Crypto Watch column | Moving from play-to-earn to play-to-own

Third column (13 Feb 2022)

This is first published in the Business Times.

BLOCKCHAIN-BASED gaming has gained strong interest from investors, reining in US$4.8 billion in investments last year. 2021 has also ushered in a new era of non-fungible tokens (NFTs) and play-to-earn (P2E) games, thanks to the massive popularity of Axie Infinity. I believe that such blockchain-based games are part of the next big wave within the crypto world.

What is P2E? The idea is simple: play the game and be rewarded with cryptocurrencies. To break it down even further, players are rewarded with in-game tokens for performing tasks such as battling other opponents, farming their own land, or breeding new characters to sell. However, unlike conventional games where these tokens are trapped in a virtual world, there is an option to cash out these digital tokens as real-world money.

As a parent of 3 children, I embrace this new wave and adopt an open mindset towards my kids playing games (well, they at least train their psychomotor and problem-solving skills among others).

Earning a living as a gamer in the future also does not seem like a distant reality (subject to my wife's approval).

However, I can see that the P2E bubble seems to be growing bigger each day. Here, I will look past the hype to see if a game is worth investing in. While P2E games seem to be steadily becoming more mainstream, I would classify these blockchain games as early experimental assets, and hence with high risk.

A page from the past: Gold farming vs P2E

As most may know, the concept of earning cash-like rewards through playing games is nothing new. The term "gold farming" has existed since the 1990s. As Wikipedia defines: "Gold farming is the practice of playing a massively multiplayer online game to acquire in-game currency, later selling it for real-world money."

Thus, the gold farm is quite similar in some way to the P2E model. However, the growth of gold farming tapered after its initial rise to stardom. I fathom that it is probably due to the fact that the game operators preferred a closed economy to retain all the value (avoid what is called value leakage), or game designers ultimately did not find the solution to building a sustainable experience around a semi-open economy despite such strong demand.

One of the more recent examples is from Activision Blizzard, the gaming company that Microsoft is buying for US$68.7 billion. Diablo III, the firm's flagship game, shut down its real-money transaction system owing to concerns around in-game inflation, degraded gaming experience and other regulatory issues.

So what is the difference between gold farming and P2E? In gold farming, in-game currency and exchange is typically centrally controlled by the gaming operator, whereas the P2E concept refers to games built with decentralised technologies, particularly NFTs and cryptocurrency.

A combination of blockchain and NFTs weakens the power of the middleman (the game operator) and grants autonomy to the individuals, allowing them to possess control over their assets and earning potential.

With the Covid pandemic disrupting the job industry at an unprecedented rate, it is only natural that emerging economies have started to view P2E games as a viable source of income.

Not all is rosy though, as industry players have highlighted myriad challenges such as price volatility of digital tokens, high barriers to acquire players, "rug-pull" risks, et cetera.

Is P2E building a bubble?

From a venture capitalist point of view, a worthwhile investment is one that delivers a value-adding and unique solution at scale and is sustainable over the long term.

To me, the most critical aspects are the exceptional gaming experience and a loyal gaming community. Everything else is icing on the cake, even if players are hooked on the prospects of making money, for the time being.

If we treat a P2E game ecosystem as a black box, for it to stay open for business and be sustainable, the inflow and outflow of money need to at least balance each other.

The reason why P2E seems like a bubble is because its focus on "to earn" at "2E" attracts a large number of similar-minded players who creates massive outflow pressure. The outflow (earnings paid to players) seem to outpace the inflows greatly.

So, how to navigate the hype?

1. Where is the sustainable inflow?

In traditional games, players' payment to access the game or purchase virtual assets can be considered the primary inflow of money into the game ecosystem.

Game operators then accept such money as compensation for the game development work, ongoing operational expenses, or pay as in-game token rewards. This is relatively predictable as inflow is what gamers pay for experience, and outflow is what operators take for profit.

In P2E games, I would be very cautious if there is tremendous outflow in the form of crypto earnings to players, but unclear or uncertain inflow.

What could contribute to inflow?

Based on past successful game titles, here are a few typical sources of inflows that I have identified:

• Direct payment for gaming experience. Traditional net in-flow of currency comes from players who contribute money in exchange for a good gaming experience. This includes the entry fee to skill based competition - for example, e-sports.
• Indirect payment from advertisement or sponsorship, et cetera, targeting the gamers. Advertising revenue provides a lucrative source of net in-flow for game developers and operators.
• Collectibles. While game-based collectibles are not new, P2E has created a new wave of NFT collectors that prove to be a strong funding source. Collectors may be game lovers, hobbyists, speculators, or investors, et cetera.

The creation of a secondary trading market for NFTs can also drive fund flow into the gaming ecosystem. Note, however, that speculators and investors are not sustainable inflow contributors as they both want to take more value out of the ecosystem.

The biggest challenge for P2E is that the inflows are so far driven by speculators/investors, thus posing a question on the sustainability.

What about outflow? In traditional games, outflow to players is kind of forbidden, thus gold farming has a history of struggles. P2E makes outflow to players a key thesis, thus offers potential disruptions, especially with its low commission rate. As Axie's founder Jeffrey Zirlin, also known as "The Jiho", put it: "Traditional games are digital economies with 100 per cent tax rates. Axie Infinity is a digital economy with a 4.25 per cent tax rate."

Despite the fact that P2E games' commission structure may be more lean compared to traditional games, it is most critical to identify the source of a large sustainable inflow to build a booming economy.

In my view, P2E's nature of attracting mainly outflow type of players will pose a challenge to its long-term sustainability.

2. Focus on the quality of gaming experience

In traditional games, players pay to play, in exchange for the gaming experience. That is also what makes them stay. Game developers would focus on innovating and improving the gaming experience to keep them stay.

In P2E games, the focus has been shifted to "earning", and sometimes a great gaming experience is not the focus, and the aim of continuously improving that experience may not be the developer's goal. While "earning" is easy to generate in the beginning by distributing from treasuries or minting, real gaming experience is what determines the long-term sustainability of the ecosystem.

I get that the prospect of making money quickly is a great user acquisition strategy, and having high user volume and engagement are attractive factors for investments. I am also not saying that focusing on user acquisition is not important at the beginning. However, at the end of the day, for a game to keep the users and attract more sustainably, it needs to have a great gaming experience, to attract a net inflow to the gaming ecosystem.

3. Is the game more focused on value distribution than creation?

You may be familiar with the share buyback tactic for public equities, or the share split. The aim of both is to increase the appeal of the equity without really changing business fundamentals. Share buyback can be an effective way of value distribution, while share splits only increase liquidity.

Similarly, many P2E games also deploy various value distribution tactics such as staking tokens, burning tokens, changing of earning ratios and so on. This has the effect of managing the cryptocurrency supply, thereby controlling inflation and supporting token prices.

Just as I was writing this article, Axie Infinity announced it would reduce SLP emissions to prevent "economic collapse". While there is nothing wrong with doing these, new investors may confuse these with real value creation efforts.

Like share buybacks or share splits, these tactics do not necessarily create long-term real shareholder value, and are typically a short-term solution to support prices, or worse to manipulate prices!

As a long-term investor, I would focus on efforts around value creation strategy instead of value distribution or liquidity creation efforts.

Beyond the token price changes, the rhetorical question I leave you with is: If more P2E games rely on a central game operator or even community to employ various tactics to control inflation or to support token price, would this "centralised" way of building a virtual economy also go against the decentralisation ethos started by Bitcoin?

More of a feature rather than a category

I feel optimistic about blockchain-based gaming and the possibility of creating a whole new digital economy based on digital asset ownership. However, it seems to me that P2E is more of a feature rather than a core product.

Our belief is that a great gaming experience should be the cornerstone of attracting players into the blockchain-based gaming space. By harnessing the decentralised concept, developers could build an open economy to allow for free exchange of virtual game assets and sustainability to be achieved eventually.

Players who wish to make a living by contributing time and effort will naturally come, and an open economy shall let the market mechanism redirect the value distribution.

Perhaps such games should be called "play-to-own", to reflect the digital ownership as core, and thus the related economic opportunities, rather than play-to-earn which seems more a marketing term.

In summary, blockchain brings a lot of inspiration and new thinking to our economy. I am excited about the blockchain-anchored digital ownership and open digital economic ecosystem being built around it.

Within the gaming sphere, value creation will occur organically as a product of a new and enhanced gaming experience. Always remember, there is no free lunch in this world. Do figure out whose money you are earning. Otherwise, you may end up as the one paying instead.

Like the article? Read the rest of the Crypto Watch Column here.

Edited by: Elise Tan

**For the latest news on Vertex Ventures SE Asia and India and our portfolio companies, follow us on Linkedin or **subscribe to our monthly newsletter.