Deterring Metaverse Speculators & Increasing Liquidity

Executive Summary

The early implementations of metaverses have seen NFT markets fraught with rampant speculation. As the industry evolves, many of these NFTs are likely to develop substantial utility due to the unique privileges they bestow within their respective metaverses. This shift also comes with an increased risk that speculative activity will undermine many projects’ long-term viability.

Why it matters

Speculators generally will choose to purchase assets without actively using them, which limits access for more active participants by reducing the supply and increasing market price. While speculator-owned assets could achieve increased utilization through rental agreements, speculators are still able to extract wealth without providing a real benefit to the economy. Rent-seekers must be cut out to improve economic efficiency.

What's the issue?

This issue warrants research around potential economic mechanisms to limit the negative impact of speculators on the market for non-fungible assets and facilitate economic growth.?

What can rent-seekers do?

This paper proposes the?Bid-Based Land Value Tax, a potential taxation method for non-fungible assets that uses principles from?Georgist Land Value Taxes?and?Harberger taxation systems?to combat speculation and value assets without the need for external bureaucracy. It also confers additional benefits around?improving buy-side liquidity?and?incentive alignment?by allowing DAOs to collect tax revenue from asset ownership, rather than just sales.

Why is this important?

This mechanism uses asset bids for tax assessment while leveraging tax revenue to incentivize buy-side liquidity and price discovery in a way that can be realistically applied in metaverse economies. After a survey of popular anti-speculation mechanisms suggested in the past, we will propose our preferred mechanism.?

Key topics this paper will cover:

1. Existing Mechanisms

a. Land Value Taxes

2. Valuation Methods

a. Comparable Assessment

b. Leases

c. Harberger Taxes

d. Optional-same Harberger Taxes

e. Anthony Zhang's Depreciating License

f. Vitalik Buterin’s Bid Variation to Harberger Taxes

3. Proposed Mechanism: Bid-Based Land Value Tax (BBLVT)

a. Examples

b. Benefits

c. Drawbacks and Areas for Further Research

4. Conclusion

Existing Mechanisms

Land Value Taxes

A commonly cited method for counteracting speculative activity is a?Land Value Tax?(LVT), championed by the 19th-century author and advocate Henry George. The concept originated for physical land but can be applied in the metaverse as well on a variety of non-fungible assets. The direct comparable is metaverse land with a specified location, which provides scarcity and utility based on proximity to desirable locations. Even if additional land is created, it would not necessarily be near something players are interested in and therefore not satisfy excess demand for land. However, other types of NFTs that have desirable utility and a permanently fixed supply (for example due to a commitment to early investors to not create more assets with that exact utility) can also benefit from an LVT.?

An LVT is implemented by separating the value of the land or base asset from any improvements the owner is able to make, then implementing a tax only on the base asset. This serves to disincentivize land speculation by making it costly to sit on an asset without putting it to use. This should result in the land being owned by whoever can use it most productively. Land Value Taxes also push asset owners to make improvements to their land as they need to offset the land tax, but are not taxed on any increase in valuation from these upgrades. LVTs still require an asset valuation method, which is combined with a specified tax rate to calculate the tax expense. The following valuation methods could also be implemented in a non-LVT scenario with both land and improvements taxed, and are often discussed in that context, but this hurts investment efficiency (getting the owner to improve the asset), as additional taxes on improvements disincentivize their production.?

Valuation Methods

Comparable Assessment

Valuations for the asset and improvements can be based on comparable sales of these separate components, as?discussed by Lars Doucet?for virtual land. Hedonic regression can derive each attribute of an asset’s contribution to the overall valuation and then set taxes based on that assessment. This method may be complex to build and require additional bureaucratic components during implementation, such as an appeals process, in order to placate participants. The system could also be exploited by users who wash-trade assets with certain traits to reduce their own taxes or increase them for competitors.?

Leases

Another option for valuing the land/base asset is to set fixed-term leases for the land and auction the leases off each period. Doucet suggests using a?Vickrey Auction, which is a type of sealed-bid auction where the winner pays the amount of the second highest bid as an incentive to set their bid at their true valuation. While this leads to high allocative efficiency (the person who values the asset most gets it) at the time of the auction, that is not necessarily the case in the periods between auctions and comes with the tradeoff that ownership can be easily lost at any auction. This tradeoff conflicts with the potential design goal of true asset ownership, which is prevalent in many metaverse projects.?

Harberger Taxes

Proposed by Arnold Harberger and popularized by Posner and Weyl in?Radical Markets, Harberger taxes are based around self-valuation by the asset owner. Taxes are collected based on the valuation the owner chooses, but with the catch that anyone can buy them out at any time at that price. Harberger taxes theoretically lead to excellent allocative efficiency and benefit those who wish to be able to buy up multiple assets simultaneously (for example getting metaverse land in close proximity without other owners noticing and raising prices).?

Some drawbacks here include many users having limited ability to accurately self-assess asset value and frequently re-assess as the market shifts. The potential for immediate loss by the owner can create a poor user experience, making Harberger taxation unlikely to be implemented in practice. Participants’ valuations also could be overstated due to their level of risk aversion.

Optional-Sale Harberger Taxes

In order to mitigate the downside of forced sales with Harberger Taxes,?Fabricio Nakata proposed?a modified version where the asset owner had the option of accepting or rejecting the bid. If they reject the offer, then they are taxed with the valuation of that offer and the bidder gets rewarded with a portion of the additional tax revenue. The owner can choose to lower their assessment but must put up money in case a higher bid occurs that they reject. This method adds some additional complexity to implement and still involves some reliance on participants being able to accurately self-assess valuations.?

Anthony Zhang’s Depreciating License?

In 2017, Anthony Zhang shared a paper on?depreciating licenses. Similar to Harberger taxes, the taxes are set based on the market resale value. However, unlike Harberger taxes, the asset depreciates by a certain percentage, for example, 10%, annually. The government auctions off the “depreciated” part (10%) and the asset owner either purchase the 10% back or someone else purchases 10% from the government and 90% from the current owner. This method encourages the right selection of owner of the asset – where an owner using the asset for productive purposes is more likely to repurchase the depreciated 10% while an owner holding on to the asset for rent-seeking purposes is likely to sell the 90% instead of rebidding for the 10%, that might return less value than sitting on the unproductive asset. A downside to this method can be that the valuation and corresponding taxation of an asset is only updated as frequently as auctions occur, which can lead to market prices deviating significantly from valuations in the meantime in volatile markets (such as the markets for most NFTs). This can be mitigated with more frequent auctions, but this places an additional burden on the owner to participate or risk losing their asset.?

Vitalik Buterin’s Bid Variation to Harberger Taxes

In 2019, Vitalik Buterin?discussed?a harberger variation focused on bids when setting the valuation for taxes. In this system, “users pay the Harberger tax by prepaying funds into a contract, and there exists a separate mechanism where users can submit bids for any item of property; each bid must be fully collateralized. The tax rate that the current owner pays is computed based on the value of the highest bid. The owner has the ability to sell to the highest bidder at the bid price at any time (or the sale happens automatically if the prepaid tax contract runs out of money)”. This bidding method gives control over sales to the current asset owner but does rely on the existence of buy-side liquidity for efficiency in asset valuation and liquidation.

More recently, Buterin made a similar suggestion for a?demand-based recurring pricing strategy for taxing ENS domains?where if a bid were open for sufficiently long, then the domain valuation would rise up to that level and if there are no bids the valuation would gradually decay. A potential tradeoff here though is that an asset holder could potentially end up paying much higher taxes than warranted if the overall market dropped and there was no longer a bid open for them to accept (even with the gradual depreciation in valuation).?

Proposed Mechanism: Bid-Based Land Value Tax (BBLVT)

The valuation method proposed by Buterin can be expanded upon in three ways to create the Bid-Based Land Value Tax model.

1. Firstly, apply the Land Value Tax method of splitting bids into two components: the bid on the underlying land/base asset and the bid for the house/improvements on top. The tax rate is only levied on the land component and owners can choose to accept bids separately for the land or house with these components split into separate NFTs. The outcome is that the asset owner is taxed using the current highest land bid only as the valuation.
2. Secondly, allocate a portion of the tax revenue towards the bidder with the current highest unaccepted bid for that asset, creating an incentive for participants to make competitive bids and leave the bids open over time. This improves buy-side liquidity for non-fungible assets and drives price discovery.
3. Lastly, it is important to clarify the taxation and liquidation protocol for implementing a bid-based taxation method. Expanding on the prepayment concept, asset owners do not always need to have funds in a prepayment contract (as early pre-payment reduces capital efficiency), they just need to add sufficient funds into the contract to cover their tax obligations for that period any time before a fixed tax due date.

To summarize the mechanism, the current owner of the asset incurs a?tax obligation?based on the current highest open bid from another user for the base asset multiplied by a specified x% tax rate. At periodic intervals, the owner must pay those taxes, with a portion of that revenue going towards the bidders who held the highest bid at various times during the period.

If the tax is not paid at the deadline, then the base asset is sold to the current highest bidder with a portion of the revenue directed towards paying off back taxes. Bids are separated between bids for the base asset and for improvements. These can be accepted independently and only the bid for the base asset is used for determining the tax obligation for the current owner. If the current owner accepts a bid for the base asset, then that bidder becomes the new owner and starts accruing a tax obligation based on the new highest bids going forward.?

What Else Did You Miss?

• Proposed Mechanism: Bid-Based Land Value Tax (BBLVT) Expanded
• Examples
• Benefits
• Drawbacks and Areas for Further Research
• Conclusion

Subscribe to?full premium content?for more details. If you already have a premium subscription with us,?click here?to view the full article.