The Metaverse and NFTs

Standards, governance and regulations are the foundation of the modern digital world. They allow systems to work together as a harmonious whole. For example, the Transmission Control Protocol/Internet Protocol (TCP/IP) standard defines how communication works on the internet, which means that people can connect and do online tasks without worrying about how to connect their computers. Web 1.0, 2.0 and 3.0 work in much the same way by enabling anyone to use their web browser and applications to interoperate with servers and systems across the planet. No one needs to worry about whether a website will work in a browser because standards require that all browsers accept HTML, JavaScript and other web-based languages.

For the metaverse to operate in the same transparent manner, standards, governance and regulations are required. With standards, people will be able to transfer their virtual possessions between worlds at will in a frictionless way. They will be able to travel into a world, then leave and move on to the next one in much the same way that people currently traverse the web, moving from website to website.

One emerging digital asset is NFTs (non-fungible tokens); they provide new entrepreneurism for individuals, businesses and investors. This technology enables more immersive, valuable and pervasive experiences and offers various options for gaming, industry, retail and other businesses. For example, in gaming, NFTs support in-game ownership of assets and land; supply chain management can take advantage of NFTs for better recordkeeping; and genealogical information can be recorded and shared.

NFTs (as well as many additional technologies) form the foundation for the metaverse. They give people a way to own the copyrights of digital assets and to execute smart contracts that give them personal control over royalties and compensation. The ownership concepts of NFTs reflect the broader promise of true ownership of assets, in effect merging the digital and physical worlds.

Businesses must also consider NFTs, blockchain and the metaverse when creating their overall digital transformation strategies. The emerging technology of NFTs will provide greater customer utility, driving greater brand value creation. Yet, there are challenges to their broader adoption for use by the masses.

• Blockchain overhead. NFTs are based on blockchain technology with all the associated overhead in the use of computer resources. Because NFTs are decentralized and copies exist on every network node, they can take up massive amounts of disk space, and because they cannot be deleted, this space is used forever. The storage and bandwidth considerations must be addressed.
• Proof-of-Work bottleneck. The Proof-of-Work method is a consensus method that uses phenomenal amounts of energy to the point where it significantly contributes to climate change. Better and more efficient consensus algorithms exist, and new ones will be developed in the future. Until they become mainstream, the future of NFTs will be constrained.
• Transaction fees. Transactions are not free—you can expect to be charged a hefty fee each time you implement an NFT or perform a transaction. These fees are based on the network activity at the current point in time; for mainstream adoption, these fees must come down by order of magnitude.
• Because NFTs are investments and can represent assets in the physical world, it won’t be long before regulators step in. The developers must form rules to prevent the marketplace from being stifled. The law has not had enough time to catch up to the fast pace of NFT and blockchain development. For instance, smart contracts are a great idea, but they haven’t yet been seriously tested in court. While NFTs are intended to provide proof of ownership (among other things), enforcing that ownership in the physical world is legally untested. If I associated an NFT with my home, does that mean I’m the owner? Will a court accept that as evidence or proof of ownership? These types of questions remain open.
• Lack of privacy. The lack of privacy is one of the biggest impediments to the widespread adoption of NFTs. Because the transparency of ledgers is part of the blockchain and NFT design, this will be a challenging problem to resolve. In many ways, NFTs and blockchains must ensure privacy when warranted before the public will accept them in their everyday lives.

The early internet suffered from many of these same (or similar) problems early in its development, rollout and adoption. Those problems were, to a greater or lesser degree, solved. Because NFTs and blockchain are new technologies, barriers to adoption will most likely be addressed and resolved.

Regulation and Enforcement

As digital assets become more popular and have greater use, regulatory agencies will inevitably be formed to help prevent fraud, place money-laundering barriers, develop taxation mechanisms, require reporting and protect consumer privacy. Requirements for security might also be regulated.

As with many modern technologies, existing regulatory standards and laws are not suited initially for digital assets of all forms, including NFTs. Because NFTs are often investments and cryptocurrencies are money, governments will likely step in sooner rather than later.

In 2022, President Biden signed an executive order to set national digital asset policies. This order “requires the Attorney General, in consultation with the Secretary of the Treasury and Chairman of the Federal Reserve, to make a recommendation as to whether legislation is necessary for the development of a US CBDC within 180 days.” The order also directs and encourages existing financial regulators to expand their activities within existing mandates, requires a whole government response and sets up the conditions for digital assets legislation such as:

• Securities. Many NFTs are used to accomplish goals outside of the realm of securities. Meanwhile, regulators might soon classify some NFTs as securities. This would allow those NFTs to fall under securities law, subject them to taxation and restrict their reselling.
• Anti-Money Laundering (AML). To fight crime, the US government has established a suite of regulations and policies requiring banks and financial institutions to implement procedures to reduce or eliminate the practice. If NFTs become subject to AML regulations, suspicious transactions will need to be reported.
• Copyright. Copyright for digital assets, including ebooks, blogs, music and videos, is difficult and expensive to enforce if violations are detected. Copyright needs substantial change to address digital assets, and those changes will likely happen sooner rather than later.

Laws vary from nation to nation (and in some countries, from state to state). Governments will inevitably formulate their regulations, but they must coordinate their efforts to present a united front. The effect on the environment is another area of consideration.

NFTs and the Environment

We’ve already discussed how NFTs and blockchain use substantial amounts of energy. NFTs and blockchains are responsible for significant energy usage worldwide because of their centralized design and consensus mechanisms. Long term, these issues must be addressed through redesign, because they will interfere with the scalability of this technology.

Some ways to address these issues in the short term include using carbon offsets (such as planting trees to match the carbon emissions). Powering mining data centres using renewable energy is another solution. Neither is a long-term solution because you can only do so much with carbon offsets and renewable energy.

Using a different consensus algorithm, such as Proof-of-Stake, requires much less energy. Switching to these alternative consensus algorithms could reduce the energy requirements (as well as reduce the gas fees for transactions). Additional viable solutions include batching multiple transactions together so that minting algorithms can mint many transactions simultaneously (i.e., batch minting) or delaying the minting until an NFT is sold.

NFTs and their underlying technologies present the case for the benefits of decentralization, and in a sense, break the traditional paradigm of a centralized approach to ownership and use of assets. In the metaverse, NFTs will help usher in greater interoperability and control. The metaverse and its many use cases such as NFTs have the potential to unleash human creativity and business innovation in ways we are only beginning to understand.