October 11, 2021

Non-Fungible Tokens, Play-to-Earn Scholarships, and Yield Guild Games underJapanese Laws

So & Sato Law Offices
So Saitos.saito@innovationlaw.jp
Shinpei Asanos.asano@innovationlaw.jp

In this post, we analyze non-fungible tokens (NFTs), play-to-earn scholarships, and theYield Guild DAO under Japanese laws. With respect to the scholarships, it is worth noting thatthey are mainly offered overseas - presumably in compliance with the relevant laws - and thatJapanese laws only apply if Japanese residents are involved. The following post is written under
the assumption that this is the case.

You can find more information about the legal and regulatory environment for NFTs in ourprevious posts:(1)‘Play to Earn’ under Japanese Laws (September 2, 2021)(2)

NFTs: An overview of the current state in Japan, the legal and regulatory environment,
and the latest guidelines by the JCBA and BCA (April 27, 2021)(3)

Buyer Beware – Digital Art and Non-Fungible Tokens (NFT) (March 22, 2021)

1.

Overview

1.1.

Play-to-Earn (P2E)

The P2E model was pioneered by Axie Infinity. Axie Infinity is an online game thatallows players to receive rewards in the form of Smooth Love Potions (SLP) when playing thegame. SLP are tokens that are needed for breeding new Axies and which can be traded on global
crypto exchanges.
1.2.

Scholarships

To play Axie Infinity, a player needs at least three Axies. In August 2021, the price forthree Axies was around USD 1,000 and as such unaffordable for many players. Yet, despite thehigh costs, the game continued to gain popularity - especially in countries with low incomes.
One of the reasons behind the continued success were scholarships. Under the scholarship1

program, owners of Axies give their Axies to players who in turn use them for playing the game.
When earning SLP as rewards, players must share them with the owners of the NFTs. The
percentage players retain is somewhere between 40 and 75 percent, depending on the providerof the scholarship and scholarship program.
Scholarship programs in a nutshell(1) Owners of Axies search for scholars on discord and other platforms.
(2) Scholars sign scholarship agreements with an owner and start playing the game.
(3) Rewards earned in the game are shared between the players and the Axies’ owners.
Even though scholars may use Axies for playing, they are not authorized to sell them under
the scholarship agreement.

1.3.

Yield Guild Games

Yield Guild Games (YGG) describes itself as a “play-to-earn gaming guild, bringing
players together to earn via blockchain-based economies”. YGG initially raised funds froma16z and other investors in exchange for YGG tokens and invests those funds into NFTs thatare used in blockchain games. Proceeds from utilizing the NFTs - for example from lending theNFTs to players of P2E games or selling them on the market - are distributed to YGG tokenholders.
In some cases, YGG further brokers scholarships for NFT holders who want to put their
NFTs to use and earn a passive income. Initial activities focus on Axie Infinity, The Sandbox,
and League of Kingdoms. Further games will be added in the future.
While the core team of YGG currently manages all activities, YGG aims to become fully
decentralized in the future. Once the transition is completed, decision-making will betransferred from the core team to the YGG DAO, i.e. the YGG token holders.

2.

Analysis under the Applicable Laws and Regulations

2.1.

Legal Structures of Scholarships

Scholars and managers enter into scholarship agreements on an individual basis. Usually,
the agreements are initiated via Discord or other channels. Under Japanese laws, the following
structures may be considered.
2.1.1. Lease Agreement
Where a scholar promises to pay a certain amount of money for the use of Axies and toreturn the Axies at the end of the agreement to the manager, the agreement might be consideredsome form of lease. Since Article 601 Civil Code only covers the lease of tangible assets, itcannot be applied directly to the lease of intangible assets such as Axies.1 Applying Article 601
ff Civil Code by way of analogy seems, however, possible.

1 It is only possible to lease tangible assets within the meaning of Article 85 Civil Code.

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Assuming Articles 601 ff Civil Code can be applied analogously, scholars would not beallowed to sublease Axies to third parties without the prior consent of the managers (Article612(1) Civil Code). In cases where the contract period is not specified by the scholarshipagreement, the agreement may be terminated by either party by giving the other party one day’s
notice (Article 617(1)(iii) Civil Code). As it is not clear whether courts will allow for ananalogous application of Articles 601 ff Civil Code, it is advisable to cover all matterscomprehensively in the scholarship agreement.
Since the use of Axies is not subject to restrictions under the Copyright Act, it is further
advisable to implement proper measures to ensure that owners are sufficiently protected (e.g.
prohibition to use Axies for breeding, prohibition to create merchandise with the Axie).2
2.1.2. Contract for Work or Delegation
Managers may among others specify how many hours a scholar must play per month,require daily logins, or instruct scholars to only use Axies with certain characteristics forbreeding. In addition, the scholarship agreement may stipulate a minimum amount of SLP ascholar must earn during a pre-defined period. In exchange, the manager agrees to pay a
remuneration to the scholar.
Depending on the exact arrangement, the scholarship agreement may either beconsidered a contract for work (Article 632 Civil Code) or delegation without legal authority(Article 656 Civil Code). In both cases, scholars would have to deliver earned SLP to the NFT’sowner (Articles 632 and 646 Civil Code. Where the scholarship agreement is structured as acontract for work, NFT owners may further require scholars to complete the agreed work
(Articles 559 and 562 Civil Code).
It is our understanding that the rewards collected by scholars are generally passed to themanager. Based on the scholarship agreement, the manager will then return a predefined
amount to the scholar for playing the game. The situation is, therefore, similar to revenues
generated by tenants of farmland.
2.1.3. FundThe scholarship arrangement may further be structured as a partnership according toArticle 667 Civil Code or a silent partnership according to Article 535 Commercial Code. In
these cases, both the owners of the NFT and the scholar make contributions in kind – the ownerby providing his Axies and the scholar by contributing his labor. Profits generated by thepartnership or silent partnership are then distributed between NFT owners and scholars
according to the scholarship agreement.
In a partnership, the owner may for example invest Axies and appoint the scholar as an
executive of the partnership (Article 670(2) Civil Code). Here, the NFT owner would have theright to inspect the scholar’s business but lose the right to manage the partnership on his own(Article 673 Civil Code). If the scholar does not play the game and defaults, the agreement
cannot be canceled (Article 667-2(2) Civil Code). Instead, the manager may request thedissolution of the partnership (Article 683 Civil Code). A voluntary resignation from themanaging position by the scholar appointed as the manager of the partnership would only be

2 Articles 21-28 Copyright Act stipulates any acts that cannot be done without the permission of the copyrightholder in respect to documents, images, and other copyrighted works.

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possible if the scholar has a valid reason for resignation (Article 672(1) Civil Code).

Lease

NFT Owners’ Rights
and ObligationsScholars’ Rights andObligations

Other- receipt of royalties- obligation to return
Axies upon
expiration or
termination of thescholarshipagreement

If the term is stipulated
in the scholarshipagreement, theagreement is
automaticallyterminated with its
expiration. Otherwise, it
can be terminated byeither party by giving
one day’s notice.

- obligation to provide
Axies to the scholar- obligation to replace
Axies that do notconform with thecharacteristics
outlined in thescholarshipagreement- obligation to manage
the Axies with thecare of a goodmanager- prohibition tosublease the Axies- right to demand thereduction of royalties
in cases of defectDelegation - obligation to pay/ Contract
remunerationfor Work- obligation to provide
Axies to the scholar- right to decline or
reduce remunerationin case of nonperformance by thescholarFund- obligation to process
certain paperwork
and to complete thework- obligation to deliver
SLP rewards to themanager- payment for
performed services- obligation to invest
Axies as an in-kindinvestment- obligation to invest
labor as an in-kindinvestment- right to inspect thestatus of the business- obligation to perform
certain services- right to participate inprofits- right to participate inprofits- right to demand- right to demand4

The agreement may
automatically terminate
upon expiration of theterm (if specified) or
can be canceled by themanager at any time. Ifthe manager decides tocancel the agreement
which constitutes acontract for work, hemust generallycompensate the scholar
for losses. If theagreement constitutes adelegation agreement, it
may be terminated at
any time by either party.
If the partnership hasachieved the purpose forwhich it was set up, it isautomatically dissolved.
It is also dissolved if
there are other reasonsfor dissolution which
are stipulated in thedissolution of thepartnership

2.2.

dissolution of thepartnershipscholarship agreement.
Proceeds are distributed
in proportion to eachpartners’ contribution incase of liquidation.

Regulatory Considerations for the Different Scholarship Structures

The regulatory considerations vary greatly depending on the legal structure of thescholarships. For scholarships structured as leasing arrangements, money lending regulations
may be considered. For agreements structured as partnerships or silent partnerships, theFinancial Instruments and Exchange Act (FIEA) may be applicable. For scholarship structured
as delegation agreements or contracts for work, no particular regulations apply.
2.2.1. Money Lending Business Act
Article 2(1) Money Lending Business Act defines money lending business as thebusiness of lending money (including the provision of funds by discounted bills, the sale ofmortgages, or similar methods) or acting as an intermediary for the lending of money.
Businesses engaging in money lending services must register with the Financial Services
Agency (FSA) (Article 3(1) Money Lending Act).
Since Axies neither constitute money nor a currency-denominated asset, the lending ofAxies does not fall under the Money Lending Business Act. It is therefore not necessary toregister with the FSA.
2.2.2. FIEAThe FIEA applies to a wide range of financial instruments and provides a comprehensive
registration regime for businesses engaging in financial instruments services (Article 2(8)FIEA). According to Article 29 FIEA, businesses providing financial instruments services must
generally register as a financial instruments business operator (FIBO) with the FSA. This also
applies to those soliciting the offer to sell rights in a partnership or silent partnership. Both are
generally considered collective investment schemes under the FIEA (Article 2(2)(v) FIEA).
Axies do, however, not fall under the category of money or money equivalent as specified
in Article 2(2)(v) FIEA, Article 1-3 FIEA Enforcement Order, and Article 5 FIEA Definitions
Ordinance. Even where the owner of NFTs contributes his NFTs to the partnership or the silent
partnership, the FIEA does therefore not apply.
2.3.

Regulatory Considerations concerning YGG’s Activities

2.3.1. Scholarship Brokerage
Since NFTs do not constitute money or currency-denominated assets (see item 2.2.1
above), the brokerage of scholarships does not constitute an intermediary service for money
lending and is therefore not regulated.
2.3.2. YGG Tokens
On August 19, 2021, YGG announced that it had raised USD 4.6 million from a16z and5other major venture capital firms. In exchange for their investment a16z and the other investors
received YGG tokens. The tokens allow them to participate in the revenues generated by theYGG. Assuming the tokens were sold to investors in Japan, it is highly likely that they would
qualify as rights in a collective investment scheme under Article 2(2)(v) FIEA – and given thetokenization of those rights – as electronically recorded transfer rights (Article 2(3) FIEA). In
order to offer electronically recorded transfer rights to the public, it is generally necessary tofile a prospectus and to register as a type II FIBO (Articles 28(2)(i), 2(8)(vii), 29 FIEA). Wherethe rights are only offered to qualified institutional investors a notification under Article 63
FIEA is sufficient.
If the solicitation is, however, performed by a DAO with a sufficient degree ofdecentralization, the solicitation falls outside the scope of the FIEA as there is no eligibleintermediary that could be regulated. As YGG is still managed by the core team, this degree ofdecentralization has most likely not been achieved yet.
Finally, it should be noted that collective investing schemes investing in NFTs are notsubject to disclosure obligations under Article 4 FIEA, as NFTs do not constitute securities.
2.3.3. Investment in NFTs
A fund investing exclusively in NFTs does not invest “in securities or in rights
connected with derivatives transactions, based on investment decisions that are grounded in ananalysis of values of financial instruments” as stipulated in Article 2(8)(xii) FIEA. It istherefore unlikely that the investment management regulations apply to the investment manager(Article 28(4)(i) FIEA).
As NFTs are further not considered crypto assets within the meaning of Article 2(7)Payment Services Act, the buying and selling of NFTs for investment purposes does notconstitute a crypto asset exchange business. It is therefore not necessary to register as a crypto
asset exchange service provider.

Disclaimer
This post is for discussion only. The content of this post has not been confirmed by the relevant
authorities or organizations mentioned in the post but merely reflects a reasonable interpretationof their statements. The interpretation of the laws and regulations reflects our currentunderstanding and may therefore change in the future.
This post does not recommend the use of or investment in NFTs, scholarships, or any othertokens or projects.
Axie Infinity and Yield Guild Games are only used for illustrative purposes. Given the formatof the post, not all details of the game mechanics and token design have been considered
comprehensively, so that the results of the assessment may deviate from the results by theregulator, or a legal opinion prepared by us or another law firm. By no means, the explanations
should be understood as a legal opinion. If you need legal advice on a similar project, please
free to contact us or consult with your lawyer.
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