P2E: A Shift in Gaming Business Models

Arhat

0x1dE1

August 23rd, 2023

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This research was originally posted on May 11, 2022.

Executive Summary

The crypto winter of 2017 had a positive effect of making the benefits of blockchain technology widely known, primarily making data immutable for the first time. Post-2017, tokenization steadily took pace; it added liquidity to the ecosystem, opened up access to new investors, and supported diverse business models. The second innings of crypto, i.e., now, is similar to the internet, with an explosion of innovation (& speculation).

One such domain is the gaming platforms and their inclusive & tokenized P2E business model. I believe, at present, P2E does not emphasize the true nature of actual ownership in web3. The shift from web2 P2E gaming to web3 P2E has not been adequately compartmentalized. Platform scams and volatile user retention due to insufficient cross-selling opportunities have resisted suitable outcomes for the web3 gaming community and explain why web3 business models need a shift from P2E to Create-to-Earn (C2E).

Gaming has evolved over the years to be intra-connected with cross-platform accessibility to be the next big thing. The transition from traditional to blockchain gaming is adapting the concept of in-game economics to have tangible value across gaming communities that promote interoperability and incentivizes gamers & developers alike. These raise challenges for the P2E business model, including managing real in-game economies efficiently, assessing constant operational risks, balancing user experience, L1 & L2 scalability, etc.

Before crypto gaming existed, P2E was only accessible to 0.1% of the top gamers in web2. Gamers that wanted to go after big money within gaming had two options: go pro for an eSports team (game-specific leagues or enter tournaments) or gain enough followers to be paid by streaming on a platform like Twitch. But it didn’t add up to the idea of what web3 promises— Inclusivity.

Hence, I believe that the dynamics of the P2E gaming model needs a shift from P2E to Create-to-Earn (C2E) + P2E. The uncertainty around user growth demonstrates the market’s competitiveness and the importance of content within games. The initial steps to realize this would be to 1) organically attract whales to the platform and 2) onboard a new demographic of gamers from emerging markets to ensure sustainable supply & demand of tokens and other in-game monetizable assets.

NFTs, especially in gaming, have been long associated with running the commerce around gaming platforms; but I believe it is essential to consider NFTs as a technological change contributing to revenue rather than a primary revenue driver.

Given my thesis that the web3 gaming business model needs a shift from P2E to C2E so that the extended crypto community sees gaming as another “common” income-generating source rather than just a hobby, my benchmark model would comprise of the following four traits: Deep liquidity pool and strong network effect, Trust from customers with a specific focus on regulatory compliance, Strong brand as a secure platform and Platform for innovation.

INTRODUCTION

The 2017 crypto winter had a positive effect of making the benefits of blockchain technology widely known, primarily making data immutable for the first time. This kickstarted the second innings of blockchain technology. Post-2017 crypto winter, tokenization, which enables securitization of any asset (real estate, intellectual property, art, in-game assets, etc.), steadily increased. Tokenization eventually added liquidity, opened up to new investors (globally and through regulatory exemptions), supported/embedded automated compliance, and reduced back-office settlement costs in certain use cases of MasterCard and Visa.

The second innings, which is right now, is similar to the internet in the late 1990s when an explosion of innovation (and speculation) occurred. Eventually, this led to mainstream adoption. The tools and services are only now coming into place to enable applications to be deployed. I believe this will ultimately lead to a more distributed “engaged” environment driving demand.

One such domain is the gaming platforms and their inclusive & tokenized P2E business model. P2E does not emphasize the true nature of actual ownership, especially what we see right now in web3. Platform scams and volatile user retention due to insufficient cross-selling opportunities explain why web3 business models need a shift from P2E to Create-to-Earn (C2E).

The long-term viability of the P2E model remains unclear, and specific challenges hovering are the following:

potentially high barriers to entry,
volatility of tokens,
regulation,
long-term scalability, and more.

This assessment is addressed to three participants in the ecosystem:

Investors following the impact of tokenization in gaming
Web2 gaming incumbents monitoring the long-term viability of the play-to-earn (P2E) business model
Startups relying on digital assets (Tokens, NFTs) as their primary revenue driver

Why Gaming?

At present, the hype has cooled off surrounding cryptos, NFTs, digital assets, and the underlying blockchain technology, but the food chain is still developing. Crypto gaming has, over time, emerged as a critical use case for blockchain and has the potential to accelerate consumer adoption, similar to mobile games in the early 2010s.

The dynamic is not contradictory to the early 2010s, when mobile games, first made popular on social media platforms, such as Facebook, migrated to iOS and Android, driving users to create mobile wallets and learn game mechanics later adopted by a broader set of applications. Then, as with now, outsiders led innovation instead of the leading console/PC publishers, which later entered the space mainly through acquisition or by building an intermediary such as PlayStation, Gameboy, Xbox, etc. In 2021 alone, companies raised ~$4B for blockchain games and Metaverse experiences, with another $2.5B in Q1’22.

Gaming evolved from in-person to multiplayer to intra-console

Reviewing the transition from Traditional to Blockchain gaming:

Blockchain / P2E gaming: The gameplay is similar to traditional mobile or PC. The key differentiator is that players can earn digital assets that have both in-game and real-world value. Assets, including tokens (currency), NFTs (weapons, skins), or digital land – are free to trade on third-party exchanges and are convertible to crypto and, ultimately, fiat currency.
In the context of video gaming: MMORPG (Massively multiplayer online role-playing game) franchises like World of Warcraft have long featured elaborate economies where players can earn in-game currency or items through gameplay. Players in these games have, at various points, attempted to sell digital assets in black or grey markets to other players for money, a practice that publishers often cracked down on. In traditional gaming, all digital assets are ultimately IP owned by the game developer or publisher.
The promise of blockchain for gaming communities: In practice, blockchain or play-to-earn games allow tangible value to be shared with player communities rather than be held exclusively at the publisher or platform (e.g., Xbox, Apple) level. Players can earn items that are actual stores of value related to prior effort and time spent and that have shelf lives extending beyond the lifecycle of games. Blockchain further enables interoperability and can serve as an incentive to developers to use digital items from other games.

Play-to-Earn (P2E) has been the go-to growth & acquisition strategy for web3.

What Web3 Gaming Looks Like

Much has been said about Play-to-Earn, but P2E has existed in web2, and it was accessible to 0.1% of the top players or users. Gamers that want to go after big money within gaming have two options: go pro for an eSports team (game-specific leagues or enter tournaments) or gain enough followers to be paid by streaming on a platform like Twitch. But it didn’t add up to the idea of what web3 promises— Inclusivity.

The shift from web2 P2E gaming to web3 P2E has not been adequately compartmentalized to reap the benefits of an inclusive earning opportunity. Attempts have been made to onboard more average gamers onto web3 gaming platforms to earn “passive” income.

But the…

Regular NFT marketplace scams,
GPU scarcity, and
Insufficient cross-selling opportunities in web3 games to replace an entire income stream.

…have resisted suitable outcomes.

Also, the challenges are numerous:

In addition to running live operations, P2E devs need to manage real in-game economies efficiently. As players engage, a new currency is minted. Demand for this currency can come from new players entering the game, but if this slows, inflation results. This, in turn, leads existing players to abandon the game, which leads to hyperinflation. Game devs must find ways to slow supply or stimulate actual demand from established players (Whales) to prevent this. From a developer perspective, this requires a long-term view of the crucial areas such as token distribution (e.g., max supply, release schedule, and stakeholder allocations).
The onboarding process for blockchain games is daunting. Players need to set up digital wallets, transact, stake & hold various cryptocurrencies, and spend much money to buy-in. At the same time, traditional games platforms (Steam, Epic Stores, iOS, Android) have significant restrictions around P2E features.
Operational risk: The 173.6k ETH (~$650M) stolen out of the Axie Infinity Ronin sidechain highlights the vulnerability of P2E games, which maintain large treasuries of crypto assets and game tokens.
Revenue generation for the developer: while players are rewarded for their efforts in-game, the scalability of how developers create recurring revenue remains a question. For example, Sky Mavis, the developer of Axie Infinity, has an 80% commission on every Axie “bred”, representing 90% of their revenue. Hence, the game needs to grow for this recurring revenue to persist consistently. The remaining income generated is through secondary transactions of NFTs used in the game, where Sky Maxis takes a 4.25% commission on each sale.
Balancing enjoyable gameplay and earning: P2E gaming may face the challenge of balancing grinding (repeating actions in-game to receive a reward) and the game itself being enjoyable for the user. Ultimately, a game needs to be pleasing to retain players.
High barriers to entry in games: Some NFT games require upfront costs to play. Axie Infinity requires users to purchase Axie’s to play, with secondary market transactions showing sales upwards of $300.
P2E might be a different addressable market: Given the mechanics of P2E incentivizing behavior through rewards, the addressable market is likely to be different for P2E vs. the F2P segment. For example, Axie Infinity has a Day 30 player retention similar to that of Day 7, which is unusual for games, given that player retention curves typically decline over time. The retention of any web3 gamer could be attributed to the higher upfront investment costs.
Layer 1 vs. Layer 2 scalability: As gas fees (i.e., transaction fees) have increased on the Ethereum network (Layer 1), which is popularly used by P2E games, more sustainable solutions are being sought after to keep transaction fees low, particularly when the velocity of transactions increase. Axie Infinity introduced Ronin (a Layer 2 sidechain) to improve the cost efficiency of transfers to players.

The Dynamics of Web3 Gaming Needs Change

In web2, streaming or competing professionally can be a sorted income replacement, but on web3, the uncertainty of user growth within specific play-to-earn titles demonstrates the market’s competitiveness and the importance of content within games. With the challenges listed above, it’s necessary we shift the focus from P2E to Create-to-Earn (C2E) + P2E.

With C2E, the focus shifts to building content WITHIN games and stimulating sustainable game tokenomics by:

Organically attracting whales[1] to their titles:
1. The movement of whales can signal various shifts essential for game development. It’s no wonder that whales drive significant NFT sales volume despite the global crypto wallet holders to less than 400M.
2. Whales usually divert their $$$ to web3 games as they can:
  1. be sold anytime to recoup some of the money spent within the game once they decide to move on or
  2. be sold for a profit if demand continues to grow over time.
Onboarding a new demographic of potential gamers to their player base, those located in emerging markets would flock to games that generate more income than the average local job and ensure sustainable supply & demand of tokens and other in-game monetizable assets.

[1] I am also assuming that, early on, most whales will be the operators in gaming platforms that influence C2E mechanics

Source: Crypto.com

The world is on the verge of the worst economic crisis, crippled by inflation, war, and unemployment. Providing the most active demographic of the internet, the gamers, with the accessibility to generate (platform + personal) revenue is the actual shift that needs to be experimented with.

The likes of Sandbox & NFT worlds encourage their participants to create experiences and share a full-fledged gaming layout on their platforms. While most web3 platforms operate on the web browser rather than mobile, I suspect mobile will be the end goal for most web3 games as emerging market demographics see the upward potential of generating full-time income.

NFTs as a technological change rather than a revenue driver

NFTs have been long associated with running the commerce around gaming platforms, but I believe it is essential to consider NFTs as a technological change contributing to revenue rather than a primary revenue driver. The shift in perception is necessary to build a common ground for operators, developers & gamers alike.

While NFTs have been the backbone of generating extraordinary returns for users and revenue for gaming platforms but similar instances of closed economy marketplaces have existed in the web2 space for a while now. I mention closed economy because web3 games today are still restricted to one’s internal ecosystem with very little oversight of cross-partnership or interoperability.

For example, The biggest PC digital distributor, Valve, has operated a closed economy to allow players to exchange value from one Valve game to another. For instance, a Counter-Strike player may sell an in-game skin on the Steam Marketplace for Steam credit, which could be used to purchase games on the Steam store, Valve hardware, or be spent on other Valve games that allow it. See the illustration below:

Web2 illustration of NFT type model: Valve's Closed Economy

The Steam marketplace business model operates similarly to how I believe the NFT marketplace within video games is likely to perform with in-game token currencies. Over time, gamers can expect that web3 games ‘could’ prevent high velocity of transactions to control the market dynamics of the in-game token currencies, i.e., supply & demand.

In web3 gaming especially, I expect every significant gaming destination to build its own NFT marketplace.

What Am I Looking for In a Web3 Game

Given my thesis that the web3 P2E business model needs to change to be more inclusive given the limited accessibility of the web2 P2E business model, I have a benchmark that I would like to notice in web3 tokenized games. Those are:

Deep liquidity pool and strong network effect: This would ensure that the in-game tokenomics are fairly hedged to withstand volatility and be accessible to an extended community of gamers to maintain demand & supply.
Trust from customers with a specific focus on regulatory compliance: Given 1) several contrarian responses from governments worldwide and 2) scams from developers, I would expect more transparency in tokenomics, treasury, and in-game voting mechanisms.
Strong brand as a secure platform: With a focus on Create-to-Earn, developers must utilize platforms that have built trust and demonstrated significant potential from the ground up.
A platform for innovation: This ensures that developers produce a virtuous cycle for monetization so that the extended community sees gaming as another “common” income-generating source rather than just a hobby.

Conclusion

It’s still early to determine the fate of the gaming multiverse. Still, every instance of crypto winter (bear markets) and extreme volatility in tokenomics should be taken as a positive sign to adopt & adapt to the changing tides.

Three reasons why we’re still very early on what truly holds for the future of gaming:

Technology is evolving: We can expect different business models & the shift from P2E to C2E may be a promising step to experiment further.
Consumer adoption is increasing: From browser to mobile.
Corporate appetite is present: Metaverse and institutional investments in the web3 space have put significant liquidity in the ecosystem to effortlessly transition from web2 to web3.

I’ll be following up with an in-depth review of a sample in-game tokenomics. If you’d like to contribute or co-author, please reach out to me.

I can be contacted on LinkedIn and Twitter.

Thank you for reading through.