The video game market is substantial. Valued at $175 billion in 2020, there are over 2.7 billion gamers globally. That’s 1 in 3 people. At the same time, gamers can’t take their money out of a game when they stop playing. So, if users are willing to spend that much in virtual worlds without any potential return on investment, what happens when their purchase becomes an asset that can be sold? This is part of the potential of blockchain gaming and why video games have the opportunity to drive wider blockchain adoption.
And yet, the blockchain gaming market is currently relatively small. While some larger gaming players – such as Ubisoft and Square Enix – have begun dipping their toes into blockchain-based games, most development has been led by crypto native companies. In this Insights piece, we’ll explore the opportunities and adoption barriers facing blockchain technologies making a major dent in video games. Let’s dive in!
What is a blockchain?
Before exploring the opportunity of introducing blockchain technology into gaming, let’s define what blockchain is and where we are in the adoption of this revolutionary technology.
Most blockchains have a few key characteristics: 1) the past is immutable; 2) they are transparent and open for all to see; and 3) transactions on the network are verified and maintained in a decentralized manner. This allows clients in a network to reach a consensus without having to trust one another. Simply put, a blockchain is a trust platform.
The idea behind blockchain technology was first described in 1991 and gained prominence when a person (or group of people), using the pseudonym Satoshi Nakamoto, used blockchain to serve as the public transaction ledger of the cryptocurrency Bitcoin. Since then, other blockchains, such as Ethereum, have emerged allowing for a range of interesting use cases. These include facilitating stores of value (e.g. cryptocurrencies such as Bitcoin), decentralized finance (“DeFi”), and decentralized autonomous organizations (“DAOs”). One of the most prominent use cases of blockchain technology for gaming has been the emergence of non-fungible tokens (“NFTs”). As we will discuss, NFTs can offer several potential benefits to both gamers and developers.
One way to think about the emergence of blockchain is through Carlota Perez’s framework for technological surge cycles. Perez studied the major technological revolutions since the industrial revolution and found that these cycles of revolution are coupled with financial cycles. Perez found that each cycle, which may take 50-60 years, consists of four phases. At BITKRAFT, we believe that blockchain has the potential to be a meaningful technological revolution and that we are in the irruption phase. We are basing our opinion on the amount of current funding in blockchain technology, the new emerging use cases previously mentioned, and the number of decentralized applications and infrastructure currently being built.
Source: Carlota Perez, “Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages”
What potential value does blockchain unlock for gamers & game developers?
The global video gaming market is substantial ($174.9 billion in 2020) and seemingly growing at a meaningful pace (19.6% growth year-over-year in 2020). It is the largest entertainment market at almost twice the size of the film and music industries combined. Given the current trajectory, some critics suggest that the application of blockchain technology in gaming is “a solution in search of a problem.” So, let’s unpack the potential value unlocked for players and developers through the introduction of blockchain technology.
For players, blockchain gaming has the following key benefits:
- Digital property rights: in traditional games, players purchase digital items (e.g., skins in Fortnite) and then can really only use these items in-game. Through the creation of NFTs facilitated by blockchain technology, these purchases transform an expense into an asset, creating actual secondary value from these purchases.
- Provenance: virtual goods now have rich histories and individuality. Imagine being able to own the exact, signed gun skin your favorite esports players used to win the world championship.
- Security: The decentralized nature of most blockchains (e.g., Ethereum) means players don’t need to trust any single developer. Their virtual goods can be provably scarce, highly secure goods operated on a cryptographic, decentralized backbone.
- Interoperability and composability: while it will take time, blockchain technology has the potential to allow interaction across ecosystems by leveraging existing building blocks. Imagine players wearing their Fortnite skins in League of Legends.
- Increased financialization: players can use their virtual items like traditional assets as collateral for usage in DeFi. For example, a player could secure financing for their next battle pass by lending out their high-end weapon.
- Financial alignment in game economies: gamers can now participate in the economics of games they love. Developers can share a portion of their revenue with the game’s supporters by issuing tokens.
For creators and developers, blockchain gaming has the following key benefits:
- Healthier game economies: Opportunity to monetize more players vs. the free-to-play model where, on average, less than 2% of players actually purchase in-game items. The ability to monetize this ‘long tail’ of users comes from a deeper willingness to spend, driven by the benefits for players mentioned in the previous section (e.g., digital asset ownership, provenance, etc.).
- Better unit economics: Sharing a portion of economics with players and creators in your game economies means lower customer acquisition costs and greater retention contributing to higher LTVs than traditional free-to-play games.
- Better economic alignment: With games like Roblox, creators keep ~30% of revenues. With blockchain games, users generally retain much more of the value they help create. But by leveraging things such as on-chain royalties, developers can unlock a new revenue stream by collecting fees on secondary market activity.
- Provides robust assurances: In addition to the credible neutrality of major public blockchains, networks such as Ethereum are already settling trillions of dollars of economic activity in a fully transparent and trustless manner. An internet-native global financial infrastructure is emerging that is highly composable, allowing for novel applications and a number of efficiency improvements.
- Capture value leakage lost to peripheral markets: Game developers design their games to take place in closed ecosystems. This has led to some economic activity taking place in peripheral grey markets. With blockchain, this demand can become a core part of a game’s business model and developers can take a fee for each transaction.
Of course, these are early days for blockchain gaming. Per Nonfungible.com, the NFT space, which includes blockchain gaming, had 142,863 active and over $2 billion traded in 1Q 2021. But there are many solutions coming to market that will conceivably allow for more complex games tapping into a web of blockchain-enabled virtual economies. Just how big could the opportunity be?
What is the prize?
The potential size of the blockchain gaming market is exciting to think about. As mentioned previously, the total game market was $175 billion in 2020 and is expected to grow to $218 billion by 2023 (depicted in the graphic below). Additionally, Newzoo forecasts that 77% of 2023 spending, or $168 billion, will be on in-game items.
Importantly, this assumes an ARPU of $62 ($168 billion divided by 3.1 billion players in 2023) as less than 2% of free-to-play users currently convert to paid users. If the characteristics of blockchain gaming allow for deeper monetization of “whales” and for some monetization of unpaid players, there is a potentially significant upside to ARPU and market size. We believe there is early evidence of this potential. One example is how the popular blockchain game Axie Infinity has seen average revenue per owner over $100, as compared to Pokemon Go’s ARPU of $1 to $10.
What are the key adoption barriers to realizing it?
With the potential value creation, which is enticing, what are some of the key adoption barriers slowing blockchain gaming down? Aside from usability, one of the main problems boils down to the so-called blockchain trilemma of 1) decentralization, 2) scalability, and 3) security. Still, there are those in the industry that are working on creative solutions to tackle these barriers, with the goal of making it possible to attain mass adoption, which we discuss below.
Blockchain games have struggled to balance these three features of blockchain technology. Scalability has been the most prominent, with many compromising on the others in order to achieve it. According to DappRadar, there were roughly 350,000 active blockchain gaming users in June 2021. Factors believed to be contributing to scalability issues include:
- Speed: Popular blockchain gaming ecosystems, such as Ethereum, are slow and thereby creating friction between market participants.
- High and Volatile Transaction Fees: Given throughput constraints, many blockchains see spiking transaction fees (called “gas fees”) when throughput is high. High gas fees disincentivize the buying and selling of gaming NFTs as profits are eliminated. This happened in 2017 when the CryptoKitties collectibles game caused transaction volume and fees to spike on the Ethereum blockchain.
- Environmental Impact: Many blockchains, such as Ethereum, currently use a proof of work system to verify transactions, which requires significant energy usage. Ethereum has announced it will transition to proof of stake in order to improve its environmental footprint (amongst other things).
- High Switching Costs for Successful Traditional Developers: Most blockchain game and infrastructure development has come from crypto-native developers, such as Dapper Labs, Sky Mavis, and Immutable. Few large successful traditional developers have announced blockchain gaming projects. It is a difficult sell to switch from a model where 100% of in-game economy sales go to developers to one where a much larger percentage of transaction volume is earned by the player community. Developers need to believe that they will earn a higher ARPU or increase their user base from switching. This will take time to play out. In addition, developers need to be comfortable with a blockchain’s security (vs. their centralized ecosystem) as well as spend the time and money necessary to launch and manage their new blockchain economies.
- Limitations on game design. Blockchain creates new challenges when designing a game. Traditional games can already make virtual items tradeable. For example, EVE Online already allow players to trade virtual items to pay for their subscription to the game. With blockchain games, designers have to figure out how to not only please players, but now also how to please investors. For game designers, this is a major shift.
- Less control of game economies. A traditional game is a closed environment where the developer controls economic activity. In a blockchain game, players can take items out of a game and sell them on exchanges. As a result, developers give up control of in-game economies in a truly decentralized ecosystem. The implications are that groups of owners can have a significant influence on the game economy or the entire game itself.
- Dearth of AAA Quality Blockchain Games: Most blockchain games to date lack the graphics and gameplay of popular AAA games. Blockchain games still need to be as fun as traditional AAA games in order to attract users.
- User Experience: The user experience of managing your virtual assets is complex. For example, if you want to move your NFTs to a sidechain, like Axie Infinity’s Ronin migration, it can take several steps. Furthermore, slower transaction speeds on some blockchain networks can interfere with gameplay updates. As the technology infrastructure is improved, users will be able to more easily participate in the various gaming economies.
Some blockchain projects have sought to solve scalability issues by sacrificing security and decentralization. These side-chains are primarily focused on increasing transaction speed and lowering transaction costs. They usually accomplish this by relying on a separate, less secure consensus mechanism. However, there are some emerging solutions, like Immutable X, that solve these two scalability constraints without sacrificing decentralization or security. The results from solving these constraints are real. Sky Mavis, the company that built Axie Infinity, saw transactions increase more than 500% in the 30 days after its successful launch of a custom scaling solution called Ronin.
Source: BlackRock. Blockchain Gaming was added to this graph by BITKRAFT and is based on estimates. An explanation of these benefits can be found in the disclosure section below.
In our view, it is important to optimize for ecosystem longevity rather than short-term concessions. Establishing trust is extremely important, and our opinion is that distributed ledger technologies have the potential to provide a unique degree of assurance in this regard. As such, we believe that robust, credibly neutral ecosystems should not be sacrificed simply for scalability’s sake.
Our take & the future of blockchain gaming
Blockchain gaming has many moving parts, and companies are working on tackling the barriers standing in the way of mass adoption. At BITKRAFT, we are interested in a) Tokens and Protocols as well as traditional equity, and b) in companies and projects that are applying blockchain technology to advance the games industry with greater technology and services. We are excited about several sectors within the industry. Some examples are:
- Games & Experiences – such as Axie Infinity and Yield Guild Games (a BITKRAFT portfolio company) – which are combining core primitives in novel ways to unlock new forms of communities, experiences, and coordination mechanisms at scale.
- Tools & Infrastructure – such as Horizon’s “Sequence” Wallet (a BITKRAFT portfolio company) and Immutable X – which are solving major bottlenecks like usability and scalability.
- Marketplaces & Platforms – such as OpenSea and Alethea (a BITKRAFT portfolio company) – which unlock greater discoverability and liquidity for virtual goods or extend their functionality.
At BITKRAFT, we believe that we are on the cusp of change with the emergence of a credibly neutral, shared infrastructure stack that anybody in the world is free to build upon. We believe the composability of ecosystems like Ethereum will compound innovation significantly faster than we have observed in the early internet. The increased financialization of virtual worlds is upon us as the technologies to connect thousands of isolated virtual economies continue to be unleashed. We look forward to speaking with founders and teams building the future in this space.
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