Lessons From Minecraft: Achieving Alpha with Non-Fungible Tokens (NFTs)
I recently read an article in Business Insider discussing how a popular YouTuber, Preston, makes money. The article goes in-depth on Preston’s plethora of businesses including a clothing line, real estate investments, game development and YouTube income of course. As it turns out, the majority of his income comes from a game development company that creates games within Minecraft.
The article explains how Preston’s game development company runs their own Minecraft server, which is essentially like creating their own game within Minecraft. When someone manages their own server, they decide what type of gameplay exists, what type of weapons can be used, the cosmetic look of the environment, and literally anything else. From my understanding, Preston likely generates income from selling in-game items such as cosmetic items. To put the demand for in-game items into perspective, Fortnite earned $2.4 billion dollars in 2018 from selling cosmetic items. Minecraft servers have similar potential.
Creating a game within a game (assuming you issue your own digital assets in that game) seems like a straightforward method to make a profit, but this begs the question: in order to achieve the highest level of alpha should one issue digital assets or trade them?
First, let’s define alpha within the context of the NFT space. According to Investopedia, “Alpha, often considered the active return on an investment, gauges the performance of an investment against a market index or benchmark that is considered to represent the market’s movement as a whole. The excess return of an investment relative to the return of a benchmark index is the investment’s alpha.” Within the NFT space, the benchmarks for alpha can be thought of as traditional crypto markets, such as bitcoin or the Bitwise 10 Large Cap Crypto Index. Any return that outperforms these benchmarks would be considered alpha.
Now that calculating alpha is defined, let’s return to the original question: does the entity issuing non-fungible digital assets achieve the highest level of alpha or can traders achieve an even higher level? How can one effectively issue digital assets and garner widespread interest? The answer lies in the power of audience.
Audience & Brand Power
Preston’s story illustrates that a key ingredient to achieving a return on investment and earning a significant income is to create an audience. Creating an audience or community to sell a product is a tried and true method that spans all industries. Kylie Jenner became a billionaire from leveraging her fame to build a brand that sells high priced cosmetics; a high margin, low-cost products. In contrast, attempting to sell cosmetics with no brand would net you a much lower profit since people have little reason to purchase a new cosmetic from an unknown source besides low price. Preston had an audience and brand before starting his Minecraft server business. Without his existing audience, I have doubts he would have been as successful. By leveraging platforms like Youtube, people have the ability to gain a massive online following and direct them to games within a game. Fortunately creating Youtube content can essentially cost nothing but time, so it is the most effective form of leverage when building a successful game within a game. It is clear that building a game within a game harnesses the power of existing communities to create better user experiences and even better investment returns.
This further suggests that alpha can be gained by creating a strong brand, growing an audience then issuing a digital asset. Consider this simple example: If I were to create an NFT art piece and sell it on OpenSea, I would likely get zero bids. However, if a famous crypto artist were to sell that exact same NFT, it would be a hot commodity. Audience + brand = alpha.
Games Within Games
Starting a game within a game might be the most efficient formula to achieve alpha. Having the ability to piggyback on top of already popular games and create a method of earning within that ecosystem requires less human and real capital. Preston did not need to hire a development team to create a base layer (Minecraft) and did not need to spend marketing dollars to attract initial players. Instead, he went where the community already was and built something they wanted. An example of items that Preston sells on his server would consist mainly of cosmetic items like special particle effects, player ranks, pets, clothing, emotes and more. If you have a large community and are creating something they want, they will buy it.
Once virtual world platforms, like Decentraland or Cryptovoxels, have hundreds of thousands of users, it will likely be a smart move to create experiences and issuing assets within their ecosystems. Instead of attempting to create “the next Fornite” yourself, it is much easier to focus on creating better experiences in existing worlds. Who knows how many games have launched that claimed to be “the next Fortnite” to only crash and burn. The capital and time one would spend on creating the next big game would be better spent on building on top of what is already being used and improving existing user experiences.
NFT Asset Issuer vs NFT Asset Trader
An NFT asset issuer creates and sells NFTs while the NFT asset trader purchases and resells them. For example, Preston’s model of crafting in-game Minecraft commodities makes him an NFT asset issuer. Asset issuers have to deal with various overheads such as server hosting, employees, office space, and more. These costs can range from a couple of hundred dollars per month to an exceptionally high amount, especially if they have a large and talented development team. Even with such potentially large expenses, the asset issuer would factor in these costs when selling their NFTs. For example, if the asset issuer has expenses of $5,000 per month, then they could issue 100 NFTs with a base price of $50 each. They have total control of the cost and number of NFTs they issue.
The NFT trader faces a much tougher challenge. He must attempt to purchase the asset on the open market at the market price set by the asset issuer. Depending on whether the sale is an auction or fixed price, they might have to compete against others to obtain the NFT. This could cause the base price of $50 per NFT to increase to $60, $70 or even $100 due to other market participants bidding against him. If they were able to acquire the NFT for that baseline of $50, they would have to sell it for roughly double the purchase price to achieve the same profit as the asset issuer. The asset issuer seems to have a clear upper hand in this specific scenario. Competition destroys alpha.
NFT Issuers Win…For Now
The asset issuer will achieve higher alpha than the asset trader for the foreseeable future. The most efficient method of becoming an asset issuer seems to be building a game or experience that greatly adds to the user experience within an existing popular game. It requires much less risk and capital because you don’t have to actually create the base layer game from scratch and you don’t have to build and hire a team. The biggest barrier to achieving success when issuing assets seems to not only be creating a game or experience that people like but also finding a community that enjoys it. These actions require high human capital costs, but not nearly as high as creating the base layer game itself. With all that being said, the NFT ecosystem is still in its infancy so the issuers will win for now. However when the ecosystem and market become much more robust, the pendulum may swing in the other direction towards the NFT traders.