Many NFT “PFP” projects provide online roadmaps around “generative” or “variable” artwork that varies based in part on the rarity of content characteristics. The mechanism often works by a buyer getting whitelisted to mint their NFT for a fixed amount, say.1 ETH, and then finding out after the fact what NFT they got from a random drawing. The scarcer the mix of features provided with an NFT, like a special hat on a cartoon character or greater membership benefits, the more that NFT may be worth. Some consumers may get a rarer NFT than others by chance. Platforms like OpenSea have formalized the presentation of rarity traits in the user interface with the odds percentage for each trait derived from metadata On NFT “reveal day,” whether a consumer wins or loses the NFT scarcity drawing, they can sell the NFT and “cash out” on an NFT platform. Is this pay first - reveal “rarity traits” later NFT mechanic benign gamification or illegal gambling?
Gambling involves, consideration (a payment, like money or Ethereum), chance (like a random drawing determining outcome), that leads to a prize or thing of value. See e.g. Wash. Rev. Code § 4.24.070. “Gambling” is defined as the “[1] staking or risking something of value [2] upon the outcome of a contest of chance or a future contingent event not under the person’s control or influence, [3] upon an agreement or understanding that the person or someone else will receive something of value in the event of a certain outcome.” Id. § 9.46.0237; see State ex rel. Evans v. Bhd. of Friends, 247 P.2d 787, 797 (Wash. 1952) (“[A]ll forms of gambling involve prize, chance, and consideration . . . .” (quoting State v. Coats, 74 P.2d 1102, 1106 (Or. 1938))). All online or virtual gambling is illegal in Washington. See Rousso v. State, 239 P.3d 1084, 1086 (Wash. 2010).
At the time of this writing, there are no reported cases analyzing whether such NFT mechanics are illegal gambling. Loot boxes in the videogame industry have a pay first reveal later mechanic, which may be a good metaphor for analysis. Loot boxes, digital assets used in video games that enhance gameplay, came under scrutiny for meeting the gambling criteria. Where regulators and courts did not act against loot boxes, it was under the theory that a consumer could not sell the “prize” or convert it into funds or something of value. One Court dismissed a purported “loot box” class action case against Google using the above reasoning, declaring:
“Plaintiffs allege that Loot Box prizes have monetary value because they can be traded in legitimate digital markets or in gray markets. However, Plaintiffs do not allege that either of the two games they downloaded from the Play Store — Final Fantasy and Dragon Ball Z — allow transfer or sale of Loot Box items. Moreover, the Court takes judicial notice of the Google Play Terms of Service prohibiting the sale or transfer of any in-app content, including Loot Box items. The Ninth Circuit has held that a virtual item cannot constitute a thing of value where its sale would violate applicable terms of use. See Kater v. Churchill Downs Inc., 886 F.3d 784, 788 n. 2 (9th Cir. 2018)” Coffee v. Google, LLC, U.S. Dist. Court, ND California, Case No. 20-cv-03901-BLF (January 10, 2022).
However, unlike many loot boxes in the videogame industry, NFTs can almost always be converted into a thing of value such as crypto and fiat and post reveal buyers selling such PFP NFTs is typically encouraged by creators as they get royalties from secondary sales.
The greatest risks of litigation in this area will probably be civil and criminal cases brought by governments and regulators. Prosecutors do not have some of the procedural hurdles private litigants have in bringing “illegal gambling” cases. Criminal cases are potent given that prosecutors can employ well-known counts of “aiding and abetting” and “conspiracy” to bolster illegal gambling violations. Such an allegation can engulf large swaths of individuals and entities that participate in the targeted NFT project, from those who control the relevant NFT drops to marketers and influencers who promote it.In some situations, something that may look like illegal gambling may miss one element and therefore not be treated as gambling, like sweepstakes with an option for free entry – the free entry usually eviscerates the consideration element. Certain games of skill, if the skill element is weighty enough, are not considered gambling as they are missing the chance element.
In summary, NFT projects that market an up-front payment in crypto after which the consumer then sees the rarity of their randomly drawn NFT when it is “revealed,” run a risk of being illegal or unlicensed gambling. Whether this NFT mechanic is gambling is an issue that will await another day for a court decision —for now it is prudent to consider the illegal gambling risks in designing, promoting, and purchasing NFTs. Mere allegations from a prosecutor for illegal gambling would likely have a chilling effect on the NFT-PFP project and the ecosystem as a whole and the desire of NFT platforms to make them available for sale to the public.