7.1 Introduction

The third phase of MLFT is that of integration into the legal economy. The legal economy is where the funds are converted into the assets that can be enjoyed. The enjoyment entails both legal fiat currency and luxury items as “reward” for criminal activities. The various convictions of money launderers demonstrate the different rewards criminals provide themselves with. These type of goods include investing in real estate, luxury cars and holidays.Footnote 1 These type of luxury items are popular rewards that need to be integrated into the economy. The advantage for legislators is that owning a luxury car is noticeable. A car must be purchased to someone’s name as must its insurance the same applies to real estate. In most developed jurisdictions the tax authorities will raise questions if someone on a low income manages to buy an expensive car or house. Money launderers therefore need to find a way to integrate their dirty funds to clean legal funds. In a sense this process makes it easier for law enforcement to discover the money laundering. This process is no longer a necessity within the Metaverse.

In order to regulate the Metaverse (and other online environments) new thinking needs to be generated with regard to the ‘legal economy’. Remember the example given in the introduction of this book. Would you enjoy attending a virtual musical? Let us imagine that the money launderer is a fan of musicals. Instead of buying a musical ticket (and the journey around it) the launderer only needs to buy a virtual ticket. Attending a virtual concert through Metaverse can be done anonymously and without the need for conversion into a good or fiat currency. Thus raising the question of whether the “legal economy” should include virtual assets? This chapter will start with continuing the discussion on how to define the “legal economy”. It will further continue by assessing the integration phase through the Metaverse into fiat currency and physical products.

7.2 Defining the Economy

The economy is generally described as the legal and informal economy. The distinction between the legal and informal economy is drawn by a line of law.Footnote 2 The informal economy is one that is not covered by a law, yet not all informal economies are equally bad. The informal economy consists of both the informal economy and the illegal economy.Footnote 3 Both are separated from the legal economy but the degree of moral culpability is generally considered different.Footnote 4 Generally speaking society considers human trafficking of a greater moral culpability than two kids mowing the neighbor’s lawn for some pocket money without filing tax returns. Thus generating a form of “grey” money and “dirty money”. The launderers aim will be to promote the dirty money to either grey or the legal economy to enjoy. The key difference between the Metaverse and traditional legal economy is that of the virtual location.

The lines of legal economy and its various shades of grey with regard to the informal economy are vague. Nevertheless both these economies take place in the physical realm. The neighbor kids mowing a lawn, earn their money in a the jurisdiction where they mow the lawn. A criminal setting up a business whereby money is laundered through fictitious bills has the business located within a jurisdiction. A drug dealer buying expensive items through cash or online, conducts that purchase and receives the goods or services in a jurisdiction. The Metaverse, however, is offered through different virtual reality providers. Purchasing goods and services or establishing a firm in the Metaverse challenges the notion of jurisdiction. Jurisdiction can occur through the terms and conditions operated by the virtual reality provider. The AMLD5’s main response to integration is through the regulation of exchange services. Companies or professionals who exchange virtual currencies to fiat currencies fall are regulated in the AMLD5. This response is no longer sufficient in response to MLFT, when considering the Metaverse.

In 2016 the ECB gave its opinion on the proposed AMLD5. The ECB considered

[…]that digital currencies do not necessarily have to be exchanged into legally established currencies. They could also be used to purchase goods and services, without requiring an exchange into a legally established currency or the use of a custodial wallet provider. Such transactions would not be covered by any of the control measures provided for in the proposal and could provide a means of financing illegal activities.Footnote 5

The ECB’s concern with regard to virtual assets not needing conversion to fiat currency increases through the Metaverse. Not only because it will be possible to purchase physical goods but also due to the possibility to consume virtual goods. The FATF considers a similar risk by stating “[the] issue may become more challenging as there is greater mainstream adoption of virtual assets and the lines between virtual assets and traditional financial assets become more blurred.”Footnote 6 The concept of what constitutes the real economy therefore needs redefining.

Generally speaking the economy is considered to be “real”, consisting of assets and transactions within the physical realm. The ECB report on virtual currency schemes does not assign monetary risk to virtual currency schemes unless real goods and services can be purchased.Footnote 7 This type of definition might include services purchased and consumed online i.e. translation during a virtual meeting. It is however unlikely to include virtual assets. Similarly the AMLD5 considers that the virtual currencies that are exclusive to an in-game environment are not considered virtual currencies. These currencies are not considered to have any value. The virtual currencies remaining within the virtual environment remain free from supervision. The anonymity is lifted when the currency is exchanged against fiat currency. Thus providing a safety net upon MLFT.Footnote 8 This reasoning works when one considers MLFT a virtual crime with effects in the real world.Footnote 9 Arguably then by regulating the exchange facilities MLFT is prevented. This reasoning however fails if we consider virtual assets to have value as an asset to enjoy rather than to exchange.

The Metaverse realities currently in existence offer virtual concerts and other events. In addition to events the virtual reality of the Metaverse will allow for the purchase of virtual goods and services. The integration of assets into the real economy is therefore changing. There is the argument that virtual crimes cannot be considered a crime unless there are ties with the real world.Footnote 10 This argument should be considered outdated by the introduction of virtual reality. The question of virtual goods and value is often considered through a link with the real-world. Whereby value boils down to how we understand the nature of the in-world reality.Footnote 11 If the if virtual worlds are no more than playing a game the assets should not be considered a risk. Value is thus distinguished along the lines of uni and bi-directional flows. This assumption, so the article continues, rests upon the notion that all participants are there to play a game rather than monetary motivation.Footnote 12 The ties with the real world become less useful as the Metaverse develops. As the Metaverse will enable the consumption of virtual goods that may not offer a direct link to monetary values in the real world. The Dutch Supreme Court therefore considered that the forced deprivation of virtual assets constituted theft.Footnote 13 Rather than a real world or monetary approach the Supreme Court considered that the goods had real value for the possessor.Footnote 14 This real value for the possessor generates a subjective approach. The approach does not value the goods based upon a monetary claim but on a value claim. This type of reasoning would allow for the inclusion of goods and services that can no longer be valued upon fiat money. This argument is novel for legal thinking as it lets go of ties with the real world. It is economically, however, a well-accepted line of reasoning.

In 2002 economist Castranova considered with regard to virtual items, that the value was subjective and depended on the contribution to the consumers well-being.Footnote 15 If a virtual concert therefore contributes to the criminals idea of well-being, it should be considered as a reward for its criminal actions. The virtual asset is enjoyed and has therefore entered the integration phase. This should be considered true even when the asset cannot be valued upon fiat currency. This theory of subjective value is well accepted by economists as Castranova explains using the example of a diamond. Diamonds are considered highly desirable and thus highly valuable. The high price is not based upon objective characteristics but on subjective market value. This market value is accepted by economists as the objects real value.Footnote 16 Hence virtual objects can also be considered as having value, depending on the market’s and individual’s subjective judgement. There is however a counter argument namely that virtual items in large quantities would never bring the same satisfaction as real world assets. Yamaguchi reflected upon Castranova by creating an important distinction between the real world and virtual world economics. The difference is that the marginal utility (how much benefit the next object brings) becomes negative in the virtual reality.Footnote 17 The decrease in consumption satisfaction would suggest that a real world connection is always needed. In simpler terms a high value watch or watches would add to the feeling of status when worn in real life. In a virtual environment these luxury items would very quickly lose its status. The assumption made by Yamaguchi, however, is that the real self has more than one virtual self.Footnote 18 This assumption will no longer be true when considering the Metaverse. The Metaverse will allow the avatars to wonder throughout different worlds without the need for multiple avatars. Thus blending the digital identity with the real self. Furthermore Yamaguchi differs virtual goods from physical goods. A concert can be enjoyed fairly similarly physically and virtually. This relatively close type of consumption satisfaction blurs the line between virtual and physical consumption. The assumption that virtual items reduce in marginal utility decreases therefore no longer holds true. There is therefore ample reason to wish to regulate the sale of both physical and virtual items. In particular because it is unlikely that anonymity will be lifted from all methods of payment. The physical equivalent of anonymous currency in the real world is cash. Cash payments are regulated.

When a transaction in cash is made of €10,000 or more businesses have the obligation to conduct a due diligence investigation.Footnote 19 These businesses have no such regulations to obey. Thus the transaction supervision fully rests upon the payment structure used by the customer. As discovered in the previous sections, however, not all of the wallets currently require supervision. It is therefore risky to solely rely on wallet supervision. The current directive restricts the use of cash transactions. Cash transactions do not directly equal virtual currencies. Cash plays an important role in MLFT because it carries little tracing risk.Footnote 20 Even in the time of electronic payments cash is preferable to most MLFT. It is difficult to follow for authorities and cash does not reveal its origins.Footnote 21 Virtual currencies, even when transacted through anonymous wallets, have an encrypted ledger trail. Thus making them less attractive compared to cash. This provides argument to consider the unregulated shops less of a risk. This, however, is not a valid argument for two reasons.

The first is that there are virtual currencies that are untraceable. These are the so-called ‘privacy coins’. The possibility of tracking this type of currency is currently debated. Whereby some argue that the coins can be traced, whilst others consider the tracing too complex for authorities.Footnote 22 There are however, other methods to prevent tracing.Footnote 23 It is not unlikely that technologies to avoid tracing will keep developing. The second difficulty is that legal restrictions apply for other anonymous payment methods. Anonymous prepaid cards are also restricted under AMLD5.Footnote 24 These restrictions are quite severe both in limitation and are restricted to be used within the Member State of origin.Footnote 25 Therefore even if anonymous virtual currencies were brought under the scope of the Directive, such informal shops would not have to comply. The risk of MLFT, however, is present. Digital art has been suspected of facilitating MLFT,Footnote 26 traders not linked to a jurisdiction would not have to comply with any form of AMLD5. To avoid the use of dirty money at such shops the legal economy would have to cover the Metaverse. Meaning that the commerce occurring in the Metaverse should not remain an informal economy. The easiest way to achieve this by prohibiting wallets from transactions with non-regulated entities. As discussed in chapter four wallets can be restricted to only transact with other regulated wallets. Whilst possible it does not provide a comprehensive attitude towards integration of virtual assets.

It is difficult to find a single rule for how to supervise the Metaverse economy and its virtual assets. Nevertheless a good start can be made by regulating some of the companies providing virtual realities. For example KYC duties can be placed upon avatar or virtual reality providers. When an avatar wishes to own virtual assets beyond a value of a certain virtual currency threshold, the identity of the avatar should be established. Thus reducing the possibility to anonymously enjoy high value of virtual assets. Technically the question could be raised why a criminal would not create multiple accounts. Though possible this would create multiple online characters. The use of multiple online characters would reduce the marginal utility of owning the asset.Footnote 27 This reduction of pleasure derived from owning the assets makes it less attractive for criminals to view virtual assets as rewards for their crimes.

The virtual reality provider and avatar provider are not your typical obliged entities to any MLFT framework. The more standard obliged entities are banks and other financial institutions. These institutions main objective is to handle finances. The avatar and reality provider are not the type of entities that have the objective to handle financial affairs. The shift is however demonstrative of where the value would be within the Metaverse’s new economy; in owning virtual assets. It is the avatar and reality providers who can supervise such ownership. Nor is the concept of placing duties of care upon those who provide a location completely new. In the Netherlands a duty of care is placed upon a landlord to prevent a weed plantation. If the landlord has neglected his/her duty of care, the cost of the administrative sanctions can be placed upon the landlord. The neglect of the duty can even result in criminal liability of the landlord.Footnote 28 This level of duty of care demonstrates that providing a space without checking for illegal activities can result in (criminal) liability. It is therefore not exceptional to consider a provider of a space liable for the activities within. Nor would it be extraordinary to consider the same to apply to a provider of a virtual space.

As a result the economy within the Metaverse moves from a fully informal economy to a largely legal economy. By installing duties of supervision to reality and avatar providers the process of integration into the legal economy is brought back. The less wealthy avatars still participate within an informal economy. However, if a criminal wishes to enjoy a larger quantity of virtual assets he or she will have to integrate them into the formal and legal economy of the Metaverse. Thus bringing the assets back under supervision. This approach, however, only applies to integration as a virtual asset. It does not aid in the detection of physical assets purchased through virtual currency. Virtual currency is largely regulated through wallets and thus there is some level of monitoring. There are, however, two exceptions namely gaming currency and local currencies. These were not considered of high risk. With the introduction of the Metaverse this risk may change.

7.3 Value and Games

The AMLD5 includes exchange services between virtual and fiat currencies. It however exclude currencies specific to an in-game environment. The nature of this exclusion is simply the lack of risk that an in-game currency carries, there is very limited redemption value. A criminal will have little want for a virtual helmet. Yet as discussed in the second chapter the concept of games has developed into a wide variety. These includes games of fiction such as Mario Brothers and World of Warcraft but also reality based games such as Second Life and the Sims. The definition of a ‘game’ is not specifically given in the AMLD5. Raising the question of whether the Metaverse or parts of it could be considered a game?

Let us imagine we are playing a sci-fi game in the Metaverse. The game is provided through a specific virtual reality connected to the Metaverse. In this game you can fight aliens and explore new planets. This game allows you to both buy and earn coins. These coins can be spent in the game shop on items that are useful to the game. Let us pretend that we have bought a virtual spaceship that can be used to transport our character to a new planet within the game. So far there is very little MLFT risk. The spaceship cannot be sold or enjoyed other than within the game. Buying the spaceship is not different from buying a new level in any other game. Will that idea change however if we could bring the spaceship to our virtual homes and enjoy it as a work of art? The spaceship can now be enjoyed as a luxury good or item of status. Perhaps I can transfer the spaceship to another avatar in return for virtual currency. Though the spaceship is still intended for the same purpose (accessing a new planet in the game), the risk of MLFT has increased by facilitating the transfer of the spaceship to my virtual home. What if in addition to a virtual spaceship the company would send me a physical miniature? A miniature that I can then sell for fiat currency. The risk of MLFT further increases even though the initial currency earned was technically exclusive to the game environment. The scenario may seem unrealistic, it is however not the first time that gaming currency has proven to be more MLFT risky than expected.

The hyperinflation in Venezuela provide an interesting case study with regard to gaming currencies. To avoid the hyperinflation, Venezuelans started using gold from the game RuneScape. The gold is based upon a centralized ledger and is technically exclusive to a game environment. The preamble of AMLD5 excludes “[…] in-games currencies, that can be used exclusively within a specific game environment.”Footnote 29 These currencies are considered to be of low risk due to their value being limited to the virtual reality of the game. Due to the popularity of the game black markets have occurred where these assets are traded. These black markets facilitated the trade between ORS and dollars which aided the Venezuelan population in storing value. The same black markets have, however, also been linked to large scale MLFT practices.Footnote 30 In this case the Venezuelans still had to transfer their gaming currency to dollars. As discussed in the previous chapter, however, these currencies can be used to purchase actual goods. The gaming currency then can be used to purchase physical objects without need for conversion.

Earlier research has therefore argued that when a virtual asset can be transferred within a game, there is the risk of a black market. The game provider should therefore have monitoring duties under the AML framework, unless the provider can prevent a black market.Footnote 31 Practically the game provider will therefore either monitor transactions to ban players suspected of selling their game currency, or monitoring and reporting suspicious transactions to the national supervisor.Footnote 32 Unfortunately to date there is no supervisory framework in place for such game currencies. In the EU neither game providers nor the exchange offices are monitored.Footnote 33 The more popular the gaming environment, the more efficient the gaming currency can act as a complementary currency.Footnote 34 Participating in these black markets is generally against the contract with the game provider.

Most game developers will have terms and agreements on selling assets outside of the game. Despite these terms and agreements there is little enforcement. The main reason is that enforcement is expensive for game developers. Sometimes costing op to millions in order to prosecute a single violator.Footnote 35 Private enforcement is only a real option if the benefits outweigh the costs, meaning that the costs must be able to be redressed from the perpetrator.Footnote 36 With the current enforcement costs it is unlikely a private individual would be able to pay such damages. The enforcement costs, however, could be limited in the Metaverse. Current enforcement costs are high due to the anonymity of gaming participants. If Metaverse avatar users are verified this may reduce enforcement costs. This would, however require all avatars to be verified. It is therefore likely that enforcement will be difficult to discover for private parties. Thus to prevent MLFT occurring through games, public laws are necessary.

The Metaverse already features immersive games. Gaming experts consider that the games that can be offered through the Metaverse will be hugely popular.Footnote 37 The gaming rewards are difficult to define. The first approach is that all gaming currencies are virtual currencies and the gaming providers will have to classify as wallet providers. The problem with this approach is that it makes it difficult for small start-ups to comply with the regulation. A second approach is to continuously scan for black markets and only when such a market exists, consider the gaming currency to be virtual currency. With regard to MLFT this strategy may be very effective as black markets form the largest risk of MLFT. The question, however, is who would assess the existence of black markets? With regard to the Metaverse a similar approach can be used as to the virtual assets. Players below a certain value can be left unverified but players above a certain value must be verified and monitored. The verification, however, would only be necessary when the assets can be transferred from one player to another or when the assets could be brough outside the virtual reality space of the game. The value of the account at which verification is necessary would need to reflect the (economic) risk of MLFT.

In addition to the complexity of value regulation with regard to games, the Metaverse will offer local currencies. These local currencies provide further complexity as they are exempted from the AMLD5.

7.4 Local Use

The AMLD5 furthermore excludes “[l]ocal currencies, also known as complementary currencies, that are used in very limited networks such as a city or a region and among a small number of users should not be considered to be virtual currencies.”Footnote 38 This excludes local currencies currently set-up by cities. There is a rising tendencies among cities to introduce their own currency. These currencies can vary from physical notes such as in Deltebre in SpainFootnote 39 to cryptocurrency such as those introduced in HullFootnote 40 and the U.S.Footnote 41 The coins have different intentions but generally share certain characteristics. Citizens can earn their coins by volunteer work, spending at local shops or are given the coins as (part of) social welfare. The coins can generally only be redeemed at local shops. The local coins are generally considered not a high MLFT risk. These coins can best be compared to a loyalty programme. Both city coins and loyalty programmes are generally earned through consumption with local shops. The redemption value is generally limited. It is therefore argued that both placement and extraction is difficult.Footnote 42 The similarities between the city coins and the loyalty programmes create a low MLFT risk. The risks can change as the city coins change. In particular the definition of a “city” can change. A city coin local to Deltebre can be considered of low risk. The total population of the whole municipality is around 11,500 people. The people receiving the coins are those on social welfare within the municipality. They can spend these coins with the local shops. This system therefore aims to promote both the welfare of those on social benefits and of the local shopkeepers. With this low redemption rate it is unlikely there is a high level of MLFT. Furthermore the local shopkeepers receiving the coins primarily hand them in to the municipality for euros. The risk of MLFT is thus very low but let’s compare this to the Hull coin. The Hull coin was intended to serve the local welfare of Hull. Whereby citizens could earn their coins based upon positive actions such as quitting smoking or volunteering. The coins could then be spent in the local shops. The amount of citizens in Hull area is around 320,000 who could all earn and spend these coins. The result was not only a major scamFootnote 43 but also a lively trade in the coin. The coin was established on very similar principles to that of Deltebre but due to its size carries a higher MLFT risk. Both coins would however likely qualify as local virtual currency. Thus raising the question when is something local?

The expected realities in the Metaverse are likely to be diverse. Whereby some virtual realities might focus on providing a gaming scenario. Another virtual reality provider may provide a virtual shopping street. The virtual shopping street can play host to a range of shops from various locations. If each shop uses its own (crypto) currency, it can be confusing for consumers. To enhance customer experience, the virtual location could introduce its own currency. The resulting scenario would be that close to that of the game Second Life where Linden Dollars were the going currency within the reality. As discussed in Chap. 3, Linden Labs, the developer of Second Life, had the transactions occur through its subsidiary Tilia. Tilia is a registered money transmitter with the US supervisor. The question is whether the same will apply to a virtual reality provider who introduces its own, local, currency.

If we imagine the currency can be used in the shopping street when is it still local? The region where the currency can be spent is limited to a single Metaverse reality. It is therefore different from general cryptocurrencies which can be spent in various Metaverse realities and beyond. Unlike local city coins, however, the currency can be spent in shops that are virtually confined to a street but physically can be located throughout the globe. Furthermore the virtual reality can be accessed by a high number of people located all over the world. The definition of a region as used by the AMLD5 is therefore given a new dimension. The second criterion for exclusion is that of used by a small number of users. Little is written on when the criteria for exclusion are no longer met. Considering the complexity of the accessibility with regard to the term ‘region’, it would be preferable to exclude small economies. As with the gaming environment legislating according to physical counterparts seems obsolete. Rather than examine whether something can be used in a region, the legislator should evaluate the size of the economy in that currency. Perhaps even giving a threshold as to when something is used in “a very limited network”. In addition the legislator should examine how the coins are obtained. I.e. are they unique to an avatar or can they be transferred between wallets?

7.5 Conclusion and Recommendations

Though it is difficult to legislate in terms of ‘placement’ and ‘integration’ it is not impossible. The legislative framework will however have to change its approach. The first is with regard to how to define the legal economy. The legal economy should be detached from the physical economy. Virtual assets can be enjoyed as much as real assets. The concept that all virtual assets need conversion has largely and will furthermore become obsolete. This change in focus closely relates to what was discussed in chapter four with regard to legislating the intention. The intention for MLFT is to obtain an asset that can be enjoyed. Enjoyment can be considered to as an object useful to commit the crime and as an asset as reward for the crime. The current concept of a reward is an asset in the physical world but with the Metaverse this no longer holds true. Therefore the Metaverse needs to become part of the legislated (and therefore formal) economy.

Secondly through the Metaverse virtual currencies that seem worthless can gain value very quickly. This applies to both gaming currencies and local or regional currencies. Rather than excluding them from the legal framework the valuable coins should be included. That means that the legislator will have to, again, look at intention. Can a coin be reasonably used for MLFT? If so the virtual currency should be included in the legislative framework. This could be best achieved through some value thresholds. If a certain amount of users are using the currency or if users wish to obtain a large amount, then due diligence duties apply to the issuer of the local coin. Some of these cut-off lines might be fairly arbitrary i.e. a user wishing to own a value of 9,999 coins may not be monitored but one with 10,000 coins might. Nevertheless these values are necessary to create clarity and are not different from cash declarations or suspicious transactions above a similar threshold.

These adjustments aim to respond to the virtual economy. Thereby creating a framework that is adept to the traditional three phases of MLFT and the Metaverse. As discussed in the third chapter there are three risks specific to the Metaverse. One of these risks, non-EU transactions, has been discussed in Chap. 4. The second and third, anonymity and NFTs, will be discussed in the next chapter.