The Year Ahead for Gaming

Introduction

As the dust settles on a turbulent year for the industry at large, we’re provided with a great opportunity to reflect on the state of play in the Web3 gaming space. Gaming was a primary driver of the 2021 mania, yet it has given way to cold realism as we move into the trough of disillusionment. All innovations must embark on this quest through the hype cycle. Both the depth and duration of that trough remain to be seen, though this year has forced a sober mind and fresh perspective.

By now, it is clear that the earn-centricity of play-to-earn titles is not conducive to long-term sustainability and ultimately leads to speculative fervor that is harmful to the ecosystems in question. That said, these early games and models have played a vital role in bootstrapping interest from the mainstream and have driven a massive talent influx to the sector. As we addressed in our mid-year The Future of (Crypto) Gaming report, we don’t believe that the earning component of these games is fundamentally flawed, rather that there is a need for a dramatic recalibration in terms of its relative prominence in games.

By early 2022, over 50% of all deals funded in crypto were gaming-related. A total of $3.6B was deployed in 2021, a figure which was marginally eclipsed this year. Despite private and public markets appearing lackluster, we are strongly encouraged by the quality of developers moving into this sector.

We believe that the fusion of conventional game wisdom with hard-learned insights from the early cycle are laying a robust foundation for the years ahead. A key observation we believe many have still failed to grasp is that the feedback loops in game development are significantly longer than in other sectors of crypto.

In a market that moves at warp speed, it’s easy to demand too much too soon. We believe that most projects shouldn’t have live tokens in the market until the bulk of their core game loops are established, which can immunize them against speculation and inflated expectations.

This report will cover several key themes we believe deserve the spotlight, some standout events from the year, emerging models that we’re watching for the year ahead, and finally, some concluding thoughts tying all of these topics together.

Themes

Infrastructure

Quality of content is the ultimate driver of onboarding users, but the underlying infrastructure plays a critical role in the creation of better games and experiences. For Web3 games to reach their true potential, they must deliver experiences as seamlessly as gamers have grown used to. After all, the bulk of the player growth for this sector has to be exogenous, as only a minuscule fraction of the world’s 3B gamers have even interacted with a Web3 game.

Ethereum’s scaling limitations. For years, Ethereum has been home to the largest number of developers and projects, making it the most popular ecosystem of choice. However, it was not designed for gaming applications. Since CryptoKitties caused issues for Ethereum in late 2017, teams have been looking for more scalable alternatives, which birthed several specialized infrastructure providers such as Immutable and Flow. In more recent times, we’ve seen these problems resurface with massive fee spikes at the base layer. We built a conceptual framework for thinking through a number of these trade-offs for scaling NFTs and games in an earlier report.

As a result, the demand for scalability solutions to combat the limitations brought forth by monolithic chains, such as Ethereum, continues to increase. In particular, EVM-compatible sidechains and layer 2 solutions present a way for developers to gain access to Ethereum’s robust ecosystem without the need to compete for blockspace at the base layer. While it’s possible to pull on-chain activity from existing live projects, there are very few games with significant numbers or consistent reporting. As such, we believe funding to be a better forward-looking indicator of ecosystem prevalence. It’s important to note that this data is drawn from The Block as well as various announcements, and many teams are launching on multiple ecosystems or have not yet publicly made an ecosystem choice (marked as TBD).

As we can see, the bulk of blockchain-gaming funding has skewed towards EVM-compatible ecosystems. This supports our earlier thesis of projects wanting to maintain proximity to the massive liquidity and security at the base layer. 2022 started where the preceding year left off, with “grant wars” between different platforms trying to attract great talent. As the market has cooled down broadly, much of this activity has slowed down. A particularly noteworthy event in this context was Immutable’s GameStop grant, which appeared to have no vesting conditions and was dumped instantly. Fortunately, since this occurrence, Immutable has nailed a much more milestones-based grant program as well as rolling out a $500M ecosystem fund. Polygon and Immutable are the undisputed champions of Ethereum gaming, and we hope to see less “PvP” dynamics on the grant/funding side and more collaboration moving forward.

While Polygon faced criticism in the past around the robustness of their technology, relying on a proof-of-stake sidechain that has at times frustrated developers, they have made significant progress towards becoming a true L2. In particular, they continue to advance their zkEVM and Plonky2 offerings after committing $1B to zk-rollups last year.

Monolithic vs. modular architecture. Another approach to more generalized scalability solutions is modular frameworks such as Polygon’s supernets and Avalanche’s subnets. While this technology is less mature, it offers projects the ability to more neatly roll their infrastructure stack and wield greater control over the user experience without having to build it from the ground up. One of the trade-offs inherent in the modular approach is composability, but that’s often not critical in gaming, where most of the activity occurs within its own ecosystem. We believe that this design space is still relatively unexplored in gaming, though it holds great potential as a long-term scalability candidate. We continue to monitor Celestia as an interesting project leading this space.

With the fallout from Terra and FTX affecting a number of games, we expect further ecosystem consolidation in the coming year. While we have already seen projects such as Derby Stars migrate from Terra to Polygon following the collapse, the dust still needs to settle as it relates to FTX and Solana. A number of teams were unfortunately exposed directly to FTX, providing an opportunity for ecosystems to try and engage distressed projects. It’s important to note that the Solana builder community has shown significant resilience in the face of a massive system shock, and its flourishing NFT ecosystem is still second only to Ethereum for 30-day volume. We hope this is a sign that the many talented gaming teams building there will follow suit in building a vibrant gaming ecosystem.

The First Wave of Blockchain Games

Since the start of the year, the top 10 blockchain-gaming projects by market cap have fallen by up to 95%. A common contributing factor was the inability of first-generation blockchain games to maintain a sustainable in-game economy and player base, though obviously broader market forces dragged everything down too. While a number of key learnings have been drawn relating to managing open game economies, as with all tokenomics, it is very difficult to apply changes retroactively. As such, we encourage greater reservations around releasing in-game tokens until games have progressed much further through development moving forwards.

The rise and fall of Axie Infinity. It would be remiss not to touch upon the game that drew mainstream attention to Web3 games. Axie Infinity’s daily active users (DAUs) hit all-time highs in November 2021 and have been on the decline ever since, marking the end of its reign as the most-used blockchain application in the world. Many are quick to forget just how staggering its growth was, where for a period, the game was generating more fees than both Bitcoin and Ethereum combined. It ultimately became clear that for the bulk of the player base, the profit motive was dominant. Due to the not-yet-existing requisite game loops to offset the substantial inflation happening in the economy, profits dwindled, and players followed suit.

The NFT-holder count has not seen positive growth since January, dropping 30% YTD. The number of unique daily wallets interacting with the on-chain elements of the game has fallen more than 95%, and transactions are down almost 70% from the highs seen at the start of the year.

While it has certainly been a difficult ride for Axie Infinity, the breadth of the Sky Mavis ecosystem has increased substantially. Despite suffering significant setbacks, such as the Ronin exploit that we touch on later in this report, the team has a lot going for them with the launch of Axie Origins as well as inviting third-party development into their ecosystem. Only time will tell if 2023 is the year that Axie Infinity is able to make a comeback.

The sudden surprise of STEPN. While token prices for all of the top 10 gaming coins by market cap were down 40% or more since the start of the year, the price of STEPN’s GMT token spiked. Despite releasing an open beta in late 2021, it wasn’t until March 2022 that the casual move-to-earn mobile game that encouraged users to live an active lifestyle saw significant growth.

Between March and April, GMT increased in price by over 2,600%. On Mar. 30th, its trading volume surpassed that of BTC and ETH, and the game itself had a self-reported 2.3M MAU. As overall interest in games like Axie Infinity declined, STEPN captured people’s attention and onboarded many into Web3 for the first time.

Unfortunately, this exponential increase in users quickly illuminated underlying flaws in the in-game economy. By releasing on-chain game assets into the economy before thorough testing, the team became somewhat restricted as the player base swelled and became dominated by the profit motive. As we predicted in our earlier report on the project, token emissions, in the form of in-game rewards, continued to increase and rapid token inflation incurred. Since the beginning of May, token prices have subsequently dropped as much as 94%.

The team has since gone on to develop a first-party anti-cheat system to combat bad actors, as well as introduce a number of new mechanics to limit token generation. STEPN did well to demonstrate the potential demand for Web3 games from a broader audience outside of traditional gamers. As the focus of the game moves away from earning and back to the original goal of encouraging users to live a healthy, active lifestyle, we will have to wait and see if they are able to replicate some of their earlier success.

A new approach from Sorare. A project that garnered a lot of attention in late 2021 after a colossal $680M raise was Sorare. Unfortunately, they too struggled to immunize themselves from the broader forces of the market. Floor prices for their in-game assets have dropped as much as 90% since January.

Regardless, the team has implemented many quality-of-life improvements in order to improve the user experience and partnered with the NBA and MLB to expand its offerings. The result is a reported total of 1.8M registered users as of May (up from 1.5M in March).

The combination of low barriers to entry, reduced friction, and a cohesive platform experience attracted a range of player types and, as illustrated in the chart below, users had the propensity to inject more value than was taken out.

Unfortunately, daily unique wallet transactions to the project’s L2 bridge suggest a small active Web3 user base. However, this still represents a 10x compared to third-party marketplace volume, demonstrating how Sorare has done well to take ownership of the trading of their NFT assets. In light of the recent move away from royalty enforcement on many external marketplaces, we expect other projects to implement similar strategies in order to retain secondary revenue streams.

Many critics choose to focus on dual vs. single token economies, and suggest that either can be a strong influence on the drop in price we’ve observed in some of the games mentioned. In our view, it’s not as simple or binary as that. It ultimately doesn’t matter how many on-chain or off-chain tokens a game has, but rather the dynamics between them and the players. Implementing sufficient economic levers early and allowing for a buffering period to make adjustments will result in more sustainable loops over time. We elaborated on this in our Future of (Crypto) Gaming report earlier this year.

There are less than 700 reported blockchain games as of November 2022 (143 of which have announced receiving >$1M in funding). The market downturn will undoubtedly place strain on many of these teams, and it’s unlikely that all of them will make it to launch. It is important to reiterate that game development usually happens on multi-year timelines, and diminished downstream financing prospects could place projects that failed to raise sufficient runway in the bull market at risk.

Doom and gloom aside, there are a number of well-funded projects we expect to launch sometime in 2023 that are already well into their development cycles. This next generation of blockchain games will be instructive, and monitoring the reception of these more polished titles should give us a real pulse check on the appetite from mainstream gamers.

Web3 Gaming Guilds

The rise of play-to-earn drove an explosion of activity around gaming guilds that sought to industrialize activities around these economies by equipping scholars with assets. Early entrants profited handsomely by onboarding underserved communities that benefited from supplementary income amidst a global pandemic. However, as in-game profits fell, so did the demand for NFT scholarships. As we highlighted in our in-depth update on the current state of guilds, token prices have continued to fall throughout the year, and we are witnessing a number of pivots to try to ensure their continued survival.

What’s left in the war chest. The majority of guild funding rounds were completed at the height of the P2E craze in Q4 2021-Q1 2022. The timing of these raises proved extremely important, especially for those conducting a public token sale. GuildFi, for example, was able to raise $140M in just 72 hours late last year.

As treasuries grew, so did the number of blockchain-gaming investments. The aligned incentives shared between guilds and early-stage gaming projects proved to be a popular relationship model, with most privately funded games having at least one guild on their cap table.

However, as market sentiment worsened and prices fell, the size of funds sitting in war chests shrunk considerably. Many of the early-stage investments made by guilds were for in-game assets in first-generation P2E games. As demand for these assets fell, guilds have had to reevaluate where to best allocate their remaining funds. Furthermore, it’s unclear how exactly value accrues to the guild master tokens in many cases.

The value of community. An important aspect of any guild is its community. Aside from their investment capabilities, a guild’s perceived value is heavily correlated to the size and quality of the participating members within.

While being wary of bot activity, guilds with healthy social metrics have shown how they can help to bootstrap an initial player base. As of Q3 2022, GuildFi has onboarded roughly 80,000 people into their partner communities, 15,000 of whom have actively participated in the games. Yield Guild Games states that out of their more than 20,000 scholars, 80% participate in at least one game outside of Axie Infinity.

The original purpose of guilds was to act as an invested partner that created and strengthened bridges between players and content. To this effect, we have seen guilds start to expand into esports, game testing, game curation, and discoverability, further driving value back to partners. However, there have been few standout examples of this in practice.

As we alluded to in our report earlier this year, we believe that guilds existing solely to coordinate resource extraction in games are likely to face significant struggles. As we move into the new year, the dynamics between guilds and their communities will likely change. Divergence into new business models will become a necessity, and the ability to leverage an engaged user base will provide a competitive advantage.

A forward look at the original promise: user acquisition. The market downturn has illustrated the risks involved in using a scholarship model as the sole revenue stream for Web3 guilds. Furthermore, early-stage investments and first-party infrastructure take time to yield returns, and it is often difficult to drive value to the guild token. We expect that in the near-term, guilds are going to have to revise their core value propositions and seek new ways to differentiate.

Virtual Worlds

The metaverse hype train was significant, with estimates of virtual real estate becoming a multi-trillion industry by 2030, headline-grabbing funding rounds, and Meta (formerly Facebook) committing $10B to metaverse developments. The momentum continued well into this year, with investors sinking over $120B into “metaverse-related” projects in H1 2022, more than double the amount raised in 2021.

The narrative of a Ready Player One future undoubtedly had a significant effect on Web3 markets. Investor confidence was at an all-time high, so both prices and volume began to pump. The total land market cap (excluding fungible tokens) across two of the largest projects, The Sandbox (TSB) and Decentraland (DCL), reached $1.2B in November 2021. The average land price hit $18k in January 2022, and by May, the cumulative secondary sales volume for digital land NFTs had reached almost $2B.

However, there was little substance to justify these metrics, and it wasn’t long before bloated valuations and the negative external market outlook led to some severe corrections. Comparing metrics across the top-performing NFT land projects shows that floor prices have dropped as much as 99% since January, with volume down 77%.

Despite this fall from grace being compounded by a looming economic recession and crashing crypto market, a more pressing issue is the lack of active players, which reportedly only peaked between 200k and 600k MAU across the top competitors.

It is essential to put things into perspective. As we highlighted in our September deep dive into TSB (updated in the table above), there is still an evident disconnect between valuations and active users compared to the Web2 competition.

Despite the total combined land market cap for DCL, TSB, and Otherdeed for Otherside (OTH) shrinking by 71%, the valuation per user for TSB and DCL is still 53 and 176 times higher than Roblox’s, respectively. Considered through this lens, one might argue these projects are still overvalued, although the monetization model is, of course, different.

In the short term, there is only one thing teams can do to reignite stakeholder confidence; build experiences to drive UA. TSB is well positioned in this regard. Despite still being in alpha, with the majority of experiences only available during limited-time events, they continue to work on growing the number of external partnerships. With more than 20 partner projects being announced in the second half of 2022, success will ultimately depend on how long it takes for new experiences to be developed and how fun they end up being.

If these projects can rise from the ashes and increase the active player base to a more competitive level (take Second Life’s average ~100k DAU as a benchmark), then we expect location to remain king. Those who have invested in plots adjacent to the most popular experiences will be in line to capture the most upside due to an overflow of foot traffic, leading to more exposure and higher demand.

Standout Events of the Year

Ronin Hack

In March of 2022, a hacker group was able to exploit the bridge to Sky Mavis’ sidechain Ronin. Developed initially as a scalability solution for Axie Infinity with plans to accommodate third-party titles over time, Ronin was processing 15% of all NFT volume shortly after its launch, more than all scaling solutions combined. However, Ronin quickly became a painful reminder of just how difficult building and maintaining core blockchain infrastructure can be.

Ultimately, in designing this EVM-compatible chain, the team had made certain trade-offs that exposed vulnerabilities. The hackers were able to forge a withdrawal signature after getting control over 5 of Ronin’s 9 validator nodes, a small validator set that “made it much easier to compromise the network,” the team wrote. In total, the attackers were able to obtain 173,600 ETH and 25.5M USDC, worth approximately $625M at the time, making this the largest exploit in crypto history.

Researchers from Elliptic and Chainalysis later attributed the attack to North Korea’s Lazarus group. While action was taken to halt all activity on the bridge as well as the Katana DEX, the damage was already done. Since then, Sky Mavis has expanded the validator set, conducted several security audits, and raised $150M to make affected players whole.

These events were certainly shocking, and it’s difficult to imagine anything of this scale occurring in the traditional gaming space. That said, there is a price to progress and experimentation, and the fact that the project survived this is a testament to both the team and the community. It’s not every day that a project can take such a large hit and live to tell the tale.

By now, it’s abundantly clear that trusted bridge setups are a point of vulnerability across all sectors of crypto. While there has long existed a temptation to build custom infrastructure in the blockchain-gaming space (see Dapper with Flow, Immutable with its rollup, Sky Mavis with Ronin, etc.), there are now several mature tech providers in the market. In addition, abstraction layers such as Stardust exist to make it even easier to interface with them. Developers should think very carefully about whether this is really an avenue they want to pursue. For the average developer, one of the existing options on the market may well suffice.

Looming Regulations

Unfortunately for operators in the space, guidelines on the regulatory side of blockchain gaming remain unclear. However, some standout cases in 2022 illustrate that US regulatory bodies are actively investigating areas outside of DeFi.

While not explicitly gaming-focused, one of the more prominent cases that caught our attention involves Yuga Labs, which is currently under private investigation by the US Securities and Exchange Commission (SEC). The probe aims to determine whether the NFTs and ApeCoin token, the official medium of exchange that will power Yuga’s ecosystem (and future gaming endeavors), issued by Yuga should be classified as securities.

Although the SEC has yet to release a comment or escalate this case to litigation, it does illuminate the agency’s efforts to make a start on regulating NFTs. An interesting point is that the SEC has historically pursued low-hanging fruit first. Projects blatantly advertising their assets or services as investment vehicles are easier to chase, but few would provide as much publicity as Yuga Labs. So, what would it mean for blockchain gaming if the SEC doubled down and widened its net?

The short answer is that it depends. The projects that face the most risk are those that have designed their blockchain assets around profit generation. If the assets gain in value as the company grows, these could be defined as securities and treated as such. This would mean that releasing an NFT collection would be subject to very cumbersome legal work that is not feasible for most startups.

On the other hand, games that sell NFTs as in-app purchases, or those emphasizing utility surrounding community accessibility or in-game content, may be able to sidestep scrutiny for the time being. A free mint also represents an interesting possibility to avoid regulations, provided owners are not promised any false sense of profitability over time. None of the above, however, addresses the potential issues surrounding in-game fungible tokens, especially those that provide value in the form of governance voting rights or revenue distribution.

There was a lot of fuss made over the Yuga Labs story, but the reality is that this may not amount to anything more than a publicity stunt as the SEC marks its territory. That being said, it certainly caused some rightful concern, and teams would do well to err on the side of caution with the inevitable arrival of stricter regulation.

Some general best practices for teams to avoid the gaze of the SEC and other regulatory bodies will be to avoid promises of value accrual, performance, or potential returns for on-chain assets. How this will impact the dynamics between projects and their stakeholders is yet to be determined.

Ownership and custodial empowerment are some of the core tenets of Web3, and bending the knee could very well upset many stakeholders. However, groups such as the Blockchain Game Alliance, Game7, and the Mythos Foundation are trying to bridge the gap and work with regulators to create a safe and prosperous blockchain-gaming industry for all participants. Unfortunately, as is the case with much of crypto, the playbook is not yet written.

New Rulings

The widespread adoption of blockchain gaming will be influenced significantly by the incumbent gaming giants who have significant sway over the industry. Following Valve’s move to ban the use of blockchain technology within games listed on Steam, most firms have remained neutral as they quietly observe ongoing developments. However, there have been some notable rulings from some of the most prominent players.

Minecraft and GTA follow in Steam’s footsteps. In July 2022, Mojang, the Microsoft subsidiary that developed Minecraft, picked a side when it released a statement banning the use of NFTs within its servers. In November, Rockstar followed suit by implementing similar regulations.

Mojang took the stance that the introduction of assets built upon a value proposition of scarcity goes against values relating to “creative inclusion and playing together.” They went on to note concerns that the wild west nature of Web3 and overinflated prices of some NFT collections could put their (relatively young) player base at risk of being taken advantage of.

At a high level, it appears that Microsoft wishes to protect itself in the short-term but will continue researching the potential of blockchain technology. This becomes more apparent when noting that the firm has made several investments in Web3-related companies (Consensys, Space and Time (M12), and WeMade).

Regardless, statements like these illustrate the associated risks of building a Web3 project on top of an existing Web2 ecosystem. NFT Worlds, for example, saw its NFT floor price crash 80% on the day of the news. No one can say how rulings will evolve over time, and those who are overly reliant on any one platform or piece of infrastructure will remain at the mercy of their overlords.

Epic and Apple take a different approach. After expressing skepticism around much of the practices surrounding blockchain gaming in 2021, Epic’s CEO Tim Sweeney has openly welcomed third-party blockchain developers onto the Epic Games Store (EGS). Mythos Games’ Web3 title Blankos Block Party launched on EGS earlier this year, with Grit (GALA Games) and Star Atlas, among others, joining in the coming years.

In more recent events, Apple updated its App Store guidelines and included notes on the role cryptocurrencies and NFTs will play within the ecosystem. The ruling confirms that apps can sell NFTs or services related to NFTs (minting, selling, trading, etc.) within the App Store through in-app purchases (IAPs), such that they can enforce their 30% fee.

Apple has been more explicit than Epic, stating that any features or functionality can only be unlocked via IAPs. Apps cannot provide external links or calls to action that take users to an external site to purchase content. Furthermore, externally purchased assets cannot unlock any additional content within the app.

To see the silver lining, we must first take a step back and look at the bigger picture. Although any developer looking to launch their game on the App Store will have to conform to Apple’s standards and cough up a significant portion of revenues, they can now feel confident that if they follow the rules, they will gain access to its 1B+ users.

Additionally, the industry as a whole stands to benefit from this update. The ability for users to publicly showcase their NFT collections will inevitably increase exposure. And as Apple sits back and observes, they will likely adapt these guidelines slowly. Although we cannot speculate on how this will evolve, the more people that know what an NFT is and are aware of the potential benefits of blockchain gaming, the better.

We expect the majority of incumbents to remain at a safe distance. We expect firms to implement positive blockchain-related rulings only when there is a clear competitive advantage to be had (i.e., Epic fighting Steam for market share or Apple widening its moat).

That being said, we will likely see more platforms choose to participate in 2023. Large platforms such as Facebook, Instagram, and Reddit are all incorporating NFTs in some form, further increasing adoption. As consumer sentiment towards NFTs improves, it would not be a surprise to see Google follow in Apple’s footsteps and implement similar guidelines in the near future — though sideloading already exists as a happy workaround to formal Play Store endorsement.

Furthermore, Epic is not the first gaming giant to dabble in Web3. Ubisoft is one of the more notable ones which is actively looking for the right time to try again after last year’s disappointing feedback. An increasing number of gaming studios and publishers are either investing in or experimenting with blockchain-native games (i.e., Square Enix, Homa Games, and LINE), and the testing of waters is likely to continue lest anyone be left behind.

Emerging Models

On-Chain Gaming

While this is an area of blockchain gaming whose TAM is still unclear and carries significant technical execution risk, it’s certainly one of the more fascinating areas of exploration. As with most new technologies, projects that are able to build natively to the medium, and take advantage of what it has to offer, are often the drivers of significant innovation. The on-chain gaming space is very much still in its infancy, but it is already forcing us to imagine new types of gameplay and experiences.

For now, it’s not obvious that these very technical games will have broad appeal beyond the intellectually curious, but the sector has attracted massive intellectual capital determined to bring fully autonomous worlds to life. Most people will have heard of on-chain games in the context of Dark Forest, which is a truly decentralized space exploration RTS game inspired by The Three Body Problem trilogy. As the pioneers of many of these concepts, we strongly recommend familiarizing yourself with the project.

We believe “strongly on-chain games” are very well-captured in gubsheep’s definition below:

• The source of truth for game data is the blockchain. The blockchain is not just used as an auxiliary store of data, or a “mirror” of data stored in a proprietary server. All of the meaningful data is stored on the blockchain — not just asset ownership. This allows the game to fully utilize the benefits of programmable blockchain: a transparent data store that is permissionlessly interoperable.
• The game logic and rules are implemented via smart contract. For example, combat in a game, and not just ownership, is all on-chain.
• The game is developed in accordance with open ecosystem principles. The game contracts, and an accessible game client, are open-source. Third-party developers are empowered to customize or even fork their own gameplay experiences through plugins, third-party clients, interoperable smart contracts, and even total redeployment. This, in turn, allows game developers to harness the creative output of an entire (incentive-aligned) community.
• The game is client-agnostic. This is closely related to the three above points, in that a litmus test for whether or not a game is crypto-native is: “If the core developer-provided client disappeared tomorrow, would the game still be playable?” The answer tends to be yes if (and only if) the game data is stored permissionlessly, the game logic can be executed permissionlessly, and the community can interact with the core smart contracts without relying on interfaces provided by a core team.
• The game embraces real-world value digital assets. Blockchains provide a native API into the notion of value itself, and digital assets are by default interoperable with cryptocurrency. This allows game developers to build new, positive-sum incentive structures for their player and developer communities.

The notion of building autonomous worlds that reside fully on-chain and possess the ingredients to truly outlive their creators is very exciting, bordering on philosophical. In theory, if these models work, they can provide an unmatchable degree of assurance over the time, money, and energy that players invest into these worlds. Once again, there are significant technical hurdles to overcome, though we have been encouraged by the progress several talented teams are making already.

Some of the projects we are watching include:

• Dark Forest
• 0xPARC
• Topology
• Lattice/Ludens
• Matchbox
• Playmint
• Influence

Free-to-Own (F2O)

In August of this year, Gabe Leydon’s new studio, Limit Break, made headlines upon emerging from stealth by announcing a staggering $200M raise from a number of top-tier investors. The focus is on a new game launching via a model dubbed “free-to-own” that Gabe believes will replace free-to-play.

His approach involves the studio minting a genesis collection of NFTs. But rather than selling them, they are given away for free. In addition to the early community getting these assets for free, they are actually the means by which to produce more items as “factory NFTs.” This way, the assets that drive core economic activity are owned by the community.

For further alignment, a portion of these genesis NFTs is held by the studio itself, such that they are incentivized to drive enduring value to them. In Limit Break’s case, these initial factory NFTs manifested as DigiDaigakus, which are waifu characters. While details around the game are scarce, we know that each Digi periodically receives a spirit NFT which will eventually be used in the production of Heroes.

While many other blockchain-gaming projects have relied on these early mints as a source of revenue, that needn’t be the case for a company as well-funded as Limit Break. It’s important to note that other projects, such as Loot, have technically explored the free mint approach before. This time, though, it’s very much integral to the pitch, and is being used front-and-center in much of the marketing.

The reception of the game remains to be seen, though it seems that a F2O model could circumvent some of the issues we touched on earlier with the Yuga Labs case as well as the App Store rulings. If nothing is sold, it’s harder to be in violation of securities regulations or the taxing of 30% of primary sales, though only time will tell how this plays out in practice.

Critics have pointed out that much of this seems like an elaborate marketing gimmick given that there is an unavoidable degree of exclusivity that undermines how equitable the project can be. The assets were distributed to a small allowlist that some suggest included insiders. This exclusivity only further exacerbates speculation, which leaves later entrants to the community no better off than in a regular mint. Needless to say, the floor price of DigiDaigakus has risen substantially.

Clearly, this model is not applicable to all projects, as it demands more significant capital requirements that might be beyond the reach of smaller developers. It has certainly succeeded in drawing attention though. Limit Break will be a key project to watch heading into 2023, as Gabe has already suggested that the majority of their $200M will be spent on marketing — some of which is destined for a Super Bowl ad.

PlayFi and Improved Esports Monetization

One of the models we believe has great merit is PlayFi (as pioneered by NOR), which we touched on at length in our Future of (Crypto) Gaming report earlier this year. Essentially, the model looks to protect the core game loop by disallowing money to influence it whatsoever. As we have seen, if left untamed, money will usually trend towards the dominant motivator. Instead, PlayFi looks to monetize around the game through a series of metagames taking inspiration from the sports model, which has flourished across millennia.

In the gaming context, this could take the form of gambling, broadcasting/ticketing, and taking a share of tournament prize pools. While some of this may sound similar to certain modern esports, it’s our view that the Web3 infusion represents a significant step up. Ultimately, crypto is primarily going to serve as the backend accounting engine that facilitates ticketing, payments, player NFT contracts (on-chain reputation), automated tournament smart contracts, and so on.

We continue to be very excited about this model, and believe it may hold the ingredients to improve esports monetization broadly. What’s more, by doing away with crypto components entering the core game loop, platform restrictions and some of the other impediments alluded to earlier in the report can be averted. By having players themselves be represented as NFTs, we unlock a large surface area for sponsorship that was previously challenging to implement. While it’s still early, and NOR has much to prove, we anticipate these ideas having broad applicability across a number of competitive titles. Projects such as Stadium are also working on adjacent infrastructure.

Conclusion

This year has certainly been a challenging one for blockchain gaming, arguably more so than other sectors of Web3. With so much hype from the late bull cycle, it often feels like gaming has the most to prove. While things certainly look bleak on the surface, many of the greatest game designers in the world have succumbed to the allure of this new frontier.

Many gaming-industry participants that haven’t formally “defected” by leaving to start projects of their own are still positioning teams internally for participation. Beneath the surface, incumbents are tinkering and exploring, with many of the mobile publishers in particular assembling crypto-focused teams, having been further encouraged by the stagnation of mobile F2P. Apple’s App Tracking Transparency (ATT) policy that rolled out last year has changed the nature of the game for many, driving user acquisition costs through the roof and forcing teams to explore new monetization surface area. It’s our view that many of these companies are poised to act, equipped with deep experience and strong IP, waiting patiently to strike once consensus begins to form around the “next model.”

For the teams already building in the space, this year has rattled many of them and truly tested conviction. Unfortunately, many of this cohort of projects are likely to face stress in the coming year as concerns around downstream financing grow. Teams that had anticipated partial funding from early NFT mints, for example, might now find themselves up against a challenging retail and private funding environment.

In our view, 2023 is not destined to be the year that crypto gaming truly breaks into the mainstream. While we are eager to see how the market receives high-quality titles entering soft launches such as Sipher, EmberSword, and Illuvium, we fear that the hangover from much of the lunacy that took place in crypto this year will dampen consumer appetite in the near-term. The bulk of the AAA games that will more permanently change that are still heads down in their development cycle throughout the year ahead.

Furthermore, as we’ve alluded to, there remain significant headwinds in the form of distribution questions, regulatory uncertainty, and material UX frictions such as client-wallet interactions — although material improvements are constantly emerging. It’s certainly possible that we see another STEPN-like title explode into prominence, though we’re not certain the foundations are robust enough for enduring success yet.

There is, however, light in the dark. With ~$7B of funding in the last 24 months, and the massive talent capture that’s happened, we truly are entering the next chapter for Web3 games. While studios focus on executing their vision, most of the large game platforms are being forced to take a stance on crypto, which has by now demanded their attention. While the nitty-gritty of policy formation is worked through as incumbents position to try to capture value from this market, initiatives that are adjacent to gaming are making material headway.

As we touched on in our NFT Year Ahead report, large-scale mainstream consumer familiarity is being introduced as Meta rolls out NFTs on Instagram, Twitter deepens its crypto ties, and Reddit places a flag in the sand. It seems unlikely that this wave of interest from the titans of the web is for nothing, and we expect much more activity in the coming year from the big players. Polygon, in particular, has done tremendous work this year onboarding mainstream brands after attracting YouTube’s former Head of Gaming, Ryan Wyatt. We have long said that gaming and NFTs will be the trojan horse for global blockchain adoption, and for the first time, the tide does appear to be turning.

Special thanks to Cheryl Ho for designing the cover image for this report and to Ashwath Balakrishnan and Brian McRae for editing.