole.

When do we want it? Now!

Then again, maybe not every crypto casino is a nefarious mole. Last April, Atari opened a crypto casino in the 3D metaverse platform Decentraland.

Also the Flamingo Casino, another NFT-fueled gaming project, launched this past March. The owners plan to “break ground” on their virtual casino — an update of the famous Flamingo — in the Sandbox metaverse in June. It, too, will offer 11,111 VIP NFTs. It will also feature a hotel and nightclub, an arena, a movie theater, a hockey team (the Flamingos), bowling, tennis, craps, baccarat, blackjack, and a poker club and lottery. Perhaps even more alluring, the Flamingo Casino says it will distribute 50% of the casino profits to NFT holders. (Its motto seems to be: The user is the house.) So far, neither Texas nor Alabama has issued any orders against Flamingo Casino.

However, as pointed out in a 2021 white paper from the Global Betting and Gaming Consultants:

“The features which make blockchain-based cryptocurrencies attractive to users — decentralized, private and relatively anonymous — are exactly those features which cause governments and regulators concern.”

That paper also attributed the rise of crypto-gambling to users’ privacy concerns.

The paper says:

“Crypto-gambling’s growth is partly a reaction to the constant stream of new gambling regulation, which seeks to obtain more and more personal information about gamblers’ identity, income, and behaviour, and limit people’s spending until the information is provided. For this reason, VIP gamblers find crypto-gambling particularly suited to their needs.”

Crytpo casinos — the Wild, Wild West

And why Alabama and Texas (and Kentucky)? Are these states the future of crypto casinos?

Not really.

Turns out Borg and Rotunda are chairman and vice-chairman, respectively, of the North American Securities Administrators Association (NASAA) Enforcement Committee. Founded in 1919 on the heels of the Gold Rush, it protects consumers who purchase securities.

It’s this campaign to protect players and investors that has the Texas and Alabama authorities, and others, stressing over crypto casinos becoming a feeding ground for exploitation by criminal elements and (potential) gambling addicts.

In a MintDice blog from 2020, they touted the advantages of decentralized gambling over centralized gambling. They nevertheless admitted that the “absence of any stringent regulatory measures sometimes works in favor of criminals. Due to the anonymous nature of decentralized gambling, it has somewhat become the preferred financial plan for fraudsters.”

Or as Borg, Alabama’s securities enforcement director put it:

“Cryptocurrency is still the Wild West. And anytime there’s a new development or technology like this, there are always going to be fraudsters showing up and a lag before there’s regulation.”

Crypto casinos are unregulated

Jake Gray, a betting and futures industry consultant to operators, writes blog post for District of Columbia-based Ifrah Law.

Gray adds:

“Potential for user-error is extremely high when it comes to crypto casinos, which means someone can take advantage of you if you aren’t careful. And that potential is a function of how these blockchain applications are built currently.

“For example, there’s always an emphasis on the feature of anonymity, which means that you don’t know who or what you are getting involved with. Just because you can access a cryptocurrency token’s transaction history does not mean that information can be translated into restitution if you are the victim of a financial crime.”

Gray concurs:

“Whenever an industry is unregulated, especially if it’s over the Internet, there’s always this risk, and people are evidently and rightfully wary of being at risk.”

Risk on top of Risk

It’s the risk of addiction that has Keith Whyte, executive director of the National Council on Problem Gambling, worried.

As he said to NBC News:

“Crypto gambling is just piling risk on top of risk. They are unregulated, and so they are likely to be unscrupulous operators with little or no consumer protection.”

But the Sand Vegas’ owners seem to have caught the attention of securities regulators. Does that mean it was due to cluelessness or hubris?

“It’s a matter of somebody didn’t do their homework. Not the fact that it’s a casino in itself,” says Borg. “It’s the concept of what it is it and how they’re representing it. That’s why we issued the order.”

Gambling, added Borg, isn’t legal in Alabama. Crypto casinos are not legal in the US. So they’re all based elsewhere.

The meaning of ‘crypto,’ after all, is ‘hidden’

“The other thing that bothers me is that they make no distinction between the actual Sands Casino and theirs,” sighs Borg.

As the Texas order says, using the name “Sand Vegas” misleads the public. Even more so when “the company intentionally obscured its physical location and address … failed to disclose the identity and qualifications of various related individuals …”

There were more alleged wrongdoings. The order summarizes that “it had to do with disclosure.”

Borg concludes:

“If they’re legit, they’ll straighten it out.”

To which Schwarzberger and Warnke cheerfully responded:

“We are absolutely confident we can solve this situation and possibly even lead the way for other NFT projects.”

- Devon is a freelance writer in Santa Fe, New Mexico. He has written for The New York Times, Outside, and Rolling Stone, and is the author of Conspiranoia!
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