Future of Finance


How banks can make money in the Metaverse

A summary of the webinar of June 17 2022 entitled How banks can make money in the Metaverse?


What is the Metaverse?

Definitions of the Metaverse tend to be either verbose and obscure or too succinct to explain anything. A lack of familiarity with the virtual world of gaming – the current version the Metaverse is almost indistinguishable from a multi-layer game, even in terms of its use of design, characters and storytelling – is an obstacle for many people. 

But the main source of the opacity is the sheer novelty of the concept of the Metaverse. There are not enough live examples of the Metaverse in action to define whether it is a further iteration of Web 2.0 (the Internet plus social media) or a first step towards a Web 3.0 future (a decentralised and tokenised society and economy). For the present, however, the Metaverse is still dominated by the mentalities and methods of games makers.

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The Metaverse is not one universe but many. How will metaverses talk to each other to create a network of networks we can call The Metaverse?

The Metaverse as a reality – as opposed to an idea – is not a single network. It is emerging as a collection of networks, of which h Meta is one, alongside Decentraland and The Sandbox. A report by NonFungible.com counted 47 separate metaverses.  This raises the question of how the various metaverses can inter-operate to create a network of networks that can justifiably be called The Metaverse. 

The method by which the Metaverse will interconnect with the real world is Oracles – the blockchain devices that provide external data to smart contracts. Oracles can also be used to connect metaverses on different blockchain networks (at least public ones). 

However, there is a constituency in the Metaverse economy – namely, the gaming providers – that has a limited incentive to support inter-operability, in much the same way that pioneers of the Internet (such as AOL) tried to turn the Internet into a series of “walled gardens.”

Resistance to inter-operability is contrary to the principles which have inspired the blockchain revolution ever since Satoshi Nakamoto published Bitcoin: A Peer-to-Peer Electronic Cash System on 31 October 2008, outlining a decentralised, un-intermediated, anonymous method of payment. 

The Web 2.0 era is still founded on centralised intermediaries and proprietary data, whereas the promise of Web 3.0 is a future characterised by cross-chain flows of open data between inter-operating but decentralised networks. 

Oracles enable that communication to take place between networks, whether they are in the virtual world or the real one. Without such data flows it will be impossible for inhabitants of any metaverse to lay claim to a particular identity or history or asset. 

In fact, one way of characterising The Metaverse is to think of it as a tokenised economy or identity layer, in which Non-Fungible Tokens (NFTs) attest to ownership of an identity or history or asset. In other words, tokenisation contains the technical possibility of bypassing the efforts of gaming providers to contain metaverse activity within “walled gardens.” 

However, to be truly effective, the quantity of digitalised information Oracles can tap – and tap without infringing intellectual property or other ownership rights – needs to be expanded significantly. 

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Does the Metaverse need regulation?

When social media – the emblematic expression of the Web 2.0 era – emerged, there was some discussion about whether it needed its own legal and regulatory regime. The novel forms of organisation (Decentralised Autonomous Organisations, or DAOs) and transactional activity (smart contracts) created by Web 3.0 models have prompted a similar debate. 

So far, legal and regulatory constraints on social media are largely confined to privacy and data protection, though the continuing thefts of cryptocurrency and use of cryptocurrencies to circumvent taxes and financial crime controls has already led to a tightening of retail distribution controls in some jurisdictions and an increased emphasis on Anti-Money Laundering (AML) in all jurisdictions. 

Frauds are already occurring in metaverses, and breaches of intellectual property (IP) rights in the NFT markets are also rife. These are presently being tackled by using existing laws. The likeliest prompt for specific legal and regulatory action by governments that encompasses The Metaverse is mass market adoption: regulators are always looking to protect retail investors.

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Do avatars in the Metaverse have a secure legal status?

Individual consumers active in The Metaverse will be represented there – including in any transactions they engage in – by their avatar.  At present, the law does not recognise avatars as separate from the identity of the individual behind them. Breaches of IP (especially that of celebrities) are already commonplace in The Metaverse.

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How are transactions going to take place in the Metaverse as a marketplace?

The Metaverse is already functioning as a marketplace, because NFTs provide provable rights of ownership. Avatars are exchanging and lending and using as collateral assets in the form of NFTs, which represent ownership of virtual (and, in due course, real) assets. All that consumers need to start transacting in a metaverse is an account within that metaverse linked to their digital wallet.

When an NFT is sold, the payment is made in cryptocurrency to the digital wallet of the seller, while the NFT is delivered to the digital wallet of the buyer. The cryptocurrency can take the form of, say, Bitcoin or Ether already in the digital wallet, or it can be a cryptocurrency specific to a particular metaverse, which is earned as a reward for taking part in certain activities within that metaverse (such a SAND in The Sandbox or MANA in Decentraland). 

This generation of value within a particular metaverse is another argument for inter-operability between metaverses. Inter-operability means cryptocurrency earned in one metaverse can be used to pay for an asset in another metaverse, or be used as collateral for a loan in another metaverse, and that an asset in one metaverse can be sold in another metaverse. 

Once a cryptocurrency needs to be converted into fiat currency, a bank is needed to provide the “offramp” from the metaverse to the real world.  However, the experiments by Meta with using its Novi digital wallet [which is  now being closed by September 2022] in conjunction with the USDP Stablecoin to buy and sell NFTs on Instagram showed that user-friendly on and off-ramps are possible without bank intermediation. 

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Why are investors buying real estate in the Metaverse when “land” is in infinite supply in the Metaverse?

According to a report by NonFungible.com, 133,500 transactions took place in The Metaverse in 2021, many of them sales of real estate. The fact that real estate sales occur at all, in a medium in which the marginal cost of creating more “land” is virtually zero, have puzzled many observers.

However, metaverses (such as The Sandbox) have succeeded in restricting the supply of “land” in their metaverse. Once it is sold out, the only way for investors to build a presence in a popular metaverse is to buy real estate via a secondary market transaction. These, according to the NonFungible.com report, have almost all proved profitable for the sellers.

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Are retail investors in the Metaverse being exploited by professional investors as they are in the cryptocurrency, DeFi and NFT markets?

Regulators (at least in the United Kingdom) are now extremely alive to the risk that retail investors will be exploited by professional traders in The Metaverse, though the activities and the instruments currently remain outside the regulatory perimeter. The regulators have difficult choices to make, because they do not want to discourage the small faction of activity that is genuinely innovative.

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32.27: What are the roles that banks can play in the Metaverse and what services can they provide?

An important question is whether the role of banks in The Metaverse is restricted to provide on- and off-ramps to fiat currency. Even that role might be truncated if central bank digital currencies (CBDCs) become available in the major currencies and can be accessed by non-banks.

Banks are also exploring whether services they supply other than payments in the analogue world – such as accounts, loans, foreign exchange (FX), custody, brokerage and collateral management – are needed in The Metaverse.  Certainly, they face competition to dominate the Metaverse from cryptocurrency exchanges and brokers such as Coinbase, FTX and eToro.

Obvious openings for the traditional banks in The Metaverse include lending to purchase virtual real estate, creating and maintaining digital identities for customers and insurance of digital assets (rather as they implicitly insure real world assets by offering safe custody services in traditional financial markets). The forms of crypto-asset insurance currently available could not compete with a bank product.

With The Metaverse at such an early stage in its development, banks that are opening branches in metaverses staffed by avatars that can engage with the avatars of customers are really engaged in a marketing exercise: signalling to consumers (and especially young consumers) that they have the understanding and the technical capabilities to operate in The Metaverse. 

Banks are also conscious also of their regulated status and will tend to constrain riskier activities – such as credit advances against crypto-assets as collateral and crypto-asset insurance – until their regulators provide them with clarity on the regulatory status of any activity. 

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Will KYC, AML, CFT and sanctions screening checks be done differently in The Metaverse?

The extension by the Financial Action Task Force (FATF) of its 40 Recommendations on Anti-Money Laundering *(AML) and Countering the Financing of Terrorism (CFT) to the cryptocurrency markets dates back to 2018. 

However, adoption of the Recommendations – and especially of the Travel Rule, which obliges cryptocurrency intermediaries to disclose the identities of both the sender and the beneficiary of any payment above a certain size – by the various jurisdictions around the world is patchy. 

The Metaverse is undeniably subject to the Recommendations and, because effective forms of digital identity have yet to be adopted by any major jurisdiction, service providers within the Metaverse are condemned to carry out AML and CFT checks in the same clumsy and expensive way as their counterparts in traditional finance.

One obstacle to adoption of digital identities is, paradoxically, the public nature of information held on classical blockchains. In short, a blockchain is an unsound foundation for storing the information that makes up a digital identity, so identity information will always have to be held off-chain. 

Indeed, in some ways, transparency of transactions and counterparties is greater on blockchains than in traditional finance. Though “mixers” or “tumblers” can enhance the privacy of blockchain transactions, they tend to attract regulatory attention.

That said, public blockchain addresses can be tied to information that affirms a valid customer due diligence process has proved an identity to be clean from an AML and CFT point of view. Keys to digital assets – including the NFTs and other tokens that can be traded in the Metaverse – can be tied to digital identities too. 

To be workable, however, the information making up a digital identity has to be held in a secure digital wallet whose contents are useable not just across multiple blockchains (or metaverses) but across Web 2.0 applications as well.

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Will the tokens and NFTs used in the Metaverse rank in legal and regulatory terms as securities?

Whether an NFT ranks as a security is already a live question in major financial centres such as the United States, the United Kingdom and Singapore. In the United States, which has made the most progress of any jurisdiction in distinguishing tokens that are securities, any token that qualifies as a security under the Howey Test will indeed rank as a security. 

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Is the current state of technology (particularly the headsets) capable of supporting a Metaverse which has mass market appeal? 

Mass participation is essential to the use and creation of entertaining or useful content in The Metaverse. Yet mass participation is not compatible with the current technology. 

At present, consumers participating in The Metaverse must put on a helmet that covers their face and hold and operate a pair of devices in their hands. This is uncomfortable. Pending the introduction of biochips (of the kind Elon Musk is sponsoring with Neuralink) the poor user experience associated with this clumsy technology will remain a barrier to adoption. 

Other barriers include the limited speed and scale of blockchain technology; bandwidth constraints, including patchy adoption of 5G networks; and limited inter-operability between blockchain protocols. It is not unknown for metaverses to crash when too many users are on-line.

Technologically speaking, the Metaverse is at the “brick” stage that mobile telephony reached in the 1980s. Metaphorically, that means the technology is bound to improve as the current divisions between Virtual Reality (VR), Augmented Reality (AR) and Extended Reality (XR) converge over the next 15-20 years into a consumer-friendly means of accessing The Metaverse. 

The amount of venture capital being bet on such a convergence suggests informed minds believe it will happen, and that it will rely on a solid technological infrastructure underpinning it. Once a reliable infrastructure is in place to support a metaverse, investors will start to create compelling content for it on a single platform. 

Another important technological constraint that is often forgotten is the reliance of The Metaverse on novel concepts such as smart contracts (that execute transactions automatically when conditions are met or criteria are satisfied without intermediation or counterparty risk) and DAOs (the governance mechanisms behind the applications available in The Metaverse). Neither is yet well-described in law. 

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Is the Metaverse about to be taken over and emasculated by large corporations or does it have sufficient strength to transform capitalism by digitising everything?

The strongest version of the Turing Principle holds that a computer can simulate any physically possible environment. The Metaverse in its final incarnation might be the apotheosis of this way of thinking: the Matrix-like point at which the distinction between reality and simulation is invisible.

Yet at the same time The Metaverse is already at risk of becoming the plaything of large corporations such as Meta and Microsoft, which will blunt its capacity to turn capitalism on its head by putting consumers in control through the ownership and management of the data they own and create. 

There is a risk that Microsoft ends owning the Metaverse of work; Facebook or Meta owns the Metaverse of Play; and Amazon owns the Metaverse of shopping.

Smart contracts, for example, could easily degenerate into a form of corporate control, in which consumers have minimal say over their purchases and investments. Unless consumers as well as metaverse designers and developers and builders engage aggressively and intelligently with the Metaverse now and help to create its future form by purchasing as well as making the most open products and services, this is the likeliest outcome.

An alternative outcome is that Web 2.0 corporations such as Microsoft, Meta and Amazon are overtaken by Web 3.0 corporations committed to decentralisation and tokenisation. Venture capital may already be backing some of those giant businesses of the future. 

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If you would like more information or we can assist in any way or you would like to join future discussions please email Wendy Gallagher on wendy.gallagher@futureoffinance.biz