Written evidence submitted by Mr Leon Y. Xiao

I. Introduction

1. This is a written response to the UK Digital, Culture, Media and Sport Select Committee of the House of Commons’ Inquiry on Non-fungible tokens (NFTs) and the blockchain launched in November 2022.[1]

2. Leon Y. Xiao is a PhD Fellow at the IT University of Copenhagen, a Visiting Scholar at the School of Law of Queen Mary University of London, and a Student Member of The Honourable Society of Lincoln’s Inn. He researches the regulation of video games, particularly that of loot boxes and other gambling-like mechanics.

3. I declare the following as a potential conflict of interest: I have been invited to provide advice to the Department for Digital, Culture, Media & Sport (DCMS) on the technical working group for loot boxes and the Video Games Research Framework. In that regard, I have attended one working group meeting and one workshop. My complete, up-to-date conflict of interest declaration is available via: https://sites.google.com/view/leon-xiao/about-me/conflict-of-interest.

4. I address the first question in the Terms of Reference: ‘Is the UK’s light-touch NFT regulation sufficient?’ Specifically, I highlight the potential harms of NFTs and video game loot boxes converging.

5. I assume that the Committee is familiar with the UK Government response to the call for evidence on loot boxes in video games published in July 2022[2] and the relevant academic literature on loot boxes.[3]

6. I note that the Committee, having published a report that in part dealt with loot boxes in 2019,[4] was one of the first groups of policymakers anywhere in the world to recognise, spotlight, and attempt to address the potential harms of loot boxes. Accordingly, I assume that the Committee remains interested in relevant developments relating to loot boxes (particularly, scrutinising DCMS as to whether the proposed industry-led self-regulation of loot boxes will sufficiently address their potential harms and demanding DCMS to change its policies and take legislative action if needed), and, in relation to this Inquiry specifically, the convergence between NFTs and video games.

7. I highlight two types of novel products that have recently been published: (i) video games in which players can purchase loot boxes containing NFTs and (ii) so-called virtual ‘blind boxes’ that can be purchased to obtain a randomised selection of NFTs of varying scarcity and monetary value.

II. Convergence of NFTs and Loot Boxes

8. I illustrate the first type with an example: in Gods Unchained (Immutable, 2021; https://godsunchained.com/), the player is able to purchase ‘card packs,’ a form of loot boxes, directly using cryptocurrency (and therefore indirectly using real-world money, i.e., fiat currency, including pound sterling). Just like loot boxes in other games, what exactly the player will obtain from the card packs is randomised. The game’s operating company discloses so-called ‘drop rates’ or the probabilities of obtaining specific rewards.[5] However, what is noteworthy about Gods Unchained is that the rewards obtained through purchased loot boxes are NFTs.

9. Based on a recent judgment, I proceed on the assumption that NFTs are property under English law and have real-world monetary value.[6]
10. According to the UK Gambling Commission’s interpretation of the Gambling Act 2005,[7] such loot boxes in Gods Unchained containing rewards possessing real-world monetary value would legally constitute ‘gambling’ and would require a licence before they can be offered for sale. (The vast majority of video game loot boxes presently escape gambling regulation in the UK due to them not containing rewards possessing real-world monetary value.) To my knowledge, the UK Gambling Commission has not granted a licence relating to cryptocurrencies and/or NFTs.[8] The offering of such loot boxes containing NFTs for sale in Gods Unchained is therefore, in my view, illegal under UK law.

11. As far as I can ascertain, Gods Unchained has not taken any technical measures to prevent UK players from accessing its website and purchase loot boxes. Thusly, through illegal loot boxes containing NFTs, UK players are being exposed to the risks and potential harms involved with unregulated gambling.

12. It should also be noted that the mere possession and holding of NFTs and cryptocurrencies will potentially cause its owners to lose significant amounts of money, as demonstrated by recent price crashes. This is unlike traditional video game loot boxes that are bought with real-world money, whose underlying value is unlikely to experience a similar price crash.

13. Therefore, in my view, loot boxes containing NFTs are potentially more harmful than regular video game loot boxes that do not contain rewards possessing real-world monetary value. However, the UK Government response regarding loot boxes made no reference to this novel form of loot box implementation.

III. Sale of Randomised Selections of NFTs

14. I illustrate the second type with another example: NBA Top Shot (https://nbatopshot.com/), which is an ‘Officially licensed product of the National Basketball Players Association.’ This can be conceptualised as a loot box without a video game. The customer can purchase ‘packs’ containing randomised NFTs of varying rarity and monetary value,[9] but the NFTs have no gameplay purpose or value (unlike in Gods Unchained, where they are played with). The NFTs are held simply as NFTs for whatever purposes non-video game NFTs are possessed.

15. As similarly reasoned in Paragraph 10 above, applying the UK Gambling Commission’s interpretation of the law, the offering for sale of these ‘packs’ would constitute the provision of illegal gambling. I do not believe the company operating NBA Top Shot has a gambling licence in the UK, and it does not appear that UK customers are being blocked from accessing the NBA Top Shot website or purchasing these ‘packs.’ The same concern raised in Paragraph 12 is again relevant.

16. I note that physical packs of trading and collectible cards are currently not regulated as gambling in the UK, despite them being an obvious contravention, if the UK Gambling Commission’s reasoning as to the legality of loot boxes is applied. It is difficult to justify only regulating virtual packs of NFTs, when physical card packs continue to remain unregulated. Doing so might well be unfair discrimination of one industry over another.

IV. Recommendations

17. I recommend that the Committee specifically highlight the existence and potential harms of (i) video game loot boxes containing NFTs and (ii) packs of randomised NFTs that UK consumers can seemingly easily purchase.

18. I recommend that the Committee take action to ensure that video game loot boxes containing NFTs are adequately addressed by the DCMS through its current industry-led regulatory approach, and if that is not feasible, then demand the DCMS to change and harden its regulatory approach.

19. I recommend that the Committee ensure that DCMS actively communicates with the UK Gambling Commission to ensure the active and prompt criminal prosecution of any companies selling video game loot boxes and/or ‘packs’ without an overarching video game that contain randomised NFTs and are therefore illegal under the Gambling Act 2005.

20. I recommend that the Committee raise the uncomfortable state-of-affairs in relation to physical card packs’ current unregulated nature with the DCMS, as unless this is resolved (by enforcing the law as written), it would otherwise be difficult to justify regulating more novel products involving NFTs.

V. Concluding Remarks

21. We can only expect the two types of products described above to become even more popularised in the coming years. There might also be other forms of novel products involving NFTs that I have not personally seen or have not yet been invented.

22. I have not addressed other potential issues arising from the inclusion of NFTs and blockchain technology within video games (children’s involvement with so-called ‘pay-to-earn’ video games). I believe others are better placed to comment on those matters.

VI. Legal Disclaimer

23. The views and recommendations expressed herein are those of Mr Leon Y. Xiao personally, based on a reasonable search and analysis of publicly available information. No representation or warranty is given as to the accuracy or completeness of the information provided; other people considering the same might reach different conclusions from those reached by Mr Xiao. To the extent permissible by law, Mr Xiao accepts no liability or responsibility, whether in contract, in tort (including negligence), under statute or otherwise, in respect of any loss or damage (whether direct or indirect) suffered by any party: (i) as a result of, or in connection with the content of, or any omissions from, this response; and/or (ii) as a result of any actions taken or decisions made by any person as a consequence of the views and recommendations contained herein.

LEON Y. XIAO

9 November 2022