The History of Gaming and its Web3 Future

The History of Gaming and its Web3 Future

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Introduction

Overview

Fast Facts:

• The global gaming market reached $198.4bn in 2021, more than the film and music industries combined ($99.7bn and $26bn, respectively)

• The rapidly growing gaming space is projected to reach $260bn by 2025

• There are 2.5bn gamers worldwide (3bn projected by 2023)

• The average gamer plays 8 hours and 27 minutes per week

• US gaming revenue is projected to hit ~$90bn in 2022

• Mobile games make up about 50% of gaming revenue, with consoles making up ~30% and PCs making up the remaining ~20% of the market

Key-Takeaways:

• Tokens later, game first. Web3 is best suited to augment fun games, not masquerade as the star of the show. Web3 should be seen as a backend accounting feature that makes in-game digital assets more useful to players. It should not be seen as a panacea that will unilaterally improve games. Most gamers today are skeptical of web3 primitives and happy with the status quo. The gaming industry will not be challenged by web3 overnight. Rather, web3 game developers will need to convince a skeptical userbase of the benefits of crypto/NFTs with killer gaming applications.

• Major game publishers are cautious about web3. Ubisoft has walked back on their initial bullish comments towards NFTs. Apple seems to be content to stick with its onerous 30% tax on in-app NFT purchases, despite this decision’s likelihood to limit web3 adoption on its platform. Web3 game development will likely occur at the fringes until mainstream adoption hits another inflection point. Similar to the reluctance of legacy game developers to embrace mobile phones, we predict smart web3 gaming operators to capitalize on the lack of competition from industry juggernauts.

• Composability will be bottlenecked by Layer 1/blockchain ecosystem choice. For instance, a game that issues its currencies on its own Avalanche subnet would be far less interoperable than a game that deploys to Solana mainnet. Perhaps massive publishers will aggregate all their titles under a single layer 1 app chain built on top of protocols like Cosmos. The point is, there is a massive spectrum to the degree with which a game developer will make their in-game digital assets composable with other permissionless protocols. If a developer chooses to deploy on a siloed layer 1 with permissioned validators, many of the benefits of web3 will be minimized. It will be especially interesting to watch for web3 games that are built on protocols with very strong permissionless ecosystems unrelated to gaming such as DeFi, NFTs, DAOs, etc. Early data seems to suggest the opposite trend is happening, with game development congregating towards permissioned, siloed layer 1 blockchains like BNB Smart Chain and WAX.

• Non-transferable NFTs will likely be a key primitive for web3 games. Many benefits of web3 can be obtained by non-transferable NFTs. Player achievements and unified logins through wallets can enable a player’s history to travel with them across various platforms and game environments. The permanence and open-source nature of permissionless blockchains ensures that developers can always build new experiences upon this treasure trove of on-chain history. This use-case alone is already a massive improvement over the status-quo, and we expect legacy game developers to experiment with this before introducing riskier economic primitives (such as fungible tokens).

• Meta games will reign supreme. Meta games, or games built on top of other, existing games, are an obvious first move for aspiring web3 game developers. Platforms like The Sandbox are fully embracing this approach by encouraging developers to build within their ecosystem of NFT land plots and the SAND token. Successful developers benefit with existing infrastructure and intra-platform composability. The Sandbox benefits from diversifying its token economy across various games.

• Bridges will be key to mainstream adoption. We are already seeing an environment where game developers are building games on top of dozens of competing, non-interoperable blockchain networks. In this multi-chain crypto gaming future, bridges will be necessary to support cross-chain interoperability. Although there is a possibility that game developers consolidate into one ecosystem with built-in interoperability features, such as Cosmos, this seems unlikely as the web3 gaming space currently stands.

• More control, more money. Control over economies has historically been correlated with profits, and legacy publishers will be reluctant to give that up. One potential solution we see here is for publishers to employ a semi-open game economy that is siloed onto a single shard/subnet/app chain. In this scenario, the publisher would allow tokens/NFTs to work across any of their titles, but they would not allow money to leave their broader ecosystem. Regardless of whether this model is ultimately good for gamers, we would be surprised if developers don’t try it initially.

• Tournaments are a compelling use-case for permissionless NFTs/fungible tokens today. Examples of this dynamic working in practice can be found across Sorare’s suite of NFT trading card fantasy sports games. The reason this model works is because the NFTs are not required to start playing, and they only become a factor as a player increases his/her skill with the game. We see this model working well in traditional game genres such as Call of Duty and League of Legends where tournament play is commonplace with high monetary and reputational stakes at play.

• Not everything needs to be on-chain. Good web3 games will use a mix of off-chain and on-chain assets. On-chain transactions are costly from a transaction fee and data storage perspective. Today, most gamers are not spending any money at all in-game. The logical conclusion from this trend is that there must be a mix of both on-chain and off-chain assets to cater to all types of gamers. Casual gamers might be best served by assets that live completely off-chain, and this might be preferable for onboarding mainstream users who might not understand the benefits of crypto/web3 in the first place.

• Game developers may rely on DeFi-inspired business models to monetize. Imagine two separate games built on the same blockchain supplying liquidity for the biggest swap pool for their respective tokens on Uniswap. In this scenario, gamers win with composability across different games and the developers win with income generated by LP fees. We imagine creative business models that stay true to the permissionless, composable ethos of web3 to emerge over time and challenge the microtransaction-driven business model dominant today.

What does Web3 do for Gaming?

• Liquidity: Gamers retain the optionality to buy/sell digital gaming assets. Whether they are cashing in before leaving an ecosystem or bootstrapping a suite of NFTs before starting a new game, gamers benefit from a global, permissionless liquidity layer enabled by DeFi applications.

• Scarcity: While scarce items have existed in games for decades, these items are now built on permissionless blockchains in a trustless manner. Scarcity transcends an individual game's state into the global state enabled by public blockchain. Player can bring their scarce items with them to other applications.

• Self-custody: Unlike a digital asset or in-game currency that can be taken away from someone at the whim of a central authority (example), NFTs are custodied by players in their own wallets. As long as the player controls their own private keys, they also control their NFTs and/or fungible tokens. (Note: this does not necessarily translate into IP ownership which is a complex issue we discuss in this report.)

• On-chain Reputation: One of web3's biggest promises is creating an accountless internet model that unifies applications under the umbrella of a single sign-on through a user's web3 wallet. One consequence of this paradigm shift is that a player's reputation from one game can be read in by another game due to the openness and persistence of on-chain data.

• Permanence: Once an NFT or fungible currency is instantiated, it exists on the blockchain forever. This is powerful in a world where gaming APIs and servers are routinely deprecated by even the most popular games. Long after a game server shuts down, other developers can step in to honor the utility of the digital assets and retain collectible value.

• Auditability: An item's provenance is recorded in the blockchain. Some items may gain value simply because of who has held it in the past. Imagine owning a gun skin used by the winner of Fortnite's first World Cup. This mirrors the sports memorabilia industry with the added benefit of eliminating counterfeits completely.

• Decentralized Governance: Highly-engaged players can drive the strategic direction of the games they play through DAOs, councils, and guilds (such as Illuvinati Council, Yield Guild). Users can even benefit from the economic value accrual for being early adopters of a game’s digital assets, with those values rising as a game's popularity increases.

• Payments: Crypto can power seamless payments in-game with minimal friction and fast finality. Player-to-player payments and tipping are possible without central rent-seeking intermediaries. Creators on streaming platforms can monetize at a higher take-rate than what is possible through juggernauts like Twitch and YouTube. Prize pools and tournament payouts can be built natively without reliance on 3rd-party APIs like Plaid/Stripe.

• Business Model Innovation: While free-to-play dominates gaming today, it also creates an environment that is less conducive to creativity in the gaming industry. Web3 enables brand-new economic models to be tested. Early adopters can share in the risk/reward profile for developing games with fungible tokens and NFT primary sales (though this carries its own set of challenges we discuss later). Customer acquisition costs may decrease and retention may increase when players have skin-in-the-game (though this is not necessarily the case depending on the economic design of the game).

• Composability: Allowing completely different games to interact with one another will unlock new gaming use-cases that have never been possible before. To the extent the gaming space is built out on siloed blockchains, this vision will take longer to achieve and may require cross-chain bridging.

• This space has endured its own set of growing pains, evidenced by the decrease in market cap for the top GameFi tokens by roughly 75%.

• Web3 games have not yet consolidated around a single chain, with many chains seemingly vying for market share in the web3 gaming space.

The History of Economies in Video Games

1978-1983: The Golden Age

1983: The Video Game Crash

1985-2013: The Console Wars

Early 2000s: The Advent of Online Gaming

2010s: The Rise of Mobile

Present Day: Free-to-Play

Why do we game? The psychology of gaming

Why do we game? The psychology of gaming

Why We Play

• Test skills: Games provide sandboxed environments where players can develop and test their own skills with live feedback against other players and/or a computer. Broadly, these skills encompass problem solving, navigating through a map/course successfully, player-vs-player combat, reaction times, critical thinking, and many other modalities. Pac-Man is a concrete example of this concept with audible and visual cues when a player successfully gobbles up dots, and clear negative feedback when a player is captured by a ghost. Players obtain a great deal of satisfaction from encountering new challenges and overcoming those challenges with feedback throughout the process. Well-architected games, with mechanisms such as skill-based matchmaking, smooth learning curves, and logical progression, will ensure that players stay in a flow state while playing the game. These flow states allow players to detach from reality and focus intensely on the task at-hand at the edge of their abilities, and this is a deeply satisfying psychological phenomenon.

• Act independently: Gamers generally like to exercise agency over their actions and dislike when they don’t feel in control. Gamers want to feel responsible for their actions, regardless of the outcome. Too many artificial constraints can suffocate a gamer’s enjoyment of their environment. Good game developers can create environments that allow players to exercise full autonomy and control over their playable characters without introducing too much openness such that the game does not lack a purpose. This final point is a main area of distinction between game-like metaverse worlds, such as Second Life, which lack any directed gameplay, and popular games with metaverse-like features, such as Fortnite.

• Connect with others: Games often serve as digital commons where players can interact with their friends or complete strangers. In first-person shooters, this may manifest in the form of pre-game chat lobbies and in-game team chat. In role-playing games, this may manifest as text or audio-based chat based on an avatar’s proximity to other avatars. In single-player games, this manifests in the form of good storytelling where the player is connecting with fictional characters. Humans are innately social creatures, and games provide a vehicle through which players can connect with one another and share experiences.

Types of Players

• Achievers: Players who prioritize resource accumulation, status, and completion of all game objectives. These are the types of players who may complete weekly challenges in games like Fortnite and Warzone or aim to collect all in-game items in games like The Legend of Zelda.

• Explorers: Players who deeply immerse themselves in the game’s environment, seeking to uncover new experiences and test the game’s technical limits. These are the type of players who seek out easter eggs and glitches, sometimes posting videos of these easter eggs to an audience on Twitch or YouTube.

• Socializers: The lions-share of gamers. These are casual players who prioritize connecting with other players via in-game audio and/or text chat. They are typically less interested in following the game’s purpose and find satisfaction primarily from the feeling of belonging. Socializers also tend to cluster around friends who may fall into other buckets, and they help anchor strong network effects within games.

• Killers: Players who gain satisfaction from impacting the experience of other players, typically to the other player’s downfall. They thrive on chaos and high-stakes risk-taking. In RPGs, these were the players who sought out other players in player-vs-player environments to steal their loot. In competitive games like Warzone or League of Legends, these are the ranked tournament players.

Lessons in Gaming Psychology: Web3's Missing Ingredient

Sinks and Faucets

• Utilities: Typically, these are nominal costs for ongoing in-game activity such as Runescape’s toll at the Al Kharid gate or the armor depreciation mechanics in games like Elder Scrolls. Game developers need to be careful to not rely too heavily on utility sinks as they can make the game more painful than enjoyable for players.

• Casinos: The introduction of gambling mechanics in games reached its zenith in the mid to late 2010s. On the one hand, they serve as extremely effective sinks with statistically guaranteed negative expected value for players. Developers usually dangle the rarest in-game items as rewards, stimulating strong demand from the player-side for these rare items. Examples include Loot Boxes in Call of Duty (since discontinued in favor of Battle Passes) and Runescape’s Treasure Hunter. The issue with introducing in-game casinos is that players hate them and view these as exploitative measures. Regulators have also been increasingly hostile towards this mechanism with countries like Belgium outright banning the practice in 2018.

• Collectibles: One of the simplest and most effective sinks is selling ultra-rare collectibles, for high amounts of in-game currencies, directly to the players. Examples include condensed gold in Runescape, which costs upwards of 10mn GP and can’t otherwise be made by players. These types of sinks tend to be the well-received by players as they don’t inherently change the game’s mechanics and they reward long-time players who have accumulated enough resources to buy the collectibles in the first place. It also allows these same high-tier players to signal social status and hierarchical worth by way of displaying these expensive, collectible items. In the world of web3, grail NFTs issued directly by a game would achieve similar goals, and this mechanic seems like an inevitability for future web3 game developers.

• Taxation: In-game taxation serves as a sink to counterbalance new digital asset issuance. Traditionally, taxes in games are levied by game marketplaces, such as RuneScape’s Grand Exchange, which not only charge a 2% tax on each sale but then uses the proceeds from these sales to buy back and burn additional items listed on the marketplace. Taxes are already leveraged in the web3 gaming space with Axie implementing a 4.25% tax on all marketplace sales and Star Atlas outlining a plan to implement a land value tax. We expect in-game taxation to be commonplace across web3 games.

• Consumables: Consumables are high-velocity, low-value, in-game items that are used by players to create high-value, non-transferable items. RPG games, like Runescape’s construction skill, are the canonical example of this sink mechanic. Essentially, players have a strong incentive to signal status with player-built houses, and, most importantly, these houses cannot be bought or sold. They must be built by the players themselves with the player’s construction skill. The act of levelling up one’s construction skill in Runescape requires the player to churn through massive quantities of raw materials like planks, nails, and tools. However, the satisfaction of levelling up this skill coupled with the creative outlets it provides to players, and the social clout it grants players, actually makes it a compelling use of one’s resources. As a result, demand for these consumables manifest in a very organic manner, helping eliminate massive quantities of the game’s currency from circulation. In the Runescape example, planks are the number one item transacted on the platform’s Grand Exchange. We imagine successful web3 games, particularly those incorporating virtual land, to employ a similar mechanic using a mixture of transferable and non-transferable NFTs.

• Donations: Perhaps the most community-friendly of all sinks, donations are in-game mechanisms where players literally burn their in-game currency. Runescape famously implemented this with the Well of Goodwill and awarded players rare titles/accolades based on the amount donated. The rarest title in the game, “The Billionaire” was awarded to those players who donated 5bn GP or more (an extraordinary amount even for elite players). The social clout that came with this non-transferable title dwarfed that of party hat holders (the rarest in-game item). This mechanism is also reminiscent of in-game prestiging popularized by Call of Duty 4 (and discussed in detail in a later section).

• Staking: Although staking mechanisms have existed in games before web3, they were popularized by DeFi protocols and are a core primitive in the web3 gaming space. The purpose of staking boils down to removing currency and/or NFTs from marketplaces by incentivizing users to stake their digital assets in exchange for earnings. Axie Infinity incorporates staking mechanisms for both its fungible currency and non-fungible land plots. Yuga Labs also plans to incorporate staking of their $APE coin, the native fungible currency for their Otherside metaverse game. The key challenge with staking, as seen with the rise and fall of OHM forks last year, is preventing new currency issuance used to pay yield to stakers from devaluing the currency itself. If a gaming protocol simply relies on massive token inflation to incentivize staking pools, the sink turns into a faucet.

• Fees from Ancillary Infrastructure: STEPN is the canonical example of a web3 game levying this model. To swap SOL tokens for GST tokens, the user is forced to swap via STEPN’s integrated exchange. STEPN takes a fee on each swap and could theoretically also use the earned funds to burn excess tokens. By creating a core piece of infrastructure to power the game, developers can charge fees in the game’s native currency and create a natural sink.

• Derivative Works (mods): Games like Fortnite and Minecraft encourage community-driven game mods that build on top of the base game’s underlying architecture. Web3 seems extremely well-positioned to fully leverage the power of community mods for games due to the open-source ideology commonplace in web3 developer circles. So long as the modded version of the game requires the same in-game currencies and/or NFTs as the base game, the modded games will naturally spawn increased demand for in-game currencies. This organic demand can theoretically counterbalance new digital asset issuance. The Sandbox metaverse platform is architected with this strategy front-of-mind. Broadly speaking, “meta games,” or games built on existing infrastructure and/or IP, are well-suited for web3 games to leverage as currency sinks.

• Garbage Collection: This sink mechanism simply refers to the phenomenon of a player dropping an item (typically in an RPG game) and the game itself completely deleting the item from existence once enough time has elapsed and no other player has picked the item up. Most players are savvy enough to prevent valuable items from dropping and disappearing, so this sink has limited effectiveness compared to other methods.

Currency Distancing

Market Control

Impulse Buying

Limited Impact Items

Commodifying Captivity (Prestiging and Battle Passes)

Why Play-to-Earn Failed and Where We Go From Here

• Completely free-to-play: Any time a new player joins, they are issued 12 or more common cards for free. These cards are not NFTs and do not live on the blockchain. This strategy helps increase the TAM of the player base, which is crucial to onboarding potential whales. It also allows casual gamers or socializers to test the waters before committing capital.

• Fixed supply of rare NFTs: As the number of new players increases, the net issuance of in-game digital assets does not change at all. This ensures that each NFT holds its value over time, though it does mean that rare NFTs will become increasingly difficult to obtain as more users join the platform.

• No currency distancing: In fact, Sorare doesn’t even have a fungible token that’s used for its games. Instead, Sorare supports purchases of NFTs in USD with a credit/debit card. It appears Sorare is attempting to strike a balance between ease-of-onboarding and proper game economic design. Until web3 becomes more mainstream, it is possible that currency distancing takes a backseat due to the added UI/UX complexity of incorporating fungible tokens.

• Use of tournaments for NFT utility: We are very bullish on the use of tournaments to create utility for rare NFTs, which is the entire premise of Sorare’s fantasy sports NFT game. A player must work their way up the ladder to unlock higher-level tournaments that require rarer NFTs to compete. By allowing players to compete against others for valuable NFTs, Sorare is coupling NFT utility with a player’s level of engagement and enthusiasm to play at a high level. These engaged players also happen to be the most monetizable for the developer. This mechanic also keeps mercenary players looking to make a quick buck at bay.

• Partial market control: Players can buy and sell their NFT trading cards on both Sorare’s marketplace and any Ethereum-based NFT marketplace like OpenSea. Although Sorare’s marketplace doesn’t implement any visible sinks in the form of fees, they have the option to do so at a later point if needed. However, their conservative approach to asset issuance likely precludes the need to do so.

• Captivity commodification mechanism: While Sorare is allowing players to carry their rare NFTs into the ensuing season, the stats players accumulate for each NFT will reset each season. This model, popularized by prestiging and battle passes in successful games over the last decade, helps keep players engaged with Sorare’s platform at the expense of other potential competitors. We think other web3 games will find ways to incorporate this powerful mechanic given its track record of success in AAA titles such as Call of Duty.

Conclusion & Outlook