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Axie Part 1 – Fundamentals That Can’t Be Overlooked

Jun 30, 2021 · 12 min read

By Yan Liberman, CFA, CAIA, Joo Kian, and Jayden Andrew

Axie Infinity is the digital battle pet game taking the world by storm. It’s the poster child of the play-to-earn gaming movement, helping thousands of people across the globe earn a living as we speak. Even billionaire Mark Cuban has caught the Axie bug, in his words, “now anybody around the world can play and make money playing.” Coupled with their recent launch of Ronin, the release of the Play-To-Earn documentary, and crossing the 1 million Axie mark, there’s plenty to be excited about at Axie. 

In this report, we take a deep dive into all things Axie. We present the latest statistics reflecting Axie’s soaring popularity, explore the economics of Axie breeding, examine the performance of Axie’s treasury revenue since the Ronin launch and observe the fascinating interplay between SLP price, supply, and burn. For those of you wanting to adopt a digital battle pet of your own, we provide an overview of the Axie marketplace. Finally, we leave you with an exploration of the exciting developments going on behind the scenes at Axie and what to keep an eye out for in the not-so-distant future.

Axie has been growing at an exponential rate since the launch of Ronin. It’s clearly demonstrating what rapid user acquisition looks like. As seen above, daily active users, Axie holders, monthly marketplace volume, and Discord members have seen significant growth since the end of April. The Axie community treasury has also grown significantly.

Axie Infinity has gained attention recently due to its play to earn design, especially after the video published by Play-To-Earn showcased how it has helped people in the Philippines make a living off playing Axie. Last year, a Venezuelan player published an article showing she could earn more playing Axie for a few days than working for a month. We used Google Trends to estimate “Axie Infinity’s” search popularity, 100 being peak popularity for the term and 50 being half as popular. We can see that interest in Axie grew massively in the past three months and has the highest interests in the Philippines, Venezuela, Cuba, Qatar, and UAE.

Daily active users, unique Axie holders, and Discord member count have significantly increased since April 24. Total Discord members plateaued around 100k users for the first couple weeks of June due to a 100k user limit on Discord. After communications with Discord, the Axie team had the limit removed allowing member count to continue its upward trend.

Axie Infinity has integrated Ramp.Network(a fiat-to-crypto platform) into the Ronin Chain, allowing for players to buy ETH easily using a credit card. This allows for non-crypto players to top-up ETH into their Ronin wallets and purchase Axies off the marketplace in a simple way. The data shows on-ramp buying as Ramp currently only supports buying of ETH and does not support the selling of crypto-assets. Fiat on-ramp daily volume hit an all-time-high of ~130 ETH on 22 June, significant considering it was under 20 ETH 1 month ago. Since the only use of ETH on Ronin is to purchase from the marketplace, it is expected to boost marketplace volume, although just by a small amount.

Daily marketplace transactions increased alongside volume which grew from ~$100K per day from end-April to a peak of over $4M in June. User growth positively affects marketplace traction as 3 Axies are needed to play the game.

Axie’s treasury has grown significantly since the Ronin launch. As seen above, the treasury’s total revenue has increased from less than $1mil at the end of April to over $14mil today. One of the things uniquely attractive about the gaming industry more broadly is its resilience to macro turmoil, as evidenced by both 2008 and COVID. Similar dynamics are emerging within crypto as Axie Infinity posts its highest growth months ever despite a dramatic market sell-off. 

We have also highlighted the split of treasury fees, coming from breeding or marketplace fees. Before the Ronin launch, marketplace fees dominated the treasury. However, since the Ronin launch 2 months ago, breeding fees have grown to account for over 50% of total treasury revenue. Before Ronin, breeders paid SLP and transaction fees in ETH, which was often too high for many users. Not only was this bad for breeders, the treasury also wasn’t receiving any breeding fees. High transaction fees on Ethereum were the limiting factor for many smaller players wanting to breed their Axies. With the launch of Ronin, this fee structure changed for the better. Users now pay the same amount of SLP, but instead of forking out the cost of ETH for gas, they spend 2 AXS. This cost reduction is responsible for the recent uptick in breeding. Additionally, by replacing the cost of ETH gas with a payment of 2 AXS, the treasury now has a new income stream. 

Axie released a statement on 30th June, stating “we will increase the AXS portion of the breeding fee to 4 AXS. This decision was made to ensure Axie population growth remains healthy and create additional utility for AXS”. There is expected to be a decrease in breeding rates due to the change but with the current high growth it may only be slight.

Axie’s Price/Earnings Ratio helps us to understand how much of a cash flow generating machine the game has become. To calculate the P/E Ratio, we used Fully Diluted Valuation divided by the annualized 30D average earnings. P/E has come down from over 800 at the end of April to the recent low of 7.59. There are two distinct periods in Axie’s history, pre-Ronin before 28 April, and post-Ronin. Axie’s treasury daily growth increased from sub-100k in April to a peak of over 600k in June. Ronin’s cheap gas fees made it cheaper to breed Axies and transact on the marketplace, increasing revenue for the community treasury.

It’s worth noting that these are actual earnings that pass through directly to token holders. Projects will often conflate revenue and earnings, where participants like liquidity providers take a share of revenue and the residual is passed on as earnings to token holders. All of this income is going to a community owned treasury that will be distributed to token holders after the staking component goes live. These are retained earnings in their truest form.

Near-Term Projections

We extrapolated current trends to project Axie platform growth through the end of 2021. The platform is currently seeing ~30% week-on-week DAU growth. DAU’s increased by roughly 55k in May and 172k in June, representing growth rates of 167% and 197%, respectively. We realize these growth rates are elevated because there’s still such a small user base, so we assume a 50% growth rate in July, and decline it by 10% every month until Oct, where it’s held flat at 20% going forward. This translates to an average of about 160k new DAUs every month, which we believe is on the conservative side because June alone saw an increase of 172k. 

It’s important to note that the composition of DAUs in this game is different from most games, which are heavily dominated by individuals playing for fun. Axie has players that are motivated by fun, but it also introduces speculation oriented users and play to earn users. The speculative component isn’t binary, it’s the driving force for many users to varying degrees. The play to earn component is more binary, but it creates an additional stream of consistent, profit driven players. These users farm resources that are then consumed by entertainment and speculation based players, helping drive the game’s growing economy. As the user base grows, this improves the upside for speculators by increasing the pool of demand for their rare item. This flywheel creates incentives for all types of participants to join the ecosystem for their own motivations. This is why we believe our user growth projections are reasonable, if not conservative. Using the requirements of new users to participate in the game, we’re able to forecast profitability metrics from this user growth.

We kept % Fees from Volume at 4.25% and applied them to our volume estimates. Despite Monthly Volume per user continuing to trend higher over the past few months, we conservatively model a Monthly Vol per user taper from 12 ETH in June to 8 ETH in December. This metric can, and likely will, trend higher in the short term, but we expect user growth to outpace volume growth in the long run. The secondary benefit of using conservative growth estimates is that it makes the EoY metrics that much more impressive.

Projections for AXS in the treasury were also a function of DAU growth. We assume 4 AXS per new Axie bred as these are fixed variables. AXS Fees were 2 AXS per new Axie but it will be increasing to 4 as of July 2021. Since every new user needs 3 Axies to play, there’s a strong relationship between user growth and demand for breeding. In May and June, the ratio of new Axies bred to new DAUs, was 5.2 and 4.7, respectively. The current ratio of Axies to DAUs is under 5, meaning there is slack in the market. At the surface, you can imply Axie supply is currently in line with user demand since each user needs 3 Axies to play, but there are power users and various collectors who hold many Axies. That’s why we believe there’s a strong possibility for that ratio (Monthly Axies Bred/Monthly New DAUs) to remain above 3, but gradually decline in future months. Applying this ratio to DAUs, we’re then able to figure out how much AXS will accrue to the treasury.

By the end of year, the community treasury is projected to have 15.6 mil AXS and 26.6k ETH in it, equal to roughly $149m at today’s prices. This does not include the additional AXS that will be deposited there once staking incentives go live. Token holders are entitled to this treasury and will begin receiving distributions after staking goes live. They are also able to dictate how it’s spent through governance. 

We estimate that ~24% of circulating AXS will be held by the treasury by the end of the year, assuming no outflows from the treasury. The inflows come from breeding fees paid in AXS and because 35% of issuance based staking rewards will be directed into the treasury. Circulating supply expansion comes partly form the 65% of issuance based staking rewards that are directed towards stakers, and primarily from various vesting tokens across different groups of holders. Axie is scheduled for a Q3 release of staking rewards. It will be interesting to see how the treasury build-up plays out, given that treasury growth will likely be higher than circulating supply expansion as seen above. This also doesn’t account for the portion of the supply that’s going to be staked to receive distributions from the treasury.

Potential Weaknesses In The Axie Flywheel?

One way the flywheel could break down is from significant over-breeding. ‘Over’ is relative to the need for these Axies from expected future players. It’s a multistep breakdown with knock-on effects. Significant over-breeding front loads demand for SLP, and the issue starts to grow when the play-to-earn group that’s coming in to farm it is relatively undersized. They begin to farm SLP and sell it on the open market, but the bid for SLP is weak. This occurs because in the background, the price of Axies is beginning to fall since there aren’t enough new users to offset the increased supply. Breeding becomes less appealing because Axie prices come down. Since SLP is used for breeding, that means a decline in demand for SLP, which is how the previously referenced bid for SLP disappears. SLP price decline makes the play to earn model a lot less appealing for new entrants, and player growth also declines while the Axie supply glut persists. This is how you could get to a scenario where the economy stalls.

We believe this is a low probability event because this would require substantial runaway breeding combined with an environment where none of the other natural rebalancing components are effective. In most cases you’d continue to see an influx of play to earn players despite the suppressed SLP prices because it’s still worthwhile for them. This would gradually eat into the Axie supply surplus and lead to breeding demand once again. SLP price is clearly a component here, and SLP speculators actually help normalize price volatility a bit. They function as a source of demand when natural demand slows down and a source of supply when prices are running hot. Opportunistic breeders also perform a similar function to help reduce their personal average breeding costs by accumulating during times when prices are cheap. In the interim, another interesting component the team have control over is the cost of breeding Axies, which they’ve actually just raised from 2 AXS to 4 AXS. In this sense, the team can function like the ‘Fed’, raising breeding costs(interest rates) when inflation gets too high to curb breeding and lowering it when they want to stimulate the breeding.

In the long run, continuing to add utility for Axies is the best mitigant against this type of situation. The team is aware of this better than anyone, and they are designing the game with multiple measures in mind. The one we think is most noteworthy is that upgrades to both Axies and Land in the future will require crafting ingredients. These crafting ingredients are sourced by ‘releasing’ Axies, creating a deflationary element to the Axie supply. The deflationary element on its own isn’t the main novelty here, it’s that progress in the game will be dependent on breeding and releasing Axies, meaning breeding won’t exist purely to create Axies that need to be sold to new players. Decoupling breeding demand from the need for new players is crucial. This will also increase the value of upgraded Axies, improving the upside for speculators and collectors. Most importantly, it will strengthen the economic flywheel at the heart of the Axie economy.