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In my previous article, we looked at the emergence of the metaverse, its roots and its implications for the way we live, work and play. In discussing the instantiation of social gaming as a metaversal phenomenon, we looked at Pokémon Go as a social expression and the positive economics, or lack thereof, behind it.

Gaming, in particular online and subscription titles, had a negative carry to it. The pay-to-play model was analogous to a truck with one foot partially on the brakes and the other foot having to step harder on the accelerator to maintain speed. The energy in game development was centralised on the need to deliver an experience and not necessarily player competitiveness and betterment. The advent and popularisation of blockchain changed all that. 

Enter the metaverse of crypto-gaming.

From pay-to-play to play-to-earn

Crypto-gaming is a phenomenon borne out of positive economics and made possible by the Layer 1 (L1) infrastructure of blockchains that provide the machinery and the thoroughfare for application-based functions (or ‘smart contracts’) to be written on top – the so-called Layer 2 (L2). Layer 1 holds the highly generalizable storage and computation logic across a public ledger system while Layer 2 uses that ledger system to create programs for specific use cases thereby giving it purpose. The entire ecosystem, as applied to human socialisation, is an expression of the future of work and play – a true agent of the fourth industrial revolution! 

Necessity is the mother of innovation. Luca Pacioli authored the first book on double entry accounting in the 15th century as a system for error checking in the flow of commerce and goods, particularly across the great oceans between Europe and Asia at the time. This naturally gave rise to the limited liability corporation in the 17th century with the East India Company (London) and the Dutch East India Company being two of the most emblematic examples of profit-sharing from mercantile ventures. In both instances, the creation of systems and structures were motivated by the compelling positive economics of a nascent globalized trade network.

The forces that drove crypto gaming into existence are equally compelling and borne out of the network effects and economies of scale of social inclinations:

dApps: As discussed earlier, with the development of Layer 1 (L1) blockchains as fundamental building blocks, this paved the way for Layer 2 (L2) applications that offer more tangible utility. The monetization of gamers’ efforts in-game was an age-old problem and NFTs built on L2 networks became the natural release valve for those express desires.

Adoption: As is the case with any social network, the value of a protocol and its tokens is a function of its use. In the early days, protocol founders are keen to get their tokens into the hands of users. One apparent method was to allow gamers to earn these tokens by building tokenomics into in-game mechanics.

Market: The forces of willingness-to-play and willing-to-pay emerge from the natural tendencies of stakeholders. Gaming, even in its infancy, was never an individualistic affair as users shared stories and traded experiences offline. The internet merely provided a scalable outlet to bring out the social aspects of players’ tendencies. Now, it has become an entertainment Mecca infusing play with spectatorship, sponsorship and betting. Blockchain provided the backbone to democratise the distribution of rewards – fair pay for fair play.

Source: https://dappradar.com/blog/bga-blockchain-game-report-q3-2021

These forces described have clearly manifested in the case of crypto gaming (or gameFi) as indicated by the growth in unique active wallets attributable to gaming where the rate of acceleration far outstripped that of other NFTs and DeFi applications. A wallet address is required to make deposits and withdrawals of credits earned through gaming. As a vanguard of the Fourth Industrial Revolution, gaming has cemented itself as a social and economic force to be reckoned with.

But does crypto gaming have staying power?

Reinventing the Bazaar

Non-Fungible Tokens (NFTs), for those who don’t already know, are programmable application-layer logic that run off the L1 blockchain. NFTs have tapped into the very fabric of art, culture, music and gaming – these forces are huge purveyors and enablers of adoption. As per the Australian Financial Review, “People are speculating with assets that are fun. Speculators are everywhere, but they play a role in funding this new wave of innovation.” 

Within the subculture of gaming, NFTs represent a radical re-tooling of the most basic building blocks of micro-economic expression in gaming-as-a-service. It has: 

(1) made possible, and feasible the ability to earn passive income at scale and en masse and 

(2) created a vibrant marketplace for vast amounts of capital to flow into the tokens and assets that underpin the means of productive expression in gaming.

The employment of NFTs, according to Bitcoinist, encourages amateurs and hobbyists to become active blockchain participants and, in doing so, access previously landlocked gig-economy revenue streams “through engaging in a hobby likely already integrated into their daily routine”. But this business model offers more than just the attraction of play-to-earn. In 2020, there were 2.5 billion gamers on mobile platforms, 1.3 billion on PC and 800 million on consoles. Arguably, a substantial and growing proportion of these players will migrate over to crypto games over time. This is perhaps more true for developing nations where play-to-earn proceeds can make up a significant portion of one’s monthly income

The engagement rates, and ad revenue, that come with these types of mind-blowing numbers will open the door for an entire product ecology to grow from these gaming roots. And this is already happening in the eSports arena but also across the diaspora of community level events where funding has come pouring in in the form of guild sponsors, brand sponsorships, merchandise and betting markets. 

Source: https://coinmarketcap.com/view/gaming/

The market capitalization of metaverse tokens is a measure of their dominance among players as these tokens are the lifeblood of the economy within and around the game. For many months, Axie Infinity was the crown jewel of the gaming metaverse and remains in pole position to this day. Competition is fierce however and as shown by Axie’s persistent usage deceleration in recent times and the exponentially increasing popularity of its close competitors, the leadership board and the flow of capital between titles is in constant flux.

Still, play-to-earn gamers remain incentivized as a whole and the market continues to grow, with no sign of apoptosis, despite the rapid waxing and waning of individual titles. Volatility has yet to dissuade participation in crypto and gaming looks to be of no exception.

Genres

Every genre and subgenre in traditional gaming has seen a direct DNA clone instantiated in the crypto metaverse. And that shouldn’t come as a surprise – if something was fun and popular, it will remain fun and popular but with the added feature of participatory compensation. The following is a short summary of the various genres that are becoming popular across blockchain games.

World builder – Fans of Sim City and The Sims will be familiar with this playstyle. Resources are expended to purchase real estate and build physical environments within the game e.g. building structures, cities and other explorable spaces. Players can then charge visitors a patronage fee to explore their creation or even lease it out. In Sandbox, a Minecraft-inspired game, the SAND token is the unit of currency used to purchase, develop and improve in-game real estate.

Grand Real-Time Strategy (RTS) – In the crypto successor to MMORPG titles like Eve Online, players operate in an adversarial network where they must compete against other players for resources and/or influence. Gameplay is often immersive, collaborative and involves longer playthrough sessions. Star Atlas, a space-based combat strategy title, is one of the most ambitious and anticipated crypto game titles in development at the time of writing. Using the Solana blockchain for game logic, game mechanics are built around two tokens: (1) the ATLAS token as the in-game currency and (2) the POLIS governance token which is used beyond the game as a voting mechanism to influence its development path (see DAOs below).

First Person Shooters (FPS) – As the genre suggests, your character runs around a map with guns and the goal is to kill off the other players before they do it to you. The basic playstyle is usually survival, or last person standing, but team-based Capture the Flag (CtF) is also popular. War Field by Golder Games is very similar to Counterstrike: GO and uses the GLDR token as its base currency. Every kill earns the player GLDR which can then be used to purchase better equipment and training for enhanced lethality.

Turn-Based Arcade – Players take turns making their moves to try and best one another. Players have the opportunity to plan and strategize their moves, however, in Player-vs-Player settings these moves are almost always timed to maintain gameplay cadence and intensity. Illuvium, based on the popular Pokémon franchise and set for release in 2022, allows players to capture creatures (Illuvials) and train them for battle. Illuvium uses the Ethereum token as the game currency. Players earn ETH through battles won and Illuvials can be traded on an NFT marketplace powered by Immutable X, a Layer 2 protocol built on ETH’s Layer 1, to improve transaction efficiency. Governance, on the other hand, is powered by an in-house token ILV (see DAOs below).

Cards – Dungeons & Dragons basically. This is a cross genre between turn-based play and strategy. Players buy playing cards that possess special powers, characteristics and abilities. Each type of card has its strengths and weaknesses against other types of cards. Similar to Chess or Go, players have to be forward-looking and anticipate future moves by their opponents in order to decide the best order of play. Note that we use the term ‘card’ loosely to represent a particular gaming style. Guild of Guardians, for example, is a free-to-play mobile app that operates the game-as-a-’free to play and earn’-service. Players form teams (or guilds) and enter dungeons to fight and defeat monsters. Artefacts and equipment dropped by defeated enemies are used to craft valuable items which can be equipped or sold for CGG, the in-game currency.

Avoiding Animal Farm: fair representation for fair work through DAOs

DAO stands for Decentralized Autonomous Organization. It is another line of effort in the creation of the metaverse economy but an important one. Structurally and conceptually, it is analogous to the corporation but also much more featureful. The corporation is owned by shareholders where each common share entitles the holder the right to one vote and the right to any dividends declared for that class of shareholders. 

The DAO embodies the characteristics of ‘decentralized’ and ‘autonomous’ because it allows users anytime and anywhere to exert influence over the ecosystem and express their share of voice. This is achieved by virtue of requiring “a consensus to be reached by holders of governance tokens” in order to make changes to protocols. The programmability of DAOs make it easier to foster an online community around a shared mission – a community where participants are socially connected despite being geographically distanced. As CoinTelegraph reports, “governance of DAOs and their operations are written in smart contracts, consisting of automated if-then statements, making them transparent and auditable”. In these respects, the flexibility and access of voting in DAOs make them a superior structure relative to the corporation.

A DAO is owned and controlled by those that own its governance tokens. To have a say over the running of the business governed by the DAO, governance token holders will need to stake their tokens. These tokens give holders the right to influence the activities overseen by the DAO but do not bestow any direct economic benefits – these are represented by a different token. This is a point of distinction between holders of governance tokens in a DAO vs. holders of common shares in a company. Whenever you hear or read the words “governance token” you know the topic must be DAO-related. These structures represent innovations in politech and add a politically meritocratic dimension to the metaverse.

Source: Coopahtroopa

Every crypto game is instantiated with a DAO sitting above it as its governing body. The DAO governs the development of the game as well as the distribution of economic benefits to participants (tokenomics). Theoretically, the DAO helps create a player-owned system where the will of players (workers) as an ensemble can be expressed through its governance tokens. From Forbes: “Each governance token gives its owner the power to take part in the game’s development and internal fund allocation, with that power, of course, being proportional to the amount of tokens each user holds.” In practice, players can sell their governance tokens to a capital-rich participant who can accumulate enough votes to project their will on the majority. So a DAO is fair insofar as providing the opportunity for participatory representation…but DOES NOT GUARANTEE it. People can always choose to forfeit their share of voice and influence by selling their votes.

The endgame

We’ve come a long way. We finally have all the pieces we need to begin to understand the big picture of where crypto gaming, as a metaversal phenomenon, might take us – and what could be a logical steady state for the industry. For this whole thing to not be a Ponzi scheme, there has to be sustainable and justifiable positive economics stemming from the natural tendencies and inclinations of participants. If there is money to be made, it must be money made off of gamers’ willingness-to-play which means there must be a matching willing-to-pay out there somewhere that attributes value to said gamers’ efforts. Otherwise, we would simply be funneling capital from new entrants to incumbents and the house of cards collapses the moment we run out of bodies to throw at the network.

Before we embark on an analysis of the ecosystem and its sustainability, we first take stock of all the stakeholders in crypto gaming and what they bring to the table.

Gamers – The ‘workers’ whose willing-to-play efforts become the productionized units of labor powering the ecosystem. Incentive schemes to encourage this ‘production’ of effort can range from limited gain / limited loss through to unlimited gain / unlimited loss and any combination in between. The risk profile will scale with the format of competition but, suffice to say, the expected payoff ought to be positive to ensure that a sustainable ‘living wage’ yield can be earned from playing.

Developer / Publisher – The creators and distributors of the game, responsible for creating the game’s built environment and its rules engine as well as setting up its governance.

DAO – A highly programmable structure encoded with the rules and logic for popular representation in how the game operates and the manner in which rewards are distributed.

NFT Creator – The entities responsible for minting the smart contracts that provide exclusivity of ownership to game assets. NFT creators are, first and foremost, game developers but in certain instances the developer SDK may be made available to the community to allow decentralized creation of game assets under a creative commons license.

NFT Curator (Investor) – NFTs that encapsulate sought-after assets become extremely valuable to players that deploy these assets in the game and to rent-seeking collectors looking for yield and capital appreciation.

Sponsor / Trainer (Investor) – Entities that finance the training and equipping of players under a profit-sharing model. As most crypto gamers hail from capital poor developing nations, trainer sponsors play an essential role in injecting liquidity into the ecosystem at the operational and coalface level. More on this point below.

Speculators – Observers and spectators who make up the audience and betting markets around a game. Through their participation, they add a powerful and non-linear boost to the ecosystem’s network effect. 

Brand Sponsors – Individuals and corporations looking to market to an audience. Given the breadth and depth of the gaming community, brand sponsors will look to target professional as well as community level events.

In bringing it all together, we start to form an image of this ecosystem. The diagram above is a possible, but not necessarily definitive, topological representation of a game’s ecosystem with all pieces in place. It represents a practical endgame steady state founded on the realities of positive economics of organic human endeavor. This system can be sustained, and avoid becoming a runaway positive feedback loop, so long as:

The willing-to-play dynamic is founded on a sustainable play-to-earn model.

And…

The willing-to-pay dynamic does not come from actors in their role as players but rather from actors in their role as investors, sponsors, speculators and spectators who are willing capital contributors to this ecosystem in a manner that fully funds the play-to-earn dynamic.

I need to point out that the ‘sponsor’ role within the guild ecosystem plays almost as important a role as the gamers. Many crypto game titles have taken off as a result of speculative long positions in the underlying game token.

An increase in the value of these tokens also increases the value of NFTs which are denominated in these tokens. Hence, the upfront capital commitment required to start playing can become a significant barrier to entry – an almost guaranteed conclusion for gamers with lives entrenched in the third world. Guild operators help alleviate that pressure by fronting the capital that will train and secure the livelihoods of their guild members – in return for a share of their profits as specified under a DAO.

A capital ship in Start Atlas can cost almost 30K USD…well outside the means of any one player.
Source: https://play.staratlas.com/market

And this leads to the essential and functional operation of the DAO to ensure fair rules in reward distribution are consensually agreed upon to stave off disquiet. As discussed, reality can deviate from ideology here since participants can sell away their influence by myopically offloading their governance tokens. To that extent the DAO, and by extension the game ecosystem, is at the mercy of its constituents when it comes to efficient and equitable operation. Ultimately, history has shown repeatedly that the masses do not always act logically in accordance with their own best interests. And that’s part of the reason why we can’t have nice things.

From ‘Play-to-Earn’ to ‘Play-and-Earn’ and back

Although the play-to-earn model discussed has the potential to reach a sustainable steady state, I envision that, as the industry matures, the ecosystem will gravitate toward a center of mass between play-to-earn and play-and-earn models. This is important because the play-to-earn crowd are generally and mostly enticed by the financial reward from their participation whereas play-and-earn players are mostly in it for the gaming experience – the reward is more a convenient and opportunistic byproduct. 

The vast majority of play-to-earn crowd are from poorer developing economies where the proceeds from gaming can make up a significant proportion of their periodic income. They’re in it for the income and many of them will have to go through guild sponsors to access financing and training in order to get started. And given the fiercely adversarial domain of competitive gaming, the necessity of training is almost a foregone conclusion – especially for players who rely on peak performance to maintain their game-derived income.

On that front, guild operators can be (and should be) a source of innovation within the gaming ecosystem. In financing players with upfront capital commitments, and curating an NFT vault, they become asset managers. And in training and managing player guilds they become human resource managers and allocators.

The capital needed to acquire NFTs for play is only one barrier to entry. Another barrier, especially for gamers that hail from lower socioeconomic strata, are the delayed payment protocols embedded in most game DAOs. Players can often wait up to a fortnight or longer before their rewards and winnings become available. A player from the Philippines or Malaysia or Indonesia whose primary source of income is from gaming would not be able to stomach that kind of lag. To that extent, professional guild operators have the opportunity to develop actuarial models that provide players with the option to access certainty equivalent cashflows, in part or in whole, at the time of their need.

Further up the value chain are the less numerous but more coveted play-and-earn crowd where the business model is based more around providing an enjoyable and immersive gaming experience and where the financial rewards are more of a convenient byproduct of their participation.

While play-to-earn business models require more effort and deliberation in their design and implementation, play-and-earn models are arguably less onerous since participation is more equitably distributed across two sources of motivation: entertainment and reward.

In my view it is important, for the maturation of the crypto gaming subculture, to mitigate concentration and contagion risk by (1) creating incentives that attract a greater share of the play-and-earn crowd and (2) developing titles and gameplay that are attractive from a leisure and entertainment perspective.

After all, it is primarily the latter (the ‘play’ aspect) that best aligns with one’s social tendencies. Income is a necessity while leisure and entertainment is a want. And since positive economics in this sector require connectivity and balance between the centers of willingness-to-pay and willingness-to-play, we need to ensure that there is sufficient nexus between entertainment value and humanity’s social needs to subsequently generate the capital inflows that sustain the livelihoods of players who rely on that income.

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Please note this article does not constitute investment advice. Investors are encouraged to do their own research beforehand or consult a professional advisor.

Jeff Gao

Jeff Gao

Jeff Gao is CEO of Cypherpunk Holdings. Jeff joined the company in April 2021 as an advisor to the Investment Committee. A quant and data scientist by way of training, Jeff holds a degree in Commerce (Actuarial Science) from The University of Melbourne and is a BSc / MEng (Electrical) graduate from Monash University. Prior to joining HODL, Jeff worked across a range of start-ups in his hometown of Melbourne Australia and currently holds a lecturing post at Kaplan Business School. Jeff is also a sophisticated investor and runs a small family office, managing private wealth.

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