web3 future
https://medium.com/@syaweng/web2-vs-web3-gaming-evolution-and-challenges-part-i-ffa1fb9bae4e
Web3 gaming evolution and 5 economic challenges (Part I)
By: Alex Takei and Sophia Weng
Last week, the crypto market crashed, wiping out $2 trillion USD in market capitalization. That is almost $7,000 USD of loss for each of the 300 million crypto users worldwide. My (Sophia’s) small crypto investment dwindled into pennies on the dollar (it will take me much longer to pay for my student debt now...) But just 6 months ago, crypto investments reached an all time high with venture capitalists deploying $30 billion+ globally in 2021 into crypto startups (Forbes). Mass adoption of Web3 was just getting started and we were cautiously optimistic about web3 games’ potential to onboard the next million users.
But now what?
On one hand, millions of people lost their savings and many companies are bound to go out of business. On the other hand, with less hype and distraction, it is a good time for serious teams and communities to focus on developing fun games and sustainable economies.
Back to square 1.
Using our collective experience playing and building some of the most popular web2 and web3 games (e.g., Hearthstone, Diablo, Axie Infinity, Gods Unchained, Crypto Raiders, Mini Royale: Nations, Crabada, etc.), Alex and I put together a primer on web3 game economy. (Thank you professor Ali Yurukoglu for advising us). Our goal is to share observations and predictions on the space. This writing is not exhaustive and could become stale very quickly (we wrote this in May 2022 and things have taken a nosedive since). For those who are new to or buidling web3 games, this is an overview of current web3 game economic developments. For those are reading from the future, this serves as a record of
In this 2 part series, we explore the evolution of web3 gaming, from web2 to current day and some economy challenges web3 games face.
Part I: web2 vs. web3 economies,web3 gaming evolution, web3 gaming 101
Part II: 5 web3 gaming economy challenges, web3 game future states. Read it here.
Introduction:
It may surprise some, but the recent wave of online digital economies and ownership is not new and harkens back to the 1990’s with the launch of Ultima Online in 1997. Video games in the web2 world were the vanguards for digital currency (internet money) and digital assets and thus, in some sense, web3 economies (and not just within the business of video games) proffered by blockchain technology today is merely the decentralization and expansion of something that already existed. However, for gaming specifically, the voyage into web3 and crypto has changed the way internal economies within video games are (and should be) built. It is an incredibly impactful transition; in web3, games live and die not only by their game design and popularity, but also by whether their economies are designed to endure the toughest economic force of all: human behavior and incentives.
Prior to describing the shifts in economic design blockchain and crypto has propagated, a brief summary of traditional in-game economics is below:
What are traditional web2 economies?
Video games have been monetizing in creative ways for over two decades. In addition to common business models such as free-to-play (F2P), subscription, and box titles, many video games also have elaborate in-game economies selling digital or utility assets via several in-game, virtual currencies. These game economies generate, if the game is good, meaningful interaction with their players post launch, driving tail revenues post the initial pay gate. The essential skeleton of a web2 economy is the following:
In-game currencies — virtual currencies artificially constructed by the game developer (not convertible back to fiat)
Sources — ways to acquire in-game currencies
Sinks — ways to spend in-game currencies
Web2 in-game currencies:
A developer typically issues at least 2 types of in-game currencies: (1) a soft currency and (2) a premium currency. A premium currency is buyable by fiat and a soft currency is earned through playtime. Developers issue in-game currencies for several reasons (some are more nefarious than others), but the primary rationale is (A) to avoid being considered a payment provider like PayPal, (B) to manage the economy across regions with different fiats (e.g. dollar vs. peso) using one universal currency and (C) to create an intermediary currency that allows you to control the economy without being explicit about it.
Web2 Sources:
Video games provide players various opportunities to earn soft currency, from simply logging into the game, to completing specific tasks and quests, to winning a tournament. This leads to a behavior often called “farming”, i.e. when players repeat the same tasks that generate currency. Premium currency is purchased via fiat at a fixed exchange rate (typically currency packages are sold in 5 pricing tiers).
Web2 Sinks:
There are often a variety of ways to remove currency from the system but most center around consuming currency to reap some benefit. Often this is through assets or services sold to the community. These can be cosmetics (non gameplay impact, purely visual), utility items (cards, consumables, anything that the player needs to play the game), and value added services (account name changes, stash space, anything that augments a player’s ability to play the game, i.e. nice to have’s).
Web2 Business Models:
A web2 game with a healthy economy will tie all these economic features together in a way that complements gameplay, world building, narrative, and player needs. The in-game economy is often combined with overarching business models like box sales, loot boxes, direct purchase, battle passes, subscriptions, and in-game marketplaces to build out a complex system that in itself can often proffer the player a decent amount of fun. A key feature of web2 games is that their economies are closed — once fiat enters the developer ecosystem, it cannot exit. This has strong implications on the monetary and fiscal policy tools necessitated for a developer to control their economy.
What is a web3 economy (Game-Fi)?
The onset of blockchain technology (open ledgering and digital ownership) and crypto (officiated “internet money”) has dramatically changed the type of economy that a video game developer can build. Prior to web3, all video game economies as aforementioned were closed (does not include loopholes or unsanctioned methods to transfer game currency to fiat) but Game-Fi describes the transition from a closed to an open economy. These, more than their predecessors, mimic the real world economy of a nation state. The essential skeleton of a web3 economy is the following:
In-game currencies — virtual currencies artificially constructed by the game developer (may or may not be converted back to fiat)
Sources — ways to acquire in-game currencies
Sinks — ways to spend in-game currencies
This list is exactly the same as web2 except the details within are quite different.
Web3 Currencies:
Although best practices on currencies have yet to be solidified, web3 game developers have *typically* been issuing two currencies: (1) a soft token (earned through play or completing tasks) and (2) a governance token (issued by the developer and most akin to web2’s premium currency). The primary difference between web2 and web3 is the absence of “in-game”, i.e. the game developer may make the soft token and the governance token exchangeable and buyable using fiat. Unlike web2 tokens, which are tied to the account that earned or bought them, web3 tokens have varying levels of tradeability.
Web3 Sources:
The web3 soft token works like web2 soft currencies, earnable through gameplay; however, some blockchain games have allowed their soft tokens to trade on an exchange (e.g. Coinbase), allowing players who have not engaged with the game systems to own soft tokens. The governance token is a bit more complicated and has either been distributed bespokely to players by the developer (air dropped), is purchasable on an exchange (using fiat), is earnable through gameplay, and can be the medium of exchange on trades (selling NFTs to receive governance tokens).
Web3 Sinks:
In web2, digital assets usually have cosmetic or utility value and web3 is no different; however, ownership of web3 assets can be transferred. As of today, common assets sold to the community are Access NFTs (units needed to play the game) and Utility NFTs (assets or tools that help a player play the game better or more efficiently). These non-fungible tokens can be purchased on third-party marketplaces (e.g., OpenSea, Magic Eden, ImmutableX) or game marketplaces (Axie Marketplace). Often, minting or buying NFTs consumes some form of token (could be game (AXS) or exchange token (ETH)). In terms of services sold to the community, blockchain games have been offering their players voting rights, i.e. permission to influence decision making around the game, in exchange for some form of governance token lockup (however, there’s been wide variety on how these are designed). Tokens can also be used for in-game activities like crafting and upgrading, adding to the utility of soft and hard tokens specifically. Finally, since the governance token is akin to equity in the game itself, it acts as a form of asset speculation where holding the token is akin to holding stock in a company.
Web3 Business Models:
The key difference between a web2 and web3 economy is that value can exit from a web3 ecosystem. The space is quite young and thus some of the common web2 gaming business models (e.g. battle-pass, loot-boxes, etc.) have yet to be layered onto the current generation of blockchain games. Instead, the focus has been on designing economic levers to solve issues like inflation and other forms of malicious behavior like hoarding and capital flight (to be discussed later). Below is a summary of the changes in economic design from web2 to web3.
Economic Design Summary: web2 vs. web3
Web3 Gaming: Evolution
The first web3 games were developed before 2018 but the genre was made popular by Axie Infinity in 2021. The typical web3 game teams consist of crypto natives, game enthusiasts and traditional finance professionals. They focused on gamifying decentralized finance and onboarding non-crypto players. These games were grassroot organizations funded and driven by the community. Many players joined because it was a more fun way to invest money (the DeFi investors) or it made them (players) a lot of money. However, Gen1 web3 games faced a lot of challenges including:
Long (1hr +) and costly (>$50 gas fee) onboarding
Light gameplay (not fun compared to traditional games)
Unsophisticated and mercenary player base motivated by the pursuit of profits
Economy crashes from poor design and bad incentives
Hacks and scams from bad actors
In the last year, web3 games have evolved tremendously as more traditional game developers joined the space. These teams are typically funded by players and VCs, and promise to make more fun, sustainable and higher quality games. Mini Royale: Nations was founded by traditional F2P mobile developers and raised $21 million USD in its Series A to make a first-person-shooter crypto game. In May 2022, A16Z announced a $600 million gaming fund to invest in traditional and web3 games. New web3 teams want to professionalize crypto game development and attract traditional gamers who may be early adopters of crypto games. These teams have also learned from past token economy design mistakes and are incorporating new DeFi primitives (protocol-owned liquidity) and design (capping asset ROI) to address the challenges that have been plaguing the space. However, most games are in early development and are still not comparable to traditional games.
Web3 Gaming 101: How does play occur today
Unlike traditional games, there is a broader range of what constitutes “play” in web3 gaming. Players, once they acquire an NFT, token, or download the game client can interact with a web3 game in a variety of ways, ranging from minimal engagement to daily minutes more akin to a traditional F2P title. Below are high level archetypes of play in web3 but note that current web3 games can natively be one or more of these gameplay styles (i.e. some Web3 games don’t truly have “gameplay”, the game is the “economy and inventory management” within itself).
Passive Engagement — stake tokens and wait for game to appreciate, buy NFTs and then resell them to the engaged community at a premium
Mid Level Engagement — plays the “economy game” (i.e. manages resources), trades ERC-20 and ERC-721 tokens on marketplaces
High Engagement — engages with the actual gameplay systems (if they exist), engages with the community (i.e. blogs, Discord, Twitter), actively trades ERC-20 and ERC-721 tokens on marketplaces, plays the “economy game” (i.e. manages resources)
Web3 gaming evolution and 5 economic challenges (Part II)
By: Alex Takei and Sophia Weng
In the last piece, Alex and I wrote about the evolution of web3 games. Read part I here. Now, we explore some of the challenges and solutions of web3 game economies and future paths of this genre.
Web3 Gaming: Economy Challenges
Poor economy design and unsustainable incentives attracting the wrong users are the biggest contributors to the fall of early web3 games, such as Axie Infinity. Compared to web2 games, web3 game economies are easily impacted by outside factors (e.g., general market crash). Early web3 game economies were modeled after DeFi projects, which offered large incentives for participation. “Play-to-Earn” games attracted many income-seeking stakeholders who drove up the demand and price of tokens. Income-seeking participants (net extractor of money) typically outnumber fun-seeking players (net contributor of money). These projects were not designed with the right market levers and eventually (explained in the next section), the game economies reached a tipping point and user growth and prices crashed.
Below is a list of 5 (non-exhaustive) economic challenges web3 games face.
Inflation / Speculative Growth
Monetary Participation Gate
Capital Flight
Speculator Hogging
Liquidity Management
1. Inflation / Speculative Growth
Many web3 games are modeled after the most successful web3 game, Axie Infinity. Axie founders admitted to accidentally pioneering the play-to-earn model when players started trading its soft token, SLP, on decentralized exchanges. However, Axie Infinity was not set up for an open economy and viral growth. Specifically, its soft token, SLP, and Axie NFTs were designed with little demand/supply levers (no supply cap) and often reinforced each other’s growth. As players made money from farming and cashing out SLPs, more people wanted to join the game, either to breed and sell Axies, assets required to play the game, or farm SLP, input required to breed Axies. Demand for new Axies led to increased 1) breeding frequency, 2) cost of Axies and 3) SLP prices. Growth was a positive feedback loop and the increase in soft token and NFT prices attracted more players. In the beginning, capital investment from new users was enough to pay existing Axie breeders and SLP farmers. Once the new user growth stalled (because no one can afford Axies anymore), the economy crashed and SLP and Axie NFT prices sank by more than 75%.
Other web3 companies that modeled their game after Axie Infinity’s economy and breeding mechanism, such as Pegaxy and Thetan Arena, experienced rapid growth and hyper inflation as their token supplies outpaced the value generated from the game. The prices crashed when players could no longer afford the entry ticket. These economies were unsustainable because growth was derived entirely from revenue generated from new players (some compare this to a ponzi scheme).
Newer web3 games recognize the inflation and speculative growth issues and have employed some of the below mechanisms to manage supply growth of tokens and NFT.
More Sinks (Ways to Spend): Increasing ways to spend money is one of the most effective and long-term solutions to reduce token supply. However, developers must release new gameplay and features alongside new ways of spending and cannot arbitrarily introduce currency sinks.
Burning Mechanisms: Companies can burn their tokens and NFTs to reduce supply. Some companies are actively burning soft tokens to reduce supply. A new crypto game (“move-to-earn”), STEPN, announced it will repurchase $26 million worth of GTM soft tokens to burn, starting in April 2022. The burning has been effective in reducing short-term supply but does not solve the viralious supply generation problem, which comes from players wanting to max out earnings. In fact, it may perpetuate the perverse expectation that the company will continue to repurchase and stabilize token prices. Other games such as Crypto Raiders introduced an opt-in perma-death feature where NFTs can be rendered useless upon death for some events / dungeons. However, this is a slow supply lever because most players are wary of losing their NFTs and less likely to participate.
Limit Return on Asset: Companies have also obfuscated the earning of ROI-generating assets to reduce farming behavior and value from leaving the economy. They are 1) time-gating asset production (e.g., once a day), 2) implementing marginal return on play (e.g., less earning for playing an additional hour) 3) making earning less “grindy” and predictable (e.g., complete a quest to maybe get rewards) and 4) making earning more social (compete in guild tournaments). In late 2021, Axie Infinity removed SLP earnings from daily quests to reduce supply generation after a period of hyperinflation. In Mini Royale: Nations, players cannot earn soft tokens from merely completing daily quests. Both mechanisms reduce the supply generation, making earning secondary to the gameplay experience. Axie faced a big backlash since the majority of its players joined to make money. Mini Royale: Nations has yet to launch its soft token, but players are well aware of the difficulty of earning soft tokens.
Repair and Decay Mechanisms: Many games also include repair and decay mechanisms in their product roadmap. These features mimic real world asset production and can reduce the earning potential of assets and serve as a sink for governance and soft tokens.
2. Monetary Participation Gate
Many web3 games require NFT ownership (e.g., Access NFTs) to play. Access NFTs are used for 2 reasons: 1) provide initial capital for the team to develop the game and 2) pure copycat behavior of earlier web3 games such as Axie Infinity. Web3 gaming companies typically sell genesis NFTs at a modest cost (comparable to the box cost of a traditional game of $60). However, if the game becomes popular, the NFTs shoot up in value and become a barrier to entry for most players. It becomes more problematic when players, not game developers, control the supply growth of the Access NFTs, since players breed and sell the majority of the new Access NFTs. An average Axie cost $800 USD at its peak. Secondly, Access NFTs reward early adopters and the high return encourages risk taking. The crypto market is largely unregulated and many investors lost $2.8 billion from rugpulls (developers collect initial investment and disappear) and scams in 2021. Below are the 2 levers companies employ to reduce barriers to entry.
Rental Model: Some games have created an NFT rental market or a scholarship model. NFT owners, typically guilds, can rent their assets to players (also colloquially known as scholars amongst Discord and Reddit communities), who can’t afford the NFTs, at a 70/30 revenue split of the soft token, with 30% going to the owner. This model was made popular by Axie Infinity. Sponsored by guilds such as Yield Guild Game, millions of Filipinos became full time Axie Infinity scholars in 2021 to make a living as the country suffered from economic depression. However, the scholarship model reinforces more speculative ownership because each asset investment guarantees a level of daily earnings (pending on price of soft token). It has also been compared to modern day indentured servitude where scholars “farm soft tokens” to enrich the owners.
Free-to-play: More well funded (typically by VC) web3 gaming companies, such as Faraway and Horizon, are making their games free-to-play. However, these games suffer from the same challenges as traditional F2P gaming companies. The traditional F2P companies depend on 1% whale spenders to fund the game for the rest of 99% of non-payers. In a web3 F2P model, companies are also potentially acquiring long term non spenders that are not lucrative.
Grant Players a “Free” NFT: Some web3 games such as Crabada gave limited Access NFTs for free to community members to jump-start the game. Rules around granting a free NFT would have to be carefully designed (i.e. non tradable, limited utility beyond early levels, potentially player friendliness issues on RNG etc.) but studios could get players started with a NFT to allow them to experience the game without paying upfront. This accomplishes something similar to free to play, but key differences being 1) includes onboarding to a crypto infrastructure (i.e. wallets) 2) the asset may be endearing within itself (similar to starter Pokemon) and 3) depending on the genre of game, a full pure free to play experience may be hard to design / delineate from the crypto component of the game.
3. Capital Flight
The transactability of tokens (and NFTs to a lesser extent) also invites capital flight risk, like that experienced by traditional capital markets and nation-states. As token prices increase, success can be a double-edged sword. The stronger the currency, the higher the purchasing power of foreign goods, and the higher the likelihood of capital outflow. Furthermore, since most games do not have robust game economies (web3 games are all in early development with little gameplay and economy), there is little in-game utility and ways to spend. As a result, once there is a risk of market crash, players cash out. Below are some levers that companies and exchanges employ to combat capital flight risk:
Staking Incentive: Companies incentivize token owners to stake (commit to non-withdrawal) the companies’ soft and governance tokens for a period of time, ranging from 1 to 12 months. As a reward, web3 companies pay an ultrahigh APY (e.g., 50 to 200%). The longer the stake period and the earlier the backing, the higher the incentive. However, monetary incentives attract income-seeking players and can become a disincentive once removed. Yield farming, where players bring their capital from game to game to generate the best return, is prevalent in web3 games and decentralized finance projects. In reality, staking incentives only secure capital for as long as the companies can offer an attractive return. Secondly, staking also disincentivizes engagement, since locking the tokens up means not spending them in-game.
Store of Value in Less Liquid Assets: Games could incentivize players to store their wealth in more illiquid assets to prevent capital flight. These assets would be unique (non fungible), rare and increase in value as the game gets better. There could be many types of such assets, such as rare loots or awards. The asset should provide either emotional or functional utility for players.
Capital Flight Control Policies: While players can and should be free to move their capital, companies can introduce friction to reduce capital outflow. Such policies must not be egregious to upset players, but serve as a deterrence to pump and dump behavior. Companies can limit the number of tokens in the system to restrict value transfer. Game inventory such as health potions, material and herbs must be converted into a currency before being transferred out of the system. Companies can also institute a minimum threshold for conversion to guarantee that there will always be value locked in the system.
4. Speculator Hogging
FOMO (fear of missing out) and the promise of high returns have attracted a lot of investors who buy and hold assets to speculate or rent. In 2021, the web3 metaverse platform Sandbox sold $35 million USD worth of digital land. Today 19,000 users own land in the Sandbox, but there are fewer than 50 experiences on the platform for 350,000 users. Due to the high entry price (land floor price at 1.8Eth), many players are prevented from owning land. Some may argue that the barrier to entry is a filter for those who are serious about developing experiences on Sandbox. However, majority of the Sandbox land owners are speculators without development experience (including Snoop Dogg and HSBC), who for the fear of missing out, are investing in the digital real estate boom. There are several levers to combat this challenge
More Supply: Some players have urged companies to create more supply to deflate the cost so newer players can buy into the asset. However, this will dilute the value of existing supply and likely anger existing land holders.
Land Value Tax: Web3 gaming analysts have suggested imposing a Land Value Tax on digital land, inspired by the Georgism principle that’s applied to real scarce land. A high land value tax forces the owner to either sell or be productive with the land. Forcing speculators to bring land to market and driving out bids from speculators who have no interest in actually using the land themselves both drive down the price of land. As the value goes down, so will the amount taken in land value tax. But if speculators try to bid up the price of land again, the tax rises proportionately, automatically deflating the bubble. The LVT ultimately discourages non-usage and investor-players from participating in the game.
5. Liquidity Management
Game tokens need sufficient liquidity to trade. Bootstrapping liquidity is the classic chicken and egg problem. Market makers need demand from users to offer liquidity. Users need market makers to provide liquidity. To bootstrap liquidity, game companies often incentivize participation with high return. Below are two ways they bootstrap liquidity
Rent Liquidity: Some web3 games rent the initial liquidity from players by offering a high return. Typically, the fee is paid in the game’s governance token, which has limited supply. The return is highest in the beginning to incentivize early adopters. Liquidity providers can earn fees from 1) incentives from the game developers and 2) the decentralized exchange for providing market making service. When both fees dry up, either because 1) there is enough liquidity or 2) there is low trading volume, the liquidity providers will move their capital to a new opportunity to maximize yield. This behavior is called yield farming. Games must offer good returns to maintain liquidity. Renting liquidity is extremely expensive and does not provide for a permanent solution. Companies allocate 0–30% of the total governance token supply to pay liquidity providers.
Buy Liquidity: To combat yield farming, some web3 companies such as Crypto Raiders have employed protocol-owned liquidity. This mechanism is pioneered by defi protocol, OlympusDAO, in which a company buys liquidity from providers. The company could bootstrap liquidity in a similar manner (offering high APY), but purchase liquidity pairs at a premium to reduce capital flight risk. This is a relatively new phenomenon and has not been tested by time or many web3 gaming companies.
Web 3 economic decisions are impactful and often hard to reverse. Some of the aforementioned solutions, such as high staking incentives, are clearly bandaids, not antidotes. As a result, new games economies are improving at microscopic speed. Fortunately, there are a lot of smart people working on and writing about web3 game economies.
Beyond the Minutia: What’s Next?
The web3 gaming industry is in its infancy and new companies emerge daily to try their luck in becoming the next Axie Infinity. Our research suggests there are many challenges to be overcome. We are cautiously optimistic about the future of the web3 games and believe that a sustainable web3 game must be fun-first and earn-second. This will require a deep integration of traditional game development and crypto/defi expertise. Below are five theories for the future of web3 games:
Theory 1: Blockchain gaming is a more liquid form of eSports for everyone
For the token economies that seem and have been sustainable in the space so far, player’s aren’t making a lot from playing the game itself. For example, Gods Unchained, launched in July 2018, has one of the best gameplay experiences but offers very little earning for players. Alex earned $2 USD from a $240 USD total investment.
The Future: Play and Earn will become a standard economics feature of free to play games but NOT the primary focus of an economy (similar to Battle Pass). It’s a way to put earning potential into the hands of the masses who are not professional level skilled but moderately skilled
Theory 2: Governance tokens may not always exist (or be necessary) in future web3 games
Many of the perverse incentives stem from the governance token (i.e. Mercenary behavior, speculator hogging, speculator sell off). Governance tokens also come with an onslaught of regulator risk and costs to maintain (i.e. treasury) for the studio.
The Future: Governance tokens may not be issued in Play and Earn games and community voting rights and benefits will be granted through holding specific NFTs or quantities of NFTs. However, there are risks associated with not releasing a governance token such as crowding out a lucrative retail investor that doesn’t truly want to play the game (and you might need some of them), inability to easily raise funding prior to game launch, and dealing with illiquidity on NFTs. More on token design from Nat Eliason.
Theory 3: The more “idle” the gaming genre, the more on chain the game will be
Every on-chain transaction requires a wallet approval, (A) withdrawing the player out of the gaming experience and (B) drastically slowing down the speed of gameplay.
The Future: Idle games (auto-battlers, time resource farmers) with elaborate economies will have many transactions taking place on chain (the game is the economy) vs. genres requiring mechanics and skill (TCG, MMO) will remain more off chain
Theory 4: There will be a target investor to player ratio of X / Y
Crypto games have too many investors eager to turn profit and not enough players, throwing the economy out of balance.
The Future: As the space evolves, web3 games will find the Goldilock ratio of investors and players, similar to F2P finding the ideal ratio between whales and non spenders
Theory 5: There is room in crypto gaming for the “hardcore economy games”
There have been vocal lamentations from the traditional community that creating games mimicking real world economies are not fun and defy the escapism games were meant to create. This has been tested in games like Ultima Online, experiences that simulated real world dangers, supply limitations, uneven economic conditions (i.e. economic disparity between the rich and poor) and did not meet large-scale success.
The Future: We agree that this “type of crypto game” may not be the one adopted by the masses, and may not be the game that propels adoption forward. However, just as studios like From Software serve a “hardcore segment” of the hack and slash gaming market, we think games with elaborate and hyper nation state like economies will serve the “hardcore segment” of the crypto gaming market for whom the economy game is the fun itself.