Delphi Digital Deep Report: The Fundamentals of the Popular Blockchain Game Axie Have Significantly Improved, What Are the Reasons Behind It?

This article is sourced from ChainNews, authored by Delphi Digital analyst Yan Liberman, and translated by Perry Wang. Special Note: This report was published on June 30, 2021, and the data mentioned in the report is as of the end of June 2021.

Key Points:

• The launch of the exclusive Ethereum sidechain Ronin for the blockchain game Axie Infinity has been a key catalyst for the explosive growth of the game over the past two months, with daily active users (DAU) surging from 38,000 at the end of April to 252,000. Most new users are believed to be from the Philippines and Venezuela, which is corroborated by the increase in Google search trends from these regions.
• Through breeding and market fees, Axie's community treasury has grown from less than $1 million to over $14 million in about two months, meaning the price-to-earnings ratio (fully diluted valuation / 30-day annualized revenue) for AXS is currently 7.59.
• The negligible gas fees on Ronin compared to Ethereum have made it easier for more users to breed, driving the increase in the number of Axies, breeding fees, and market transaction volume.

Axie Infinity is a globally popular digital pet breeding and battle game. The game is a prime example of the play-to-earn movement, and as we speak, it has helped thousands of people around the world earn a living. Even billionaire Mark Cuban, owner of the NBA's Dallas Mavericks, has become addicted to Axies—"Now anyone in the world can play games and make money at the same time," he says.

With the recent launch of its exclusive Ethereum sidechain Ronin, the release of the "Play-To-Earn" documentary, and the milestone of surpassing 1 million Axies, there are many achievements in the Axie project that excite investors.

In this report, we delve into everything about Axie: we provide the latest statistics reflecting the surge in Axie's popularity, explore the economics of Axie breeding, review the treasury revenue performance since the launch of Ronin, and observe the fascinating interactions between the price, supply, and burn of Small Love Potions (SLP).

For those looking to adopt their own digital battle pets, we provide an overview of the Axies market. Finally, we explore the exciting developments behind Axie and what dynamics to watch for in the near future.

Since the launch of Axie Infinity's exclusive Ethereum sidechain Ronin, Axies have been growing at an exponential rate. The above chart clearly illustrates the rapid user acquisition scenario (data as of the end of June): since the end of April, DAU, the number of Axie holders, monthly market transaction volume, and Discord members have all seen significant increases. The Axie community treasury has also achieved remarkable growth.

Axie Infinity has recently garnered high attention due to its "play-to-earn" mechanism design, especially after releasing the Play-To-Earn video showcasing how it helps the people of the Philippines earn a living by playing Axie.

Last year, a player from Venezuela wrote an article stating that she earned more playing Axie for a few days than she did working for a month. We used Google search trends to assess the search popularity of "Axie Infinity," where 100 represents the peak popularity of the term, and 50 indicates half of that peak. It can be seen that interest in Axie on Google searches has significantly increased over the past three months.

Since April 24, DAU, the number of Axie holders, and Discord membership have all shown significant increases. With Discord's user cap set at 100,000, the total number of Discord members stabilized around 100,000 in the first few weeks of June. After communicating with Discord, the Axie team lifted the cap, allowing the member count to continue to rise.

Axie Infinity has integrated the fiat on-ramp platform Ramp.Network into the Ronin Chain, allowing players to purchase ETH easily using credit cards. Players who do not engage in the crypto space can now also fund their Ronin wallets with ETH and purchase Axies from the market in a straightforward manner.

Since the fiat on-ramp currently only supports the purchase of ETH and not the sale of crypto assets, the data only reflects the purchasing activity of fiat on-ramp. On June 22, the daily trading volume of the fiat on-ramp reached a historical high of approximately 130 ETH, considering it was less than 20 ETH a month ago, indicating very strong growth. Since the only use of ETH on Ronin is to purchase from the market, it is expected to boost market transaction volume, albeit slightly.

The daily transaction volume in the market has grown alongside the transaction amount, with daily trading volume increasing from about $100,000 at the end of April to over $4 million in June. The increase in user numbers has positively driven the increase in market transaction volume, as players need to purchase at least 3 Axies to participate in battles.

Since the launch of Ronin, Axie's treasury revenue has shown significant growth. As mentioned, the total revenue of the treasury has increased from less than $1 million at the end of April to over $14 million today. One of the unique attractions of the entire gaming industry is its remarkable resilience in the face of macroeconomic turmoil, as evidenced by the 2008 financial crisis and the COVID-19 pandemic in 2020. A similar trend has emerged in the crypto gaming space: despite severe sell-offs in the crypto token market, Axie Infinity still recorded its highest growth month ever.

Our research also highlights the contributions of breeding revenue and market fees to the treasury revenue.

Before the launch of Ronin, market fees accounted for the vast majority of treasury revenue. However, since the launch of Ronin two months ago, breeding fees have grown to account for over 50% of total treasury revenue. Prior to the launch of Ronin, pet owners paid SLP and transaction fees in ETH, and gas fees were often prohibitively high for many users, which was detrimental not only to pet owners but also meant the treasury received no breeding fees.

High Ethereum transaction fees have deterred many players wanting to breed Axies. With the launch of Ronin, the fee structure has improved. Players now pay the same amount of SLP but do not have to pay ETH gas costs, only spending 2 AXS. This reduction in costs is the reason for the recent surge in breeding activity. Meanwhile, by replacing ETH gas costs with a payment of 2 AXS, the treasury now has a new source of revenue.

On June 30, Axie released a statement saying, "We will increase the AXS fee for breeding to 4 AXS. This decision was made to ensure that the number of Axies continues to grow healthily and to create additional utility for AXS." Due to this change, breeding rates are expected to decline, but given the current high growth, it may only be a slight drop.

Axie's price-to-earnings ratio helps us understand how much of a cash flow generation machine the game has become. To calculate the price-to-earnings ratio, we use the fully diluted valuation divided by the 30-day annualized average revenue. The price-to-earnings ratio has dropped from over 800 at the end of April to a recent low of 7.59.

The development history of Axie can be divided into two distinct periods: the pre-Ronin period before April 28 and the post-Ronin period thereafter. The daily growth of Axie's treasury has increased from less than $100,000 in April to a peak of over $600,000 in June. The low gas fees on Ronin have made breeding Axies and trading on the market cheaper, thereby increasing the revenue of the community treasury.

It is worth noting that these are actual earnings that are directly passed on to token holders. Projects often conflate revenue and earnings, where participants like liquidity providers (LPs) share in the revenue, and the remainder is passed on as earnings to token holders. All of this revenue will go into the community-owned treasury, which will be distributed to token holders once the staking portion goes live. These are the most genuine forms of retained earnings.

Recent Forecasts

We infer that the current trends predict the growth trajectory of the Axie platform through the end of 2021. The platform's current DAU is growing at approximately 30% weekly. DAU increased by about 55,000 and 172,000 in May and June, respectively, with growth rates of 167% and 197%.

We recognize that the reason for such high growth rates is that the user base is still small, so we assume a growth rate of 50% for July, then a decline of 10 percentage points each month until October, after which it will stabilize at a level of 20%. This means an average of about 160,000 new DAUs each month, which we believe is a conservative estimate, as there were 172,000 added in just June.

It is important to note that the composition of DAUs in this game differs from most games, which are primarily made up of individuals looking for entertainment. Axie has some players driven by fun, but it has also attracted users aiming for speculation and those looking to earn money purely through gameplay.

Whether users have a speculative element is not simply a binary answer of "yes" or "no," but rather varies in the degree of motivation for many users. The answer to whether they are purely in it for profit tends to be relatively binary, but it creates an additional, consistent, profit-driven flow of players. These users farm resources, which are then consumed by players motivated by entertainment and speculation, helping to drive the growth of the game economy. As the user base grows, the demand pool for rare items expands, further enhancing the profits for speculators. This economic flywheel incentivizes all types of participants to join the ecosystem for their own motivations. This is why we believe our user growth forecast is reasonable—perhaps even too conservative. By leveraging the demand for new users to participate in the game, we can predict profitability metrics from this user growth.

We maintain the market fee percentage at 4.25% of transaction volume and apply it to our transaction volume estimates. Although the per-user monthly transaction volume has continued to rise over the past few months, we conservatively reduce the per-user monthly transaction volume from 12 ETH in June to 8 ETH by December. This metric can and likely will climb to higher heights in the short term, but we expect that over the long term, the user growth rate will outpace the growth rate of transaction volume. The second benefit of using conservative growth estimates is that it makes year-end metrics look more impressive.

The forecast for AXS in the treasury is also a function of DAU growth. We assume that each newly bred Axie will require 4 AXS, which are fixed variables. Currently, the AXS cost for breeding a new Axie is 2 AXS, but it will increase to 4 AXS by July 2021. Since each new user needs 3 Axies to participate in battles, there is a close relationship between user growth and breeding demand.

In May and June, the ratio of newly bred Axies to new DAUs was 5.2 and 4.7, respectively. The current ratio of Axies to DAUs is below 5, indicating a soft market.

On the surface, one might think that the current supply of Axies meets user demand since each user needs 3 Axies to play, but advanced users and various collectors own many Axies. This is why we believe that the ratio (monthly breeding number of Axies / monthly new DAUs) is very likely to remain above 3 but gradually decline in the coming months. By combining this ratio with DAU figures, we can calculate how much AXS will accumulate in the treasury.

By the end of the year, the community treasury is expected to hold 15.6 million AXS and 26,600 ETH, which, at today's prices, is approximately equivalent to $149 million, not including more AXS that will be stored once staking incentives go into effect. Token holders will have the right to share in the profits from this treasury and will start receiving income distributions once staking goes live. They will also be able to decide how to spend these assets through governance.

We estimate that by the end of this year, approximately 24% of circulating AXS will be held by the treasury, assuming no funds flow out of the treasury. The inflow of treasury funds comes from breeding fees paid in AXS, as well as 35% of issuance-based staking rewards that will go directly into the treasury. The expansion of circulating supply comes from 65% of issuance-based staking rewards, which are returned to Stakers, primarily from tokens gradually released in various forms by different holder groups.

Axie plans to release the staking reward mechanism in the third quarter.

Given the information above, the growth of the treasury may outpace the expansion of circulating supply, so it should be interesting to see what results the increase in treasury funds will bring. Our research also does not account for the token supply that will be put into staking and receive income distributions from the treasury.

Potential Weaknesses of the Axie Economic Flywheel

One way this flywheel model could break down is through overbreeding.

"Over" is relative to the expected future demand for these Axies from players. This would be a process triggered by multiple steps leading to a chain reaction. The front-end load from overbreeding creates a high demand for SLP, and when the scale of SLP is relatively small, the group purely in it for profit begins to farm. Problems start to escalate. These profit-driven users begin to farm SLP and sell it on the open market, but the demand for SLP in the market is weak.

This happens because, in the background, the price of Axies begins to decline due to insufficient new users to offset the increased supply. As Axie prices drop, breeding becomes less attractive. Since SLP is used for breeding, this means a decline in demand for SLP, which is the reason for the previously mentioned disappearance of demand for SLP. The drop in SLP prices significantly reduces the attractiveness of the "play-to-earn" model for newcomers, leading to a decrease in player growth while the oversupply of Axies persists. This situation could result in economic stagnation.

We believe this is a low-probability event, as it would require a significant amount of uncontrolled breeding and would occur in an environment where all other natural rebalancing components have failed.

In most cases, despite the suppression of SLP prices, we would still see a large influx of "purely profit-driven" players, as it remains worthwhile for them. This would gradually erode the oversupply of Axies and stimulate breeding demand again.

SLP prices are clearly a significant influencing factor here, and SLP speculators actually help normalize price fluctuations. They act as a source of demand during natural demand slowdowns and as a source of supply when prices rise. Opportunistic breeders also perform a similar function, helping to lower individual average breeding costs by accumulating when prices are low.

Another interesting aspect that the team can control during this period is the cost of breeding Axies, which has just increased from 2 AXS to 4 AXS. In this sense, the team can act like the "Federal Reserve," raising breeding costs (interest rates) to curb breeding when inflation is too high and lowering breeding costs when they want to stimulate breeding.

In the long run, continuing to add utility to Axies is the best mitigation strategy for such situations. The project team is more aware of this than anyone else, and they have considered various measures when designing the game.

We believe the most notable point is that future upgrades to Axies and land will require crafting materials. These crafting materials are obtained by "releasing" Axies, creating a deflationary element for Axie supply.

The deflationary element itself is not the main novelty; the novelty lies in the fact that players' progress in the game will depend on breeding and releasing Axies, meaning that breeding will not purely be for creating Axies to sell to new players. It is crucial to decouple breeding demand from new player demand. This will also enhance the value of upgraded Axies, increasing the profit margins for speculators and collectors. Most importantly, it will further solidify the economic flywheel at the core of the Axie economy.

Disclosure: Delphi Ventures has invested in AXS. Members of our team also hold AXS and Axie NFTs. This statement is intended to disclose any conflicts of interest and should not be misconstrued as advice to purchase any tokens. The content of this article is for reference only and should not be used as the basis for any financial decisions. This article does not constitute any investment advice.