Cashing in on virtual parcels of land?
November 29, 2019 | Written by Eric Choy and Max Hinchman
The Gist
When I heard that someone bought a virtual plot of land for $175,000 USD (not a typo), I honestly couldn’t even process the thought. What sane person can justify spending that amount of money on a virtual plot of land for a game that hardly anyone even uses? $175,000??? For a virtual plot of land???? How can you make the argument that the $175,000 is better spent than sending it to the ASPCA after watching the Sarah McLachlan commercial for the 375th time? So we decided to take a look at Decentraland to try to get an understanding of why.
I don’t ever want to say that video games are more important than the poor dog that hasn’t had a meal in two weeks, but Decentraland, in theory, is potentially a good investment opportunity. It shocked me too. This is essentially a really really really pre-beta version of Ready Player One. But currently Decentraland has some major obstacles. Like releasing the actual functioning beta version to the public. Like I said “in theory” is a good investment opportunity.
So what is Decentraland? Decentraland is a decentralized 3D virtual reality world that is built on the Ethereum blockchain. What is unique is that the entire game is created by the users themselves. Decentraland itself is just a platform. The users then create their own content. Players can buy a plot of land using the MANA coin and then create almost whatever they want. So think of The Sims meets Minecraft….with blockchain. In the game itself, players can explore all different areas, which are divided into districts. For example, players can enter areas that have a casino, a carnival, or a market.
Decentraland’s value proposition is that it allows ownership of the assets in the game. Whereas in traditional video games, a studio decides the content allowed on the game and all of the content is owned by the studio. In Decentraland, the creators of the content will have verifiable ownership of their content and are also able monetize the content. So you can make money from trading content or even by other people interacting with your content in the game.
The current gaming market is dominated by online multiplayer interactive games such as Fortnite or Minecraft. Decentraland is also an online interactive game but also it takes it up a notch by allowing other developers to create their own games within Decentraland (a video game within a video game….). Obviously there have been a lot of studies on the success of open source projects and it will be interesting to see if it can also apply to video games.
In Decentraland, players use two tokens in order to interact with the platform, LAND and MANA. LAND is an ERC721 token that is used to represent ownership of the land. Every LAND token contains the coordinates of a single point on the grid and the details of the land. The information is then recorded on a distributed ledger. The MANA coin is a ERC20 token that is used to pay for all goods and services in the game, including land purchases (available on most major exchanges).
The main issues that video games today face is that there is no way to make money off of the content within the game unless you are the game developer. Obviously there other ways that gamers can make money off of the game (streaming) but there isn’t a game that allows for the monetization of assets within the game itself. Therfore, Decentraland is the first game in which users will transact and trade real value in the game. Decentraland also aims to address issues with security breaches and censorship, which is a common theme for all blockchain projects.
Valuation
What it comes down to is how large can Decentraland (DCL) get? If we’re going to imagine a metaverse with a sprawling urban area and economic life with businesses ranging from barber shops to mega shopping malls, well we better envision a typical metropolitan area. And don’t laugh at the idea of this quirky virtual world generating a bustling community bringing people from all over the world. So to piggy back off of the creators vision and to think BIG, let’s use New York City as our benchmark for what a virtual world can thrive into. I mean, like NYC, DCL already has a Chinese community…
And just like NYC, MULTIPLE Chinese communities…
A Yoda’s Temple, ala St. Marks Place…
A Bermuda Triangle, ala Riker’s Island…
And many other eye brow raising communities…
So let’s take NYC’s GDP as a proxy for DCL for this second and see what could the value of one MANA be:
-NYC’s 2018 GDP: $1.5 trillion
-Current MANA token supply: 1,050,141,509
-Divide GDP by # of tokens: $1.5 trillion/1,050,141,509 MANA
-Potential value per MANA: $1,500
The problem with using NYC’s GDP as a proxy is that DCL’s current major and only economic market is LAND (typed with all caps as a way to differentiate itself from real physical land). Eventually DCL will develop a marketplace for other economic businesses but for now its online marketplace allows you to only buy and sell LAND. DCL is bifurcated by two types of LAND: parcels and estates. For now we will focus only on parcels because estates are essentially multiple groupings of adjacent parcels.
And now to get to the more subjective part. How to value LAND? Let alone valuing real land. In fact, real estate appraisers still find the art of valuing real land as subjective as economists trying to forecast next year’s GDP growth. I’ve even reached out to a few real estate professionals on their take on this but to no avail were they able to respond.
Seth Williams says it best in this article:
“Unfortunately, there is no “magic bullet” when it comes to valuing land. As any real estate appraiser can tell you, it’s virtually impossible to reach the point of 100% certainty about any property’s market value of a property, and that’s especially true for unimproved land.”
So to circle back to the NYC example again, perhaps we can take the total value of NYC’s land as a proxy. A research report done by professors from Rutgers University actually draw up a figure for NYC’s land value at around $1.74 trillion. This would more or less put it in the same price range as the example above using GDP as a proxy. I was really tempted in digging deeper into this research report but realized that I had to pay $35.95 just to remind myself of common knowledge of NYC’s insane real estate prices (so yea probably wasn’t worth it, but if someone has access to this report please share!).
Traditionally, as laid out in the CFA curriculum, as well as standardized by the Appraisal Institute, there are 3 approaches to valuing real estate:
1. The Cost Approach — based on the actual cost of developing the land.
2. The Income Approach — based on rental income and an assumed capitalization rate.
3. The Sales Approach — based on comparable sales in relation to mostly location, size, and usage.
But when we are talking about raw land, it sure is a guess in the air.
To pivot back to the virtual world of DCL, or also known as Genesis City (from here on out I will be using both names interchangeably), each LAND is considered 1 parcel measured by 16m x 16m within a 3km x 3km world.
“The very first critical bit of information encoded in each LAND token is two numbers: an X coordinate, and a Y coordinate, each ranging from -150 to +150. If you take these two coordinates, and lay them out in a grid, you get a map of Genesis City.”
To give you some idea of existing parcels in Genesis City, basically an owner can name it whatever they want, build whatever they want on it, and sell it for whatever astronomical price they want to. For example, this whopping 7,272,727,272,727,270 MANA price tag on 1 parcel:
The lowest parcel up for sale right now is around the 10,000 MANA range, which is about $220.
The methodology I took to derive a total value of Genesis City is fairly straightforward: calculate an average (ex-outliers) of current parcels up for sale, multiply it by the number of total parcels in Genesis City, and model in a shortened timeframe of a “real estate market cycle” to mimic the effects of a “real” real estate market (this is also necessary to price in the volatility of the crypto markets at a later timeframe).
Initially what was needed was to download the full list of listed parcels up for sale including their previous price transactions and date. I was also able to download the list of estates listed for sale but for now I want to ignore that and specifically focus on parcels (because as mentioned before, estates are just a grouping of adjacent parcels). As seen in the above example of parcels listed for redonkulous amounts of MANA, I had to divide up the data in different quartiles and take the 3rd quartile multiplied by 1.5 as the upper limit, which came out to about 205,002 MANA. So anything above this price level was not included in my analysis.
A list of descriptive statistics from the remaining data was then ran to calculate the mean and standard deviation:
To give an idea of the distribution of the data set, a distribution curve was generated to show that even a handful of parcels still lied far aways from the mean. But it was necessary to include it in the data set because for one, I wanted to show some exaggeration in the average price and secondly, these are still lower than the far cries of the original outliers taken out.
To model in a simulated real estate market cycle, I shortened the time frame from the average historical 18 year cycle to a modest 10 year cycle including the 4 stages (with differing growth rates in each) of a cycle shown below:
Since DCL just started, instead of using the words ‘Recovery’ and ‘Expansion’ in the beginning two stages, it’s more appropriate to use ‘Expansion’ and ‘Equilibrium’ to characterize them.
To start with the assumptions and current year, if we were to take the mean and multiply that by the finite number of parcels, 90,000, we would get a value of 5,240,120,864 MANA. In dollar terms that is about $117,158,622 based on current MANA prices. If we divide that by the current MANA fixed supply, we should have a value per MANA of around $0.11. This means, subjectively, that prices are undervalued at this moment. And if you are a community member, developer, or fan of this project, this should be to no surprise. Listed below are also the assumptions for the different growth rates in each stage as well as the discount factor used to calculate an NPV.
To account for the 1% burn of every MANA in each transaction, a decaying factor was plugged into the model to show a reduced level of Total MANA Supply each year.
Expansion Stage:
Equilibrium Stage:
HyperSupply Stage:
Recession Stage:
Adding up all the PVs will give a final NPV of $15.94/MANA versus the current $0.022/MANA.
I could’ve also modeled in a long-term growth rate (we could’ve used 6.4% based on the NYC study) but I felt adding in a terminal value would’ve have been more or less irrelevant to this exercise for now. If anything, it would have just increased the value more. But would love to be open to hearing your thoughts on any other factors that I could have quantified into the valuation.
Conclusion
There are a whole host of issues that Decentraland has to overcome in order to actually start gaining a user base (firstly to release beta version). While the concept of trading video game assets is a cool concept, this alone is not going to obtain user adoption. While owning and trading assets in a game is a concept that is unique to Decentraland, making money through online gaming is not. People play games because they are fun. Add in the network effect and you have a Minecraft situation.
While there are probably a few people that have philosophical reasons why they chose to play a particular video game, a majority of the people don’t. The game needs to convince people through means aside from the decentralized principles that we have heard so much about. This applies also to most of the DApps that have been developed. At the end of the day, the products need to provide value that resonates to users. Why would they make the switch to a DApp otherwise?
Overall, this is another exciting project that we will keep watching but it is another example of two of the biggest issues that the crypto space is facing, a finished functioning product and actual user adoption. But with everything in crypto, speculation is still king. And if outsiders start to notice LAND prices continuing its meteoric rise, user adoption, via FOMO, in Decentraland can be sooner than expected.
Special thanks to Decentraland community members Matty786|DCLblogger.com, JAnden, HPrivakos, fedemolina, and toonpunk for their guidance during my research.
Investing in cryptocurrencies and Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by the writer to invest in cryptocurrencies or ICOs. Since each individual’s situation is unique, a qualified professional should always be consulted before making any financial decisions.
