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Turtles, the R-Word, and the future of NFT Marketplaces

Imagine this: two weeks ago, you purchased a pixel turtle. You took your wallet for non-fungible tokens, connected to OpenSea, and transacted .09 ETH ($270) on the marketplace. In return, the picture showed up in your wallet and now, you have the option to sell the turtle at the price you want. In addition to the picture, you also received one $TurtleShell token. This $TurtleShell token can be used to do a few things. You can use the token to play a turtle battle play-to-earn game. You can stake the token to earn a percentage of DAO_Turtle revenue. And, you can use the token to vote on how the project uses its funding. Sounds cool, huh.

So, you’re excited about your pixel turtle. And, on October 9, you wake up to look at your pixel turtle. As you go to the project’s OpenSea page, you see that the floor price of the project is now 0.33 ETH ($1155). Thrilled by your $855 gain, you want to sell your turtle. But, you cannot. Confused, you go to Twitter and look up @DAO_Turtles. It is then you hear the news: OpenSea disabled trading for the project. This means that you and the other 3,300 owners who have spent over 570 ETH (now $2,160,000) cannot sell your turtles for ETH nor can other people interested in the project purchase your turtles through the platform.

What happened? In an email, OpenSea stated that the buying and selling of DAO Turtles were disabled due to “violations of our terms of service.” The email copied and pasted two paragraphs from the terms and service. Specifically, the email described that it is forbidden to use the service to carry out “financial activities” including but not limited to “buying securities, commodities, options” or use the service to list or buy assets that are “redeemable for financial instruments… or… entitle owners to financial rewards…” What the email did not specify were the specific actions performed by DAO_Turtles that allegedly broke the terms of service upon which this decision was made. The email also failed to offer a process for appealing the decision or an option to remediate and relist.

Through this situation, we can see that transacting NFTs through marketplaces can introduce a wide range of challenges for all involved parties. OpenSea does not want to be held responsible for facilitating the transactions of a token that could be perceived as a security, based on existing regulations. DAO_Turtles does not want to be singled out arbitrarily when the paragraphs from the terms and services - broadly construed - could apply to many projects that are bought and sold on OpenSea. Some holders want the mental peace of knowing that the project they purchased will not be a rug pull. Other holders want the freedom to choose the projects to support, without third-party intervention. All holders want to be able to buy and sell at their time of choice. This is just one of the many situations in which OpenSea functions as not only a marketplace but also as the R-word of NFT projects… Regulator.

Such activity gives rise to a set of essential questions. What should regulation look like for NFTs? How do we compare centralized and decentralized NFT marketplaces? And, is adoption without decentralization truly mass adoption? This week brought many NFT marketplace announcements, and in this article - I’m going to focus on two operating at the extreme ends of the regulation spectrum. The first is the Coinbase NFT marketplace and the second is Zora.

On October 12, Coinbase announced Coinbase NFT: a “peer-to-peer marketplace” for “minting, purchasing, showcasing, and discovering NFTs.” At present, Coinbase facilitates crypto transactions for over 68 million users in 100-plus countries. Therefore, Coinbase NFT will presumably onboard the next wave of NFT holders and traders.

Operating under the publicly traded company’s umbrella, Coinbase NFT will likely be required to comply with a number of financial services and consumer protection laws. Coinbase currently acts in accordance with the Bank Secrecy Act, mandating that Coinbase verify customer identities and maintain records of transactions, and the USA Patriot Act, manding Coinbase designate an officer to ensure compliance with all applicable money transmission laws.

In addition to these existing laws, Coinbase has set forth its own standards for regulating digital assets. The company recently published a proposal titled “Digital Asset Policy Proposal: Safeguarding America’s Financial Leadership.” The proposal defines digital assets as assets issued and transferred using a “distributed ledger or blockchain technology.” Most notably, the proposal recommends there be one designated regulator for digital asset marketplaces. This authority would oversee all established marketplaces, across the full lifecycle of a transaction, and mandate the disclosure of particular materials. Coinbase claims that this proposal aims to enhance transparency, protect against fraud and market manipulation, and monitor trading activities.

The reception of the Digital Asset Policy Proposal has been mixed. Some individuals view such regulation as a desirable, necessary step towards mass adoption. These folks hold that marketplaces should no longer facilitate the buying and selling of rug pull projects, works that infringe upon copyright, or projects with securities adjacent tokens. Human oversight plays a critical role in marketplaces to ensure the safety of the users or investors. Other individuals are less optimistic.

Especially critical are individuals who call themselves “crypto-natives.” Many crypto-natives believe that a prevailing strength of the blockchain is the transfer of control and decision-making from a centralized entity (individual, organization, company) to a distributed network. Eschewing opaque methods for establishing the value or legitimacy of media, crypto-natives trust in smart contracts. The advantages of this transition are both technological and social. Technologically, smart contracts that facilitate transactions are permissionless, transparent, and global. Socially, it reduces the level of trust that individuals must place in another and limits the power of any singular authority.

Rising from these prevailing philosophies is a different marketplace: Zora. Funny enough, Zora is founded by Dee Goens and Jacob Horne, two individuals previously employed by Coinbase. Zora has been picking up significant traction on Twitter this week. It prides itself on being a “permissionless marketplace protocol,” compared to other platforms that hold “our audiences and content hostage.” In practice, this means that anyone and everyone can transact and develop the marketplace, the cryptographically enforced registry of media that is independent of any one platform. There are zero fees, so people who transact with Zora only need to pay the cost of Ethereum’s gas at a given time to mint, sell or bid. These fees are standard across all marketplaces. In order to screen the NFT media to ensure that it is unique, Zora’s protocol completes integrity checks. The checks ensure that the media and its metadata are provably unique.

While Zora aligns with many of the philosophies put forth by crypto-natives - the protocol is fully on-chain and is viewed as a public good - it introduces uncertainty. How will regulators attempt to govern a protocol? Will any type of “KYC” or “Know Your Customer” be required to utilize the platform? Will customers get rugged? Like many platforms operating in Web3, Zora is still developing.

As the ecosystem grows, we will get our answers. It will be interesting to see what role regulation plays in shaping marketplaces. As well as learn more about the technological and social implications of such regulation.

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