In the era of rapid growth of GameFi, how should Hong Kong seize the opportunity?

Original: 《Xiao Za Team | Under Regulation, How Will Hong Kong Embrace the "Barbaric Growth" of GameFi?》

Author: Xiao Za Legal Team

As mentioned in last week's article 《Official Media Releases Positive Signals, Is GameFi Promising in the Domestic Market?》, based on the hot article 《Deep Dive into the Value of the Video Game Industry: Seize the Opportunity》 and the situation regarding game approvals at the end of last year, many industry practitioners believe that China's attitude towards the gaming industry is gradually loosening. Meanwhile, Web3 players also want to take this opportunity to expand their horizons. The Xiao Za team believes that in the future, compliant virtual assets will gradually establish exchanges in various regions, and the overall regulation in China will be favorable for the development of GameFi.

In addition, we believe that Hong Kong will be the second development hub for GameFi. Today's article will focus on how GameFi can seize opportunities in Hong Kong from the perspective of regulatory regulations and related policies.

The Concept and Development Philosophy of GameFi

GameFi is a fusion of the words Game and Finance, referring to blockchain games that provide economic incentives to players, allowing them to earn while playing. The GameFi ecosystem utilizes cryptocurrencies, NFTs, and blockchain technology to create a virtual gaming environment. Typically, players can earn in-game rewards by completing tasks, competing against other players, and progressing through different game levels. They can also transfer their assets outside the game and trade them on cryptocurrency exchanges and NFT markets.

Looking back at the history of game development, from the 1990s to the early 21st century, players purchased console games from large companies like Nintendo, Sony, and Sega, supported by numerous game publishers and long supply chains. In the early 2010s, a new gaming model emerged: players could directly download games to Xbox or mobile devices to enjoy the gaming experience, with basic and simpler games being free, while more challenging versions required payment. By the end of the 20th century, some complex games allowed players to purchase items within the game, such as a new gun.

Entering the era of Web3 games, Web3 game developers are monetizing game assets, allowing players to own these assets within the games. Game assets can be freely traded on secondary markets, naturally leading to price volatility. As games become popular, the value of game assets rises, attracting more investors. In GameFi, assets can be issued or created as NFTs on the blockchain (also known as NFT minting), allowing players to have complete control over their assets, with authenticity and verifiable ownership.

In the gaming circle, GameFi is giving rise to the NFT market. In-game assets, such as rare weapons or items, can be exchanged with other players or rented out for a fee. Outside the game, GameFi's NFTs can serve as collateral for DeFi lending protocols and can be used for staking and liquidity mining. An increasing number of NFT games are establishing and selling on-chain virtual land as NFTs, combining it with cryptocurrencies to create interoperability between the time value in games and the real world.

Current Regulatory Status of GameFi in Hong Kong

Web3 games sit at the intersection of gaming and finance, with the underlying logic being blockchain technology and smart contracts, which are at the core of DeFi. Currently, there are no specific regulations targeting GameFi worldwide, but the overall trend is towards increased regulation of cryptocurrencies.

Although different games have varying business models and game economies, most game assets are NFTs operating on the blockchain, which can be freely traded on NFT markets. In other cases, assets within the game need to be converted into NFTs before players can trade or sell them. The Xiao Za team believes that regulation of GameFi can actually be approached from two main directions: (1) Do the assets in the game qualify as NFTs?; (2) Do game assets generate income and can they be considered an investment? If players generate income using tokens, then it should fall under the jurisdiction of financial regulatory authorities; if tokens are purchased solely for in-game operations and to enhance the gaming experience, they should not be blindly regarded as an investment and should not fall under regulatory scrutiny. Due to rising demand and limited supply, assets in games can increase in value, but it is not expected that they will generate profits.

Currently, Hong Kong does not have specific regulations for GameFi, but the policy declaration on the development of virtual assets in Hong Kong released in October 2022 can be applied: Hong Kong maintains an open attitude towards virtual assets. Since there is no requirement for game publishers to obtain licenses in Hong Kong, this is favorable for the development of GameFi. According to the definition of virtual assets in Article 53ZRA of the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022, "a type of encrypted digital value representation, expressed as account units or economic value storage. An asset whose function (or intent) is to serve as a medium of exchange accepted by the public for the payment of goods or services or the discharge of debts, or for investment purposes; and can be transferred, stored, or traded electronically." We cannot directly conclude whether NFTs fall under the category of virtual assets.

However, the current regulatory strategy of Hong Kong regulators towards NFTs still follows the FATF's approach, categorizing NFTs by function. NFTs with collectible value as artworks are not subject to regulation, while NFTs with securitization payment and investment characteristics will fall under regulation. The FATF also recommends that regulators in various countries adopt a case-by-case approach to regulate NFTs, clearly identifying the characteristics and attributes of NFTs in different situations to determine whether they are securitized, and not to focus solely on terminology.

Returning to GameFi, typically, assets in games provide players with a better gaming experience and more rewards. However, some game assets, such as avatars or ordinary costumes, serve purely aesthetic purposes and do not have a substantial impact on gameplay or earnings. However, if game creators promote or mention financial incentives while holding such assets, it is highly likely that these game assets will be regarded as securities. Some games allow players to generate passive income by staking or lending game assets to other players without playing the game.

In fact, the lack of regulation can, to some extent, provide opportunities and advantages for Web3 game players, but it is also a double-edged sword. Regulators will pay further attention to this field, sanctioning and eliminating subpar practitioners while retaining credible actors that bring positive significance to the market. Given the cryptocurrency crisis of 2022, countries are emphasizing transparency in their regulatory attitudes towards cryptocurrencies, focusing on protecting investors' interests.

Conclusion

Although GameFi does not have specific regulatory laws and regulations, it does not mean there is no regulation. The Xiao Za team believes that during this transitional period, there are still many opportunities for GameFi to seize. However, if more incidents similar to FTX occur in 2023, GameFi may face a crisis of trust, not only under pressure from venture capital supporters and retail investors but also increasing vigilance from regulators worldwide, leading to stricter regulations. Players in the gaming circle should be cautious in promoting the nature and use of game assets, and if there is a trend towards securitization, they need to be even more prudent in refining relevant information to avoid risks.