Why NFT marketplaces can never be truly decentralized

By now, you probably have read countless stories of how supposedly decentralized NFT marketplaces can remove, freeze, or block NFTs and sellers. These actions were necessary to reduce and remove the proliferation of scams, phishing, wash sales, and other illicit activities. And we should expect more moderations in the these marketplaces to provide safety. Moderation within the NFT marketplace is simply essential to protect users, intellectual properties, and brands for NFT to gain trust, more adoption and fully realize the full potentials of the NFT technology.

With billions in NFT trading volume, the sector has been operating outside the financial compliance requirements, but both financial regulators and law makers are now paying close attention. This scrutiny has forced both OpenSea and Metamask to comply to the US sanctions quickly without warnings.

Implementing financial sanctions is only the first step for NFT marketplaces. We should expect more compliances and regulations to come.

These recent actions left many users confused, with some outraged. The surprise comes from the belief that these NFT marketplaces are decentralized and cannot be controlled by any entity, organization, or government. For NFT experts like us, not only we were not surprised, we had been expecting it. It boils down to the simple reality — it’s virtually impossible to decentralize.

The technology challenges

At the core of the issue is that blockchain technology, a decentralized ledger (database), is still very much just that — a ledger for keeping deeds of ownership, not the full content. Smart contract is touted as the solution, but it is limited to operating with the ledger’s on-chain data. Meaningful applications require more complex computations, content access and delivery, and user interactions. Consequently, these applications must build their own off-chain services and/or rely on infrastructure service providers to deliver a comparable Web2 experience expected by the end-users.

One can argue that the underlying smart contracts enable individuals to trade peer-to-peer, bypassing any centralized entity. This may be possible theoretically, but it’s nearly infeasible in reality, especially for NFTs.

• Ordinary users do not directly interact with the blockchain nodes but through a wallet provider and a UI layer. The UI is hosted by a centralized entity, and the centralized entity must operate within the jurisdiction of the company’s location. A recent example highlighted how Metamask and OpenSea had to quickly block Iranian IP addresses without warning to comply with US sanction law (OpenSea is based in the US).
• Most contracts deployed on the blockchain must be changed or upgraded when bugs or security issues are discovered. These contracts are owned and managed by a centralized entity.
• Infrastructure companies, whether telecommunication providers, cloud providers, or service providers that Web3 applications depend on can enforce their own rules (terms of service), government sanctions, or local laws regarding content or internet activities.
• Users do not interact directly with the blockchain but through intermediaries, including their wallet providers. Blockchain technology will no doubt add more capabilities over time, and the amount of data in the ledger will increase in size. The devices we use daily (e.g. a phone, a laptop) are simply incapable of processing large amounts of data that cloud servers can. Consequently, the end users will always continue interacting through the intermediaries, the centralized service and application providers.

For a more in-depth technology review, Moxie Marlinspike, co-founder of Signal, has a well written blog explaining the centralization issue with Web3, specifically with NFT.

The content moderation challenges

Any marketplace must have a set of rules, typically outlined in the terms of service (ToS). Rules can vary widely among the marketplaces, but generally they do not allow illegal content such as child sexual exploitation and content that infringe on other intellectual property rights or copyrights. Local laws may impose even further restrictions on content and trading activities.

Traditional and centralized marketplaces such as eBay and Etsy already have invested significant resources to filter, moderate, and stamp out much of these problems. The centralization nature allows them to build technology that is more efficient at detecting and removing content violations. Better policies can be crafted when checks and enforcements are possible and quick. For example, NFTs can be curated or undergo an approval process with clear guidelines. Sellers would have the correct expectations of what content and activities are permissible and receive appropriate feedback on violations and chances to make correction.

The decentralized NFT marketplaces currently face more challenges moderating content because they don’t monitor and control the content. Already, we are seeing activities that will enable more moderation, by creating more centralizations.

• Content hosting — NFT marketplaces such as OpenSea already download, caches, and directly host NFT content (the actual images and media). This approach enables faster content delivery and enables content moderation.
• Access control and content filtering— NFTs with inappropriate or questionable content must be filtered, and repeat offenders will have to be denied access, whether blocking wallet or blocking NFT contract addresses.

The steps taken to moderate content certainly will deliver better and safer user experience, but this approach will take NFTs further away from decentralization.

The regulation and compliance challenges

So far, NFT marketplaces have largely avoided any regulation or financial compliances by operating with only cryptocurrencies and outsource the fiat-to-cryptocurrency conversion to regulated exchanges or services. This practice is increasingly gaining scrutiny from regulators as the popularity of NFT and trading volume increase, not to mention the prevalence of frauds, scams, and lack of user protections that are currently going unchecked.

While there is lack of regulatory clarity for NFT marketplaces, we should expect some form of the existing financial regulations to be applied directly or indirectly.

• Anti-money laundering (AML) — The US, EU, and many other countries have stringent anti-money laundering regulations that all businesses must apply. Typically, many businesses depend on their financial institutions (e.g. banks, payment providers, etc.) to take on much of this burden. By handling payments through cryptocurrencies directly, NFT marketplaces likely will be required to implement AML compliance themselves. At the moment, due to the lack of clarity regarding cryptocurrencies and compliance, NFT marketplaces are operating on a gray zone, but it’s only a matter of time before regulators knock on their doors.
• Sanctions — As we have already seen recently, businesses must implement government’s sanctions. Sanctions are imposed on multiple levels: country level, organization entity level, and individual level. NFT marketplaces cannot implement organization or individual sanctions by allowing anonymous users. Blocking the entire country/region is both inefficient and often not effective as users in the sanctioned countries can use VPN to bypass the access restriction.

When regulations tighten, NFT marketplaces will be required to conduct a much more stringent approach to obtain true identity of users, through a process commonly known as know-your-customer, or KYC. A proper KYC process would prevent sanctioned entities or sanctioned individuals from participating in the marketplace. Coupled with transaction monitoring, marketplaces can build risk profiles and block transactions suspected of money laundering or other illicit activities such as wash sales or market manipulation.

NFT marketplaces will thrive with centralization

The focus shouldn’t be whether centralization or decentralization for NFTs or for the applications. Instead, we should focus on the benefits that NFTs bring — transparent ownership, and the deed of ownership is protected by the decentralized blockchain. The ownership that NFT represents will allow owners to freely trade without restriction or ambiguity. There are so many digital items that can benefit from implementing NFT technology. We have already seen how NFT has transformed digital art and enable artists to capture the economic benefits directly on the marketplace. NFTs as playable character or in-game items is also fast becoming popular. We can expect more with innovations, but we should also expect more safety and user protection as NFTs become mainstream.

At Gameflip Market, protecting our users and earning trust is our highest priority, and to date, over 40 million listings had been created, and over $130 million had been safely transacted. Proper regulations and compliances had already been built into the platform, and clear rules and guidelines are published and enforced. Through our proven and battle tested platform, NFTs are safely transacted with credit cards and popular payment methods, just like any other e-commerce transactions. And we go further with our Gameflip Omni — support multiple blockchains.

NFTs created through our Gameflip Omni will support multiple blockchains, empowering users, creators, developers, and brands with more choices and flexibilities.

At Gameflip, we believe in giving our users choices, and we will continue adding more choices that will benefit our users and fulfill our mission of enabling mainstream gamers to simply and safely conduct commerce across all categories of gaming and entertainment digital assets.