Opening arguments begin today at the Supreme Court in MGM v. Grokster, a case that pits two powerful groups against each other: MGM and a coalition of major music companies on the one side, and Grokster, Morpheus, and a community of software companies and technology advocates on the other.

It’s also a case of competing values: copyright protection vs. technological innovation. The music companies want to see technology providers held responsible for copyright infringement enabled by their services; technologists complain that this is an unreasonable standard, and one that would stifle innovation.

MGM v. Grokster has been tried twice before, with the courts deciding in favor of Grokster both times. The decision will turn, here as in the past, on the question of whether Grokster and Morpheus fall under the protection of the Supreme Court’s Betamax standard (established in the 1984 case Sony v. Universal Studios), which insulates creators of hardware and software from liability for copyright infringement practiced by users.

In order to qualify, Grokster must meet several criteria. First, it must demonstrate that the technology is capable of substantial noninfringing uses. The lower courts have consistently found that Grokster and Morpheus meet this standard, citing uses such as “distributing movie trailers, free songs or other non-copyrighted works; using the software in countries where it is legal; or sharing the works of Shakespeare.”

The second question is whether Grokster has contributed to infringement by its users. This is where second-generation P2P technologies distinguish themselves from Napster. Unlike Napster, which was run through a set of servers hosted and maintained by the company, P2P clients such as Grokster and Morpheus use a decentralized architecture that allows users to trade information and files without accessing a central server. This cuts the technology providers out of the loop, and likely protects them from the charge of contributing to infringement.

But as Stanford law professor Lawrence Lessig and others have pointed out, innocence on this count may be a form of guilt, as the question becomes one of “willful blindness.” Did Grokster deliberately design limits into its technology to shield it from incriminating knowledge, and could the system easily have been designed to prevent copyright-infringing use? The case may be decided on this point.

Should the Supreme Court rule in favor of Grokster, it will eliminate the music and film industries’ best hope for a knockout punch in the fight against illegal downloading. Instead of taking down entire networks for infringement, they’ll be forced to prosecute individual violators – a much more expensive approach, and one fraught with p.r. problems.

They will also likely step up efforts to frustrate illegal file-sharers through ever-more-aggressive “spoofing” techniques. This represents an interesting technological arms race in its own right. On behalf of music and film industry groups, companies like Overpeer and MediaDefender already monitor existing P2P networks and flood them with sophisticated decoy files that look just like the real thing, but contain only white noise or advertisements. Such efforts have been effective in limiting the spread of illegal files and driving exasperated users to legitimate for-pay services like iTunes. (According to Overpeer, its servers receive over 25 billion digital download requests a month.) They’ve got more malignant weapons in their arsenal, and, if push comes to shove, they may use them.

But file-sharers are finding ways to fight back. A new program called Credence, developed at Cornell University, establishes a “reliability rating” for hosts offering files for downloading. It will enable users to distinguish between good-faith P2P users with a proven track record and Overpeer servers loaded with dummy files. Credence is already included in the latest version of the popular P2P client LimeWire.

If the court rules instead in favor of MGM, expect a deluge of lawsuits. All of the major P2P networks and clients will face litigation unless they modify their architecture dramatically to prevent the trafficking of illegal files. More importantly, so will BitTorrent, an increasingly popular file-sharing technology that allows for the efficient distribution of much larger files than traditional P2P networks.

The Motion Picture Association of America fears that BitTorrent may be to DVDs what Napster and its offspring were to music: the leak that becomes a flood. The MPAA has already begun prosecuting individuals in the United States and Europe who host the indexing sites that enable users to find and illegally download film files using BitTorrent technology.

A decision in favor of MGM will mean the end of P2P as we know it. Existing P2P services will probably look to transition to for-pay models just as Napster did after it lost its own copyright infringement case (A&M v. Napster). Ironically, it could be Napster’s founder Shawn Fanning who helps them do it. Since leaving Napster, he has gone on to co-found a company called SnoCap that is working to facilitate deals between P2P services and music companies by negotiating general rights and pricing agreements with labels.

But even with the law on their side, copyright owners may find it difficult to enforce with so many offending technology providers, hosts, and users residing outside of the United States. In some instances, the transnational problem can be overcome, as when American copyright holders got an order for an Australian court last February to raid the Australian offices of Kazaa’s parent company, Sharman Networks.

Other times it can’t be, as the recent brouhaha over Allofmp3.com illustrates. The Russian-based site sells some 300,00 audio tracks, including those by major American pop stars, for as little as a nickel, and distributes the files without any of the restrictions (burning, sharing) common to stores like iTunes.

While this is a clear and blatant violation of American copyright law, a court in Russia recently found the site is perfectly legal according to Russian law, which has no rules pertaining to the distribution of digital goods. In the absence of homegrown P2P networks offering free music, Americans may gravitate to services like Allofmp3.com.

There’s also new evidence that users are finding avenues for sharing beyond P2P. According to a survey released last week by the Pew Internet & American Life Project, about half of the 36 million Americans who say they download either music or video files do so outside of P2P networks or paid services. 28% of downloaders say they get music and video files via e-mail and instant message, and 19% say they have downloaded files from someone else’s iPod or MP3 player.

The volume of this off-the-grid activity probably doesn’t approach the levels of P2P file sharing, but it does speak to the myriad ways people can and will continue to get access to music and video, Grokster or no Grokster.