Web3 gaming evolution and 5 economic challenges (Part I)

By: Alexandra 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.), Alexandra 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:

1. In-game currencies — virtual currencies artificially constructed by the game developer (not convertible back to fiat)
2. Sources — ways to acquire in-game currencies
3. 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:

1. In-game currencies — virtual currencies artificially constructed by the game developer (may or may not be converted back to fiat)
2. Sources — ways to acquire in-game currencies
3. 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).

1. Passive Engagement — stake tokens and wait for game to appreciate, buy NFTs and then resell them to the engaged community at a premium
2. Mid Level Engagement — plays the “economy game” (i.e. manages resources), trades ERC-20 and ERC-721 tokens on marketplaces
3. 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)

In Part II, we explore 5 web3 gaming economy challenges and web3 game future states. Read it here.