That thing about CryptoKitties

CryptoKitties have made quite a splash, as the first collectible that is available in smart contract format on the Ethereum blockchain. Some of the prices paid are eye-watering, with the currently highest executed price being 247 ETH or $117,000 at the time the purchase was made. The kitty purchased in that transaction was this beauty here

Hi, my name is Genesis, the first of her name

and her (or his? see below) vital specs give some clue on why that kitty was particularly expensive:

Not only is this kitty very pretty, it also has a fast cooldown period (see below), so genetically it is very attractive for breeding (see below). Also, the serial number is kinda cool: Generation 0, Kitty #1 — so if you buy that those kitties are collector items (see below) then certainly this one has a special place. It is also worth pointing out that not all kitties trade at crazy valuations

At the time I am writing this, there were almost 40,000 transactions, covering about 32,000 unique kitties, and the average and median sale prices were $131 and $23 respectively. Looking over the data, there is a very high peak, starting at the aforementioned $117,000, but falling pretty quickly to $30,000 at place 25. Then there is a very long tail of transactions that are $0.50 (ETH 0.001) and $1 (ETH 0.002). It would be very interesting to look at this trade data over time.

Erm, OK, so I understand that I can buy kitties, but what does this actually mean to buy a kitty?

Glad you asked. The essence of ownership of those virtual kitties is that for every kitty there is a database entry that shows who the current owner of this particular kitty is. Note that this is not too different from how securities are held at an electronic registrar, the key difference being that securities are registered in my name (or in the name of my broker, bank or custodian), whilst kitties are registered to an Ethereum address — he who controls the private key controls the kitty.

OK, so I own a kitty. What can I do with it?

Well, first of all you can look at it, and some of those kitties are pretty cute. I am not quite sure about this, but as the owner it seems to me you can make kitties private so that only you can look at them, but in practice most kitties seem to be public — just cycle the number in the below URL 
https://www.cryptokitties.co/kitty/27746 
(see eg kitty #1000 for an example of a kitty that is either private or for some reason does not exist).

More importantly you can transfer ownership of this kitty to someone else, which again is not too different from traditional securities whose ownership can be transferred at will (often via an organised market or at least an intermediary, but this is not strictly necessary).

Finally, and this is the most interesting, you can put those kitties to work as they can breed new kitties, and you can sell those new kitties (provided you find a buyer), or you can keep them or give them away. The way it works is as follows: when two kitties love each other very much then — after a certain time, and provided the relevant fees are paid — they create a new kitty, and this new kitty’s genes are a combination of their parent’s genes, so as in nature the child kitties will resemble both of the parent kitties.

Oh. This breeding thing sounds interesting. Tell me more!

The breeding makes the whole thing more exciting and game like, as it allows to actively do something with the kitties, other than just looking at them. Also, it is — or can be — the source of a nice income stream, but I am getting ahead of myself.

Kitties do not per se have a gender, but every time they love each other very much they can choose their gender (well, their owner can; and only heterosexual couples are allowed). The difference between male and female kitties is that the latter produces the child (which then belongs to the female kitty’s owner — read into that what you want) whilst the former (well, his owner) receives the siring fee.

Excuse me? What is a siring fee?

Like when you own a prize stallion, whenever your kitty sires a child you get a siring fee. The way it works is that if you are the owner of a kitty you determine a price at which you are happy to share your kitty’s genes for other kitties to produce offspring, and then it is up to others to choose from the available males, at the price points offered.

So I can create as many kittens as I want?

Well, kind of. There is a time component to this. For example, our friend Genesis is a fast cooldown kitten, meaning it can bread every minute. Other kittens take much longer — up to 1 week if you have a catatonic one:

Putting our valuation hat on, it is clear that the cooldown period is pretty important: newly bred kittens are PIK dividends of a cryptokitty asset, so the DCF valuation of our cryptokitty investment will depend on the frequency with which it can produce offspring, and the quality of the offspring it produces.

And how do I buy and sell kittens?

However and where ever you want really. The default location where to buy and sell them is the Marketplace but you can buy and sell them on Amazon, on eBay, on your personal web site, or in a dark alley if you want. The advantage of buying and selling on the marketplace is that transactions are atomic, meaning that if you have the cash (well, Ether) you get the kitty and vice versa, so you don’t run counterparty risk (and good luck suing in court for delivery of your kitty; not saying it won’t work, but it probably ain’t cheap). On the other hand the market place takes a fee — so really your choice.

So when I own my kitties, I’ll own them forever?

The strict answer is of course no: if you sell or transfer the kitty to someone else, or if you don’t take care of your private keys and the kitty is stolen, then you don’t keep it, but you knew that already.

So let’s assume you don’t sell/transfer/lose your kitty, then do you keep it forever? The short answer is “it depends”. Cryptokitties rely on the Ethereum network to be around, so the first question is whether Ethereum will be around forever. For a reasonably time horizon the answer is probably yes — even if Ethereum falls out of favour there will probably always a few nodes running it. The more interesting question is what happens in terms of a hard fork, and we’ll discuss this in a second.

Before I can discuss this however I need to dive a bit deeper into the technical details (ht Luke Zhang): Kitty ownership is recorded in the Kitty Ownership smart contract on the Ethereum blockchain. There is a second contract, the Gene Science smart contract, that deals with the combination of genes when two kitties produce offspring. Also, and this is important, the kitty on Ethereum is only specified via its genome, a 256-bit integer (allowing the enormous amount of 10e77 different kitties; having said this, the human genome is around 4MB in size). This genome is transcribed into an actual kitty — image, description, cooldown time — via a proprietary server. As Luke says:

I’d also add that the issue is not only that Ethereum is expensive to run and to store things —cryptokittens are a commercial business after all, and keeping this on a proprietary server keeps the IP protected: if the kitties would be entirely determined by there two smart contracts (whose code must by definition be publicly available) someone else could just copy those contracts, re-submit them under new ownership, and set up a competing cryptokittens operation. Also, this proprietary server ensures that cryptokitties can only live on the blessed chain (or chains): if Ethereum forks into multiple chains, then the server might or might not provide kitten services to all of the post-fork chains.

OK. I think I understood. So what does this mean? Are those real assets or not? And should I invest? And at which price?

Woah, easy tiger. Let’s take those things in turn. Lets start with

Are those real assets or not?

That entirely depends on your definition of asset, but you’ll probably find that it will be very hard to come up with a definition of asset that excludes crypto kittens, but that includes some more exotic assets such as fine art, or the copyright to literature, images, or movies: you can own a kitten, and ownership gives you certain exclusive rights, notably

  • the bragging rights, ie being referred to as the actual owner of that kitty on that kitty’s profile page
  • the right to receive siring fees if someone chooses one of your kitties for mating with one of theirs
  • the right to receive the offspring if you have one of your kitties mate with another one
  • the right to transfer ownership to someone else of your choosing, and against a consideration of your choice

Arguably from a fundamental value point of view a kitty is more of an asset than a Picasso, the latter being a pure momentum (aka greater fool’s) asset that only gives you bragging rights, and that relies on someone else paying more for it than you paid to make a profit.

Should I invest?

First of all, nothing here should be taken as investment advice. I have no idea whether Genesis is worth $100k — one can reasonably argue it should be worth a lot less, or a lot more. It will be interesting to see how much money Genesis and other highly priced kitties will make in siring fees and by selling its offspring — keep in mind that Genesis has a very brief cooldown period.

At which price?

See above. Having said this, maybe at one point there will be a market price for certain features, like Genesis’ pretty diamond, or certain colors and patterns. In this case you could value a kitty based on its ability to pass on those desirable features to its offspring, and the frequency with which it can produce offspring. Also, there is the rarity effect: Genesis is and will always be the first cat ever to be conceived from the first ever crypto collectible — the bragging rights associated to this are not insubstantial.

OK. But seriously now. Is this a thing?

Cryptokitties might seem like a nice joke, but they are actually really interesting an innovative in a number of areas, notably

  • digital collectibles, ie the ability to produce digital items of limited supply that people value because they are scarce (and cute…)
  • dynamic gamified digital assets, ie the ability to create new kitties, which relies on both (mate selection) skills and means of production (ie kitties, and/or funds to pay the siring fees)
  • asset tokenisation, ie the ability of holding (and trading) off chain assets on chain using a smart contract

Let’s discuss those in turn:

Digital collectibles

People collect all kind of stuff, and collectibles are ultimately all momentum assets, ie they have no or little intrinsic value, and their prices depends mostly on the amount of money that other people are willing to pay for them. Even for assets where you could argue there is a certain enjoyment value — say the Picasso that perfectly matches the furniture in the living room, or the Pollock that perfectly matches the usual state of the childrens’ room — typically the people who have the skill and knowledge to distinguish an original from a copy don’t have the money to actually own an original and vice versa. So ultimately pretty much all of the value owning collectibles — as opposed to owning copies of collectibles — is in the associated bragging rights.

For real world collectibles, illegal copying is a major issue, and probably many people paid over the odds for a copy that they thought to be an original. Even if people do own the actual collectibles they probably paid a lot of money to experts who asserted that those collectibles are genuine — collecting stamps, rare baseball cards, rare Beanie Babies or Picassos comes at a transaction cost. Those transaction costs disappear for digital collectibles: Genesis is the kitty number 1 in the Kitty Ownership Contract on the blessed fork of the Ethereum blockchain, and the owner of this kitty — currently a Stimpson J. Cat — can prove his ownership eg by signing a challenge with the Ethereum private key corresponding to Genesis’ registered owner address.

Dynamic, gamified digital assets

That title is a bit of a mouthful; what I mean with this is that the collectibles are not static, but that you can do stuff with them, and that there is a certain suspense and game effect : choosing the right kitties to own or to sire your kitties is not only about how they actually look — which everyone understands — but also which genetic traits they have, and how those traits are likely to appear in their offspring.

Supposedly, insider trading is not allowed, meaning that everyone who has taken part in producing the genetic code is not allowed to talk about it, and/or to buy kitties. So people will have to find this out Mendeleev-style by running experiments, and there are probably revenue opportunities by doing this expertly.

Asset tokenisation

This is probably the most interesting part of this entire project: kitties are off-chain assets that are uniquely (?) identified on-chain using their 256 bit genetic code. All asset transactions — including production of off-spring — happen on-chain. However, the on-chain assets are only valuable because they have been blessed off chain: in case there are multiple forks of the kitty smart contracts because the Ethereum chain has been forked — or multiple instances of the kitty smart contracts that are running on the same Ethereum block chain — the off-chain server determines which of those contracts is the blessed one that actually owns the asset.

There are numerous applications to such a contract. For example, the ownership of real world assets held in a warehouse could be assigned to smart contracts of this type, with some right to redeem the actual assets when surrendering the token. Or the ownership of paintings in museums could be assigned that way, maybe giving the right to have your name or corporate logo displayed prominently next to the painting, or even the right to borrow your painting from time to time to have it displayed in your home, lobby, or in a commercial exhibition.

In the industrial space this technology could serve to support an “Uber, just for [service X]”. For example, if the asset in question is some big piece of machinery like a crane, a token could correspond to having that crane for a specific period of time. Or, tokens could buy you processing or storage capacity on some cloud.

Last but not least, you can tokenise some really interesting collectibles. For example, Wu Tang Clan could sell an album on a tokenised basis, where the music is only streamed to the authenticated owner of the token (ideally in some DRMd manner, to avoid it being copied at this point).

I’ll stop here — asset tokenisation is fascinating, but that will be the topic of another post.

TLDR

The cryptokitties might appear like a stupid game, but it is actually pretty neat technology.

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