Axie Infinity allows players to battle, breed, and trade NFT-based virtual creatures, and allows players to generate significant real-world profits. What are the tax implications of blockchain-based games?
Axie Infinity is a blockchain-enabled game that can be played on iPhones, Android phones, or PC’s. At first glance, Axie Infinity is highly similar to games you may already be familiar with, such as Nintendo’s Pokémon franchise, placing players in a virtual world that allows them to collect, battle, and trade fantasy creatures.
Axie Infinity, however, operates with a key difference when compared to other games. Unlike Pokémon or other franchises, the economy of Axie Infinity’s virtual world intersects with the real-world economy by bringing the interactions onto the blockchain.
Unlike traditional games which exist within closed virtual worlds, Axie Infinity allows players to extract the value of the assets they gain in-game, and translate it into real-world value. These assets, the titular “Axies” of the platform, are worth significant amounts of real-world capital — the highest valued “Axie” sold had an exercise price of 300 ETH in late 2020, with a market value at the time of USD $130,000.
The profits generated by Axie players have caught the attention of regulators and tax authorities around the world — The Philippines Bureau of Internal Revenue issued specific guidance to Axie Infinity players in August 2021.
What is Axie Infinity, though, and what are the broader tax implications of the intersection of virtual game assets and real-world assets?
How Does Axie Infinity Work?
New Axie Infinity players start playing the game by borrowing or buying Axies — the creatures used by players in core game mechanics. Axies can either be purchased from an Axie marketplace or borrowed from Axie lenders, who are referred to as “Managers” in the game. In return for lending their Axies to new players, Managers are entitled to a cut of the new player’s earnings in-game.
After creating a team of three Axies, players download the game client to the device they will play on then interact with various game modes to increase the level and power of their Axies, such as an “Adventure mode” or “Arena mode.” Players can also breed new Axies by spending various in-game tokens.
The key difference between Axie Infinity and other games is that each item within the game is an NFT, or non-fungible token.
What is an NFT?
An NFT, or a Non-Fungible Token, is a unique token issued on a blockchain network that can’t be replaced with any other token. A Bitcoin is an example of a fungible token on a blockchain network — each individual Bitcoin is interchangeable. Non-Fungible Tokens, however, are singular and can be considered equivalent to a rare trading card.
In simple terms, most NFTs exist on the Ethereum blockchain. An NFT is associated with additional information that makes it unique, and can take virtually any form — any kind of digital can be an NFT. The NFT trading ecosystem has exploded in popularity over recent years, with Australian digital artists such as Lushsux generating over $500,000 in sales of NFT artwork in Q1 2020 alone.
NFTs are can be purchased for cryptocurrencies such as ETH — the flow of value into the NFT ecosystem begins with the exchange of AUD or other fiat currencies for cryptocurrencies on exchanges, then the trade of NFTs for crypto on NFT marketplaces.
Why Are Axie Infinity NFTs Valuable?
Axie Infinity adds another value layer on top of the NFT ecosystem by “gamifying” player interactions with NFT tokens — the Axie Infinity ecosystem creates scarcity by limiting the number of Axies available to players and placing players in gameplay loops that increase Axie scarcity. It takes a significant amount of real-world value and effort in order to breed a new Axie creature NFT.
Axie Infinity players earn tokens by playing the game, which can then be used to breed new Axie NFTs. The Axie NFT is minted on the blockchain when it is created, which ensures that the Axie is verifiably unique and cannot be tampered with. The items or creatures represented within the Axie platform cannot be considered to be equivalent to the items or creatures represented in other highly popular online games, such as World of Warcraft — items in these games are not unique, nor do they represent NFTs on a blockchain.
Demand for rare Axie NFTs is high — the rarity of an Axie NFT directly correlates with the increase in efficiency if offers players seeking to use it in-game to create new Axie NFTS, and therefore represents an investment for some players. Other players seek to speculate on Axie NFT markets to generate profit.
How do Axie Infinity Players Generate Profit?
Axie Infinity players generate profit from their in-game efforts in multiple ways. Throughout the Axie Infinity gameplay loop, Axie Infinity players earn two different types of tokens — SLP tokens and AXS tokens. SLP tokens are used in the breeding of new Axies, and can be cashed out for cryptocurrencies within the Axie marketplace.
AXS tokens are a proposed governance token that, once implemented in full, will provide players with the ability to influence the development of the game but at this stage offers no monetization opportunities within the game. AXS tokens can be traded on Binance, Huobi, and a number of other cryptocurrency exchanges, which allows players to further monetize their in-game efforts.
While SLP tokens allow players to generate small profits, the breeding and trade of Axie NFTs are where larger transactions with significant tax implications take place.
What is the ATO’s Tax Treatment of NFTs?
The ATO defines cryptocurrencies as digital assets in which encryption techniques are used to regulate unit generation and verify transactions. As blockchain-based digital assets, Axie NFTs, therefore, fall under the definition of cryptocurrency, which places Axie NFTs under the same tax classification as cryptocurrencies.
While NFTs are inherently collectible, they do not call under the ATO classification rules for collectible or personal use assets. NFTs are therefore subject to capital gains tax — under Australian tax rules, Axie Infinity NFTs are considered as property.
The following actions, when applied to Axie Infinity NFTs, are likely to trigger capital gains tax. These actions include:
● The sale of an Axie Infinity “Axie” or NFT
● Giving an Axie Infinity NFT away as a gift
● Exchanging or trading an Axie Infinity NFT for another NFT, or for other cryptocurrencies.
Other actions that are possible within the Axie Infinity game ecosystem have other tax implications that should be considered. NFTs are taxable property in the same manner as cryptocurrencies — the process of “breeding” Axie Infinity Axies within the Axie Infinity ecosystem is functionally equivalent to mining cryptocurrency.
The sale of self-generated Axie Infinity Axie NFTs is therefore likely to fall under the same tax classification as profit derived from cryptocurrency mining and is therefore 100 percent assessable as taxable income.
Some Axie Infintity players “lend” Axies to new players and receive a portion of the rewards gained by the new player. This mechanism is functionally equivalent to the process of lending cryptocurrencies, and is, therefore, a disposal event under ATO guidance.
Key Takeaways
Axie Infinity is a unique “gamified” application of blockchain technology that allows players to generate real-world profits through the creation and trade of in-game items that represent blockchain-based NFTs. Any gains realized through Axie Infinity or similar NFT-based games are subject to Australian tax law.
The intersection of NFTs, blockchain technology, and tax can quickly become confusing. If you’re not sure about your crypto tax obligations regarding NFTs, reach out to our crypto accountants.
