August 26, 2021
Author:Yuffie • ユフィ
It’s 2045, an 18-year-old Wade Watts climbs through a mountain of twisted metal, squeezing through a gap to reach a hidden cargo van. He opens the rear doors, revealing a hideout equipped with computer parts, gaming gear, and an omni-directional treadmill.
Wade pulls on his haptic gloves, grabs a VR headset from his backpack, places it on his head, logs on, and is then ushered into a metaverse called the OASIS...
For anyone who has watched or read “Ready Player One”, you may have recognized the above prelude that was taken from the start of the movie/novel. For the benefit of the uninitiated, “Ready Player One” is a sci-fi novel-turned-film that depicts a teenager’s search for an easter egg in a virtual reality game, which would grant him control of the game itself, all set in a dystopian future (2045, to be exact).
Why is this relevant? The film depicts an alternate universe in the future, one where society spends a significant part of their lives gaming in a virtual world. In today’s world, gaming has become increasingly mainstream, taking a larger share of consumers’ time / disposable income / attention away from traditional media.
In this article, we will explore the NFT gaming landscape through four sections:
NFT gaming is not exactly new - CryptoKitties, one of the first games deployed on Ethereum, was launched in 2017. Whilst there has been an uptick in interest in NFTs lately (with the recent buying frenzy of art NFTs), NFTs itself require a use-case if it were to sustain real interest in the long-run.
Any concerns over NFTs being a hyped-up fad can arguably be countered with a legitimate use-case. This is where NFT gaming comes in.
Just as DeFi has become Ethereum’s main product-market fit, gaming is the most obvious use-case for NFTs. Why?
In the modern gaming industry, the rise of in-game purchases known as “microtransactions” have enabled an extra-form of monetization, increasing the average revenue per user (ARPU) of a game via the sale of in-game weapons or cosmetic items. Ardent players are willing to pay extra for these in-game items as they provide unique features or more “powerful” attributes to help them in the game.
Drawing this parallel to NFTs, an NFT token that is usable and provides utility to the user will end up having a solid intrinsic value. An art NFT may have unique traits or a unique name that makes it scarce (and hence some sort of buyer value), but it will still remain a collectible as long as the holder is unable to use it. Arguably, the only “value” that is intrinsic to an art NFT would be its (i) story / association, and (ii) collectability / resale value.
Gaming offers an additional aspect of value that art NFTs are unable to do so - (iii) usability / player engagement. Usability functions as a direct, and thereby a sustainable use-case for NFTs, expanding NFTs’ addressable market and attracting more mainstream adoption via player engagement. You can own a Hashmask NFT in your metamask wallet, but you can’t actually wear or use it (virtually).
Now, why would gaming work for NFTs?
In conventional gaming, in-game items do not out rightly belong to the bearer. Purchases are non-transferable, and can be viewed as a form of “lease” given that the items are locked in the game, with true ownership lying solely at the publishers’ feet as they have the ability to dictate the attributes, usage, supply, and price of an item.
As conventional gaming tends to exist on a centralized platform, if the game is discontinued or shut down, the in-game items will also cease to exist; and the item itself can only be used for the specific game it was designed for.
It is the developers and publishers that ultimately own the intellectual property of the game and its content. From a cash-flow perspective, it becomes a zero-sum game significantly skewed in favour of the developers/publishers (vs. the game’s community of users who pay to play/purchase items).
In contrast, NFT gaming offers a paradigm shift, from a zero-sum game to a positive-sum game where all parties benefit; Now, an in-game item can be tokenized to have:
Not only that, the current generation of NFT games have adopted a unique business model that accrues income to players via a “play-to-earn” model, rewarding players that participate in the in-game economy and allowing them to monetize the in-game items for real-world fiat currency.
Games like Axie Infinity go even further by launching a governance token and community treasury that decentralizes the ownership and management of the game so that any decision-making power and cash-flow accrual will eventually end up with the player community, rather than the game developer.
And why would game developers be interested in using the blockchain for their games? The upside potential is limitless - developers have the ability to design, craft, and run their own “digital” economy that is integrated with the real-world, and potentially charge a fee on all transactions within the game.
If DeFi democratizes finance, NFT games enables a community that is player-owned and driven whilst further legitimizing gaming as a way to make a living. From B2C to C2C.
As gaming has become more mainstream, its addressable market has also grown. Digital transformation has led to the advent of full-game digital downloads, mobile gaming, microtransactions, subscriptions, and eSports.
In fact, gaming has become one of the fastest growing media sub-segments, with the global games market expected to grow from c.$160bn in 2020 to c.$200bn in 2023E (according to NewZoo, a leading provider of gaming market intelligence).
74% of total gaming revenues were generated via in-game transactions alone in 2020, indicating a general willingness for players to spend on in-game items.
It is estimated that there are about c.2.7bn gamers globally in 2020 (expected to grow to c.3.1bn by 2023E), with 54% of players located in APAC, driven by mobile penetration and prevalence of F2P mobile gaming. Keep this in mind as we talk about the “play-to-earn” model later on.
What about the potential for NFT gaming? I’ve split my top-down guesstimates into three segments: (A) Total Addressable Market (TAM); (B) Serviceable Available Market (SAM); and (C) Serviceable Obtainable Market (SOM)
(A) TAM (largest possible market):
(B) SAM (segment that fits NFT gaming):
(C) SOM (sub-segment that NFT gaming can conservatively capture)
As a comparison, Axie Infinity, the #1 NFT game on Ethereum, has only c.58k daily active users (Source), which illustrates how early we are in NFT gaming
Do note that these figures are a guess at best, given our two variables (MAU growth and in-game revenue per player) are exposed to general volatility from the crypto markets; and actual in-game revenue per player (in fiat terms) may be significantly higher than what is estimated above
Whilst this market sizing exercise is a guess at best, one can argue that the numbers are conservative given that we are ignoring the cyclicality in crypto (adoption growth and fiat value). Assuming the full ‘19 - ‘21 CAGR of 335% for MAUs only gives us an implied serviceable obtainable market size that is c.2.4% of the total addressable market.
There is a saying that growth drives 80% of returns - being in the right industry at the right time is half the battle won; and NFT gaming + crypto adoption is clearly still in its early innings.
NFT gaming is not exactly new - the release of CryptoKitties back in 2017 marked the start of the first generation of NFT games that received widespread adoption. In fact, CryptoKitties’ popularity became a source of concern for Ethereum scaling as the game accounted for c.25% of network traffic at its peak (Source).
Developers would typically take months and often years to build and ship a game, and with significant costs between development and marketing. For instance, Red Dead Redemption 2, one of the costliest blockbuster titles (referred to as AAA games), cost as much as c.$540mm and eight years to develop (Source).
This development cycle translates into multi-year trends within the gaming industry, and often follows the lifespan of the various “generations” of gaming consoles. Similarly, the NFT gaming landscape should be viewed through the lens of a development cycle.
The first generation of NFT games were predominantly based on digital collectibles, many of which were inspired by conventional online collectible card-games such as Hearthstone.
Developers were concerned with the shortage of meaningful applications of the blockchain technology, and the public’s misperception of crypto back then. The team behind CryptoKitties, the first game built on Ethereum, sought to address the lack of functionality that was hindering the sustainability of digital collectibles through gaming. As games are generally free-to-play, developers profited by taking a fraction of all blockchain transactions in the game.
Earlier NFT games tended to have idle / passive game experience, relying on time-based actions that result in the collection of resources over time. For instance, CryptoKitties’ gameplay revolves around the ability of the collectibles to “breed” unique kitties with different traits depending on the combination of the two “parents”. Gameplay was also predominantly 2D in-nature, with basic graphics and animations, with numerous of the titles taking inspiration from classic games such as Pokemon and Neopets.
First gen titles also include games such as EOS Knights (idle RPG game built on the EOS platform, where the main aim is to save villagers from orcs), EtherGoo (competitive idle game built on Ethereum, where users aim to accumulate as much “goo”), Etheremon (Pokemon-inspired version of CryptoKitties, built on Ethereum) and so on.
Nevertheless, first gen titles lacked long-term player engagement as evidenced by CryptoKitties’ decline, with issues such as having a “pay-to-win” model where players have to spend in order to play at a competitive level given the lack of a proper in-game economy, and concerns over digital scarcity.
The current generation of NFT games belong to the second generation - where focus has been on improving long-term player engagement (that the first generation lacked) through their in-game digital economies, particularly with the help of “Play-to-Earn” (P2E).
The P2E model enables players to earn an income in the form of in-game tokens / rewards. These in-game tokens / rewards can either be used in-game, traded on open exchanges, or they can be cashed out for the player’s local fiat currency.
A pioneer of the second generation P2E model is Axie Infinity. It is a Pokémon-inspired NFT game where players battle, collect, raise and build a land-based kingdom for their digital pets (called Axies) in an open-ended universe. The game is currently the #1 game on Ethereum, with c.58k daily active users (>10x since October 2020) and over 7k ETH in cumulative revenue since inception.
Its popularity is underpinned by a variety of well-crafted options for players to earn an income, including:
All of these can be traded on open exchanges (such as Uniswap, OpenSea), or cashed out for fiat currency (an example would be the SLP/PHP pair on Binance P2P).
Unsurprisingly, a large proportion of Axie Infinity players come from developing countries such as the Philippines and Indonesia, attracted by the earnings potential that may sometimes pay significantly above the daily minimum wage.
Incentivizing players with an innovative play-to-earn ecosystem expanded the addressable market of NFT games, bringing more players into the crypto ecosystem (who otherwise would not have an interest in crypto), and drive up engagement levels as the game essentially becomes part of a person’s livelihood.
Other second generation games include Gods Unchained (the first NFT online trading card game where players earn packs of digital cards that can be sold for ETH), AlienWorlds (browser-based simulation game where players mine and compete for the in-game resource, Trilium), as well as the various sandbox platforms (such as Decentraland, and The Sandbox).
The upcoming third generation of NFT games is expected to come with a more refined gaming experience, leveraging on the strengths of play-to-earn combined with better game design/graphics that would align it with lower-budget AAA games.
If play-to-earn is the driver for popularity of the current generation of NFT games, the upcoming third generation of games will start bringing in the larger mainstream gaming community as production value increasingly aligns with traditional AAA games (together with the economic incentives that come with play-to-earn).
This is where we might expect to see rapid growth along the NFT gaming adoption S-curve, and could potentially be the last generation of NFT games prior to the direct arrival of large game developers.
Several upcoming high-profile titles to look out for include:
In the past, large game developers took a passive approach towards NFT gaming, largely by funding crypto-native developers through incubation labs (such as Ubisoft’s Entrepreneurs Lab). The development cost of an AAA game is significant, and hence these large developers would only take the risk of a big-budget project once NFT gaming becomes mainstream.
With the groundwork for mainstream adoption laid out by crypto-native indie developers, it would seem reasonable to assume that subsequent generations of games may potentially see large developers directly participate in the production of large-scale AAA titles (incorporating the lessons learned over the past generations, especially with play-to-earn). As crypto becomes increasingly mainstream, we will see an increasing number of traditional game companies take the plunge into NFT gaming.
To end this piece, below are some of the key considerations that I take into account when evaluating the space and particular titles in general:
Player base (and growth): online-multiplayer modes are great as the network effect they bring can become a vital source of competitive advantage. The more people play, the better the experience, thus creating a virtuous cycle especially for the large incumbents
Engagement levels: the flip-side to relying on network effects is the need to build and maintain the player base itself. This is where gameplay and in-game economic incentives come into play
Gameplay: an important factor of engagement levels; is this a game that you would enjoy playing for hours / consistently?
Tokenomics: is there a functioning, open value economy in the game? Any in-game token that captures the value of the ecosystem, and whether it can be traded and cashed out for real-world currency easily? Inflation rate? Digital scarcity of the in-game items
In summary, gaming offers a compelling use-case for NFTs - it allows players to truly own their in-game items, enjoy the value accrual of the in-game economy, and at the same time, earn a living by playing. Developers are given the privilege of creating a vibrant virtual economy, in which they potentially stand to profit enormously from if carefully crafted.
From a zero-sum game to a positive-sum experience.
Wade Watts gets to have his fun whilst earning income, and James Halliday enjoys the fruits of his labour.
Disclaimer: Any information contained in this article is for information purposes only, and does not constitute financial advice. It is based on current publicly available information, internal data and other sources that we consider reliable but which may not have been verified independently. While every effort is made to ensure the accuracy and completeness of this information, we do not represent that it is accurate or complete. Reliance upon information in this material is at your sole discretion.