DeFiance Capital: Play-to-Own will replace P2E as the future of Web3 gaming

Author: Arthur0x, Founder of DeFiance Capital

Original Title: 《Play-to-Own: A Web3 Gaming Thesis》

Compiled by: Runsheng, Chain Catcher

1. The Current State of Web 3 Gaming

Since the first brand entered the public market in the 1970s, video games have undergone tremendous changes. Over the past decade, the gaming experience and business models have evolved with technological advancements, from releasing paid single-category games for consoles and PCs to free-to-play mobile games. Today, the gaming market has surpassed $300 billion, with an expected annual growth rate of 12% from 2022 to 2028.

Our argument is that integrating Web3 elements into gaming may usher in a new era of gaming known as "Play-to-Own." We believe that unlocking economic activities within games will significantly expand the total addressable market (TAM) of the gaming industry and enhance value creation.

In 2021, we saw the potential of Web3 gaming through the rise of Axie Infinity. According to Nansen, by promoting the now well-known Play-to-Earn (P2E) model, Axie grew from 10,000 DAU at the beginning of 2021 to a peak of 3 million DAU, generating $1.3 billion in revenue in 2021. More surprisingly, Axie was still in its infancy, with its simple battle game being just a Beta version.

Axie's parabolic growth demonstrated to the gaming industry the untapped potential of Web3 gaming, inspiring a surge of gaming talent to enter the crypto space. Due to Web3 hubs and token releases, the stock prices of listed gaming studios have even been reassessed upward.

Compared to Web2 games, games that integrate NFTs have achieved greater success in player retention, growth, and revenue. We have begun to see countless projects embedding innovative "P2E" mechanisms into their gameplay. Beyond game studios, an entire ecosystem has rapidly emerged around P2E, including gaming guilds and their derivative tools, DAOs, game discovery platforms, custodians, exchanges, and analytics.

Currently, the flaws of the P2E model are recognized, facing challenges in managing inflationary economies and attracting value extractors, with few true participants. Most leading companies in the Web3 gaming space are moving beyond this model to make it more sustainable. We expect rapid experimentation in the coming months and firmly believe that the next generation of successful Web3 games will not require the P2E model to succeed.

To predict the future of Web3 gaming, we can look back at the history of business models in gaming to gain insights into the cumulative changes that have led us to this historical turning point.

2. Paradigm Shift in Business Models - Paid Games, Free Games, P2E, Play-to-Own

Looking back over the past 50 years of gaming, we can see multiple unique periods of innovation in business models alongside technological advancements.

The first commercially successful gaming business model was the paid game model promoted by the arcade game Pong: players would insert coins into the arcade machine to play for a while until they failed at a game level. Arcade games were often simple and fun, with the competitive factor of high scores attracting players to play again and again.

Later, with the proliferation of personal computers and console gaming, paid boxed retail games like Diablo rapidly developed, allowing players to enjoy games comfortably at home. The downside of paid boxed retail games is that revenue opportunities are one-time. The only way for game developers to generate revenue is to release multiple series over a period of years.

Advancements in digital distribution technology enabled real-time service games and allowed game developers to earn recurring revenue, leading to subscription-based paid game models. In this model, gamers pay a fixed fee monthly to gain regular access to game updates and optimizations. Many successful games have adopted this model, including the highly regarded World of Warcraft, which had over 11.5 million monthly paying users at its peak.

With the rise of mobile applications and the subsequent preference for casual gaming, the free-to-play/freemium model began to gain popularity. In this model, the basic gameplay of the game is completely free, but game publishers profit through microtransactions. For example, season passes and gacha mechanics allow players to gain competitive advantages by obtaining faster upgrades or more powerful weapons.

The benefits of the freemium model are evident; it allows users to easily play games and provides game developers with a recurring revenue source. However, over time, developers' increasingly aggressive "cash grab" behaviors have disappointed players, and game loops have become increasingly influenced by "pay-to-win" players who can spend money to achieve success in the game.

A common thread throughout the development of these business models is that game developers are increasingly inclined to extract more lifetime value from players while investing the least effort and cost.

The focus has shifted to profits at the expense of fairness: from products aimed at providing enjoyable experiences to hyper-optimized businesses designed to make players spend as much money as possible. This is achieved by increasing the granularity of data collection to understand player behavior and how to profit from users through predatory schemes.

In many cases, the items players strive for are exaggerated or unfairly diminished, supporting the sale of new items instead, with revenue going to developers. True ownership of in-game assets does not exist, as once players decide to stop playing, their efforts become worthless.

Meanwhile, these business models also suffer from fundamental issues of misaligned incentives. Decisions in the entire gaming ecosystem are made by developers who may not consider community opinions and rarely have any intention or means to compensate players and creators who contribute to the game's development.

3. Play-to-Earn - Incentivized Gameplay with Economic Value

Utilizing blockchain technology, the P2E business model emerged by tokenizing true ownership of activities and game assets through NFTs. P2E players can convert the time they spend in games into tokens and NFTs, which can then be converted into cash for use in the real world. Typically, in such games, the "Earn" part of the game is highly emphasized, attracting players to play for rewards, hoping to convert some into paying players.

In Axie Infinity, if players were at a high MMR level, they could earn over $200 in a day. In developing countries like the Philippines, this amount could far exceed the minimum daily wage of $10. However, relying on gaming as a job is unwise, as token prices can experience significant volatility, and if supply exceeds demand, prices cannot be maintained. The emerging gaming economy with limited content depth will not be able to support a player base focused on value extraction.

In the open economy of P2E games, the health of the economy becomes crucial, and there is an urgent need to ensure that the token faucet and sink remain balanced to stabilize the value of core currencies and items. Limiting speculation in emerging economies is also important to control user experience degradation due to volatility.

Following in Axie's footsteps, we see some P2E games attempting to mimic their success. Due to poor economic design and management, most are struggling with excessive inflation of in-game tokens—high rates of player cashing out lead to a death spiral, where falling token prices cause player income to decline, leading them to stop playing as their primary goal is to make money.

4. Play-to-Own - The Future of Web3 Gaming

From the case of Axie Infinity, we learn that in the initial guiding phase of the gaming economy, early believers and participants, primarily driven by economic returns, take on risks as they strive to acquire assets and mine resources to sell to later entrants.

However, as incentives cannot subsidize growth indefinitely, game developers must find ways to transform seekers of profit into consumers within a sustainable gaming economy.

While this can be temporarily achieved by adjusting faucets and introducing new token sinks, organic consumption can only be sustained through a continuous stream of novel and engaging content and experiences that players are willing to pay for without expecting any economic returns. The most sustainable way to develop games is to create immersive worlds and characters that are beloved by the community.

We believe that Play-to-Own will be the next evolution of gaming business models. Games are not jobs and should not emphasize the ability to make money from gaming. The term reflects the need to align game players and owners, as well as an understanding of NFT technology, all of which are about enhancing ownership.

We define Play-to-Own as:

"A blockchain game developed based on Web3 principles, which incentivizes consistency and true stakeholder ownership. Players can earn ownership of the game through their gameplay and contributions, with rewards in the form of tokens or in-game assets."

Unlike pure P2E, Play-to-Own will focus on enjoyable gameplay, sustainable economies, and fostering a strong sense of belonging to in-game assets and IP, rather than a temporary profit-seeking mindset of gamers. We believe this model will allow games to truly benefit from blockchain, such as unlocking value from game assets, better price discovery, and establishing a strong sense of community ownership.

This term implies that players actively engage in gaming experiences to gain ownership of valuable assets rather than blindly clicking through games, which is typical of poorly designed game monetization models.

Furthermore, we believe that Play-to-Own games lower the barrier for new players to engage with games and will provide sustainable rewards as a user acquisition strategy.

For example, the game might start off free, allowing players to earn small rewards that are reinvested into the game to acquire valuable game assets. Alternatively, users could easily rent NFT assets from the market through profit-sharing agreements and compete at a high level without needing to prepay large sums of money.

Ultimately, we view Play-to-Own as a positive-sum game—a simplified mental model:

We predict that player spending will be an order of magnitude higher than earnings in Web2 games, and Web3 games will transform into measuring the gross merchandise value (GMV) of all transactions in the virtual economy.

Most importantly, this will create net value for the ecosystem shared between developers and the community (in this case, +$10, from $10 to $20). With sound economic management and in-depth gameplay, Play-to-Own will be more sustainable than P2E, capable of generating revenue for developers and the community over a longer period.

5. Push and Pull Factors Accelerating the "Play-to-Own" Movement

We believe that the current misalignment of incentives in business models and the value proposition offered by Web3 jointly support this paradigm shift from first principles:

1. Web2 Incentive Misalignment in Gaming (Push Factors)

Push 1: Players always want to derive value from the time they spend in games and use it flexibly online.

From experience, we know that gamers naturally seek ways to monetize the time spent in games and showcase their best in-game appearances.

In-game trading companies like the Grand Exchange in Runescape have taught a generation of players about the economic content within games. In popular MMOs or MOBAs, gold farming and account boosting operations are also common. Players have an intrinsic mental model regarding valuable items in games and always consider exchanging these valuable items for money when exiting the game.

The restrictive economies of current games will drive more players who understand the value of virtual items into Web3 gaming, and the tokenization of in-game resources and assets reduces friction in exchange value, thereby unleashing more economic activity.

As online time increases, these digital natives also increasingly prefer digital flexibility; however, it is hard to justify investing significant amounts of money in games because the flow of value into games is one-way.

For resellable NFTs, the flow of value can be two-way. The shift in mindset from pure consumption to asset ownership among gamers should significantly increase the TAM of games, as players can psychologically justify their spending when the value of assets can grow and be sold to recover some residual value.

A significant barrier to using decentralized applications has been concerns about self-custody of funds and sending on-chain transactions through wallets like Metamask. However, we believe this is not an issue for players accustomed to managing game accounts with high-value items and in-game currencies.

Push 2: Disappointment with game developers due to misaligned incentives between developers and players.

Currently, most games are investment products oriented towards return on investment (ROI), rather than focusing on fun and playability. Game companies aim to spend the least resources on players while earning the most money. Investor pressure, expensive overheads, and strict delivery timelines can also lead to selling unfinished products to players.

In recent years, there have been numerous cases of disappointing players' trust due to failing to deliver satisfactory gaming experiences after a series of hyped trailers.

There are many such examples: expensive paid content, unfair game patches that weaken players' hard-earned items, daunting microtransactions, intrusive ads, low-quality battle passes, and lack of support when last season's cosmetics are broken…

As cash grabs become increasingly blatant and promises are broken, player communities feel increasingly disrespected and grow weary of game studios.

Push 3: Game developers and publishers can and have exploited UGC creators for their own profit without consulting the community.

Currently, creators of user-generated content (UGC) pay high costs for their work and, in some cases, may receive no compensation at all. As seen in the Steam case, game publishers can easily change rules and royalty payments.

An interesting example is DOTA, a UGC game mode of Blizzard's Warcraft 3, which attracted a large influx of players into the game. It remains unclear how much the relevant creators can profit from it. Ultimately, active developers transitioned to work for Valve on DOTA2.

In Web3 games, royalties enforced through smart contracts give professional UGC creators the confidence to build their businesses on top of games, allowing them to provide higher-quality works and a high-quality UGC marketplace to the community.

Additionally, when token incentives are used to boost UGC efforts, more creators can make a living and benefit from their creative talents. At the same time, this unlocks the speed of content generation within games. Any changes to royalty distribution can be submitted for stakeholder voting, leading to healthier discussions.

2. Web3 Value Proposition in Gaming (Pull Factors)

Pull 1: Increased liquidity in secondary markets, leading to higher transaction volumes and revenues.

The open and trustless economy built on blockchain provides a vibrant secondary market for game assets. The prices of items are determined by market forces and natural supply and demand, unless game developers intervene.

Game developers can adopt alternative monetization strategies based on smart contract-enabled transaction fees and secondary market trading royalties. Assets can be freely liquidated, allowing players to recoup some financial value from the time, effort, and money they invest in games.

We believe that, in the long run, this will lead to a significant increase in the TAM of the gaming industry.

Pull 2: Web3 games align the interests of players, investors, and developers. When everyone is committed to the success of the game, powerful player empowerment and community governance mechanisms emerge.

Currently, gaming communities cannot synchronize their development with the success of games, nor can they share any form of revenue.

Players typically have no say in game development, as most games are closed tests. Game revenues have never been shared with players and early believers, even though they are crucial to the game's success.

NFTs and token-powered games provide a solution, allowing players to have financial exposure to game tokens early in the game's release and afterward.

During the early development phase, game developers can identify and involve some of these enthusiastic holders in the game-building process. These early believers with sufficient prestige or skins in the game can also be polled for their opinions on game development.

As the game launches, governance tokens allow the community to participate in the governance and management of the game. Open communication channels can build trust and understanding, driving deeper engagement as players have ways to make their voices heard by developers.

Pull 3: New forms of user acquisition due to interoperability of assets, game history, and token usage.

A permissionless and open environment allows game developers to integrate third-party NFT assets (even assets from other games) by creating special custom skins for use in their own games. Developers can seek out communities that appear most enthusiastic or best suited for their target characters to promote their games.

As tools for identifying legitimate wallet activity mature, players' on-chain histories or metaverse profiles can be accessed and targeted by other games for user acquisition and airdrops. This creates a win-win situation, providing game developers with a new form of user acquisition while strengthening the IP, utility, and network effects of integrated NFT assets.

Ownership of tokens and NFTs aids organic marketing, as communities become effective promoters of games with minimal marketing budgets.

Pull 4: The fundraising ability of game studios increases with the use of Web3.

Due to being perceived as lower risk for exit, early liquidity provided through token investments rather than equity has helped blockchain game projects raise funds from institutional investors. According to a report by Dappradar and BGA, the blockchain gaming industry raised $4 billion in 2021, compared to $4.7 billion raised by traditional gaming startups in 2020.

Selling future in-game assets as NFTs helps raise significant funds, thereby financially reducing the risks of game projects and alleviating constraints on development work due to tight budgets. The ability to resell freely on the secondary market makes it easier to purchase.

Beyond pure asset speculation, we also see players willing to invest to realize their aspirations. As the market matures, participants will choose to primarily fund projects that demonstrate responsibility in development progress and community building.

6. What Should Successful Web3 Games Look Like?

To fully enjoy the benefits of building in Web3, we believe developers should execute the following core elements:

1. Intricate World-Building and IP Development

In short, when there are numerous activities to engage in within a world, players will spend more time in it, which directly correlates to the money spent on the game.

As community participation contributes to creating stories and characters, the game universe can be designed to combine a wide range of ideas, providing a fertile ground for UGC. When the community participates in world-building, a strong emotional attachment to the game and IP is formed. Developing a cross-media content strategy to reach audiences through various media is crucial to achieving this goal.

Additionally, developers should coordinate socially around common technical standards and actively advocate for the adoption of these standards to enhance the portability of assets across various virtual game worlds. As more third-party and content creators integrate original NFT assets, the value of IP will increase with the rise in attention and awareness.

2. Immersive Social and MMO Experiences

There should be a strong emphasis on customization, identity building, and social interactivity. With more focus on in-game avatars and properties, the motivation to consume and showcase increases, encouraging spending in the virtual economy.

Rewarding multiplayer experiences in PvE and PvP enhances the interactivity and social elements of the game. Prestige on leaderboards and guild vs. guild wars also cater to players' competitive nature, encouraging spending to maintain a leading position on the leaderboard.

By satisfying players' psychological needs and bringing them into the "magic circle," games can successfully make players forget about the financialization of assets in the open economy.

3. Deep Economic Meta-Gameplay

Skills and efforts should be rewarded more than passive gameplay or pure consumption, as these players may be higher-value customers who will reinvest in the economy. Games need stable content patches and real-time operational activities to encourage active secondary market trading of materials and valuable items, thereby increasing royalty revenue for the game.

Token inflation serves as a tool for acquiring and retaining users in the initial stages of the economy. Developers will need to monitor key economic indicators to adjust sinks and faucets and actively manage the health of the economy over time. The goal is to align inflation with the growth of the player base to strive for stability in the underlying token-based currency. Only with confidence in the long-term stability of the economy can in-game business and operations be established.

If speculation is not restricted early on, an open economy can be a double-edged sword. Economic designers should find ways to protect emerging economies from extreme volatility and asset abuse, potentially imposing direct and indirect taxes on trade and asset ownership.

Overall, the goals of games and players need to align—the success and revenue of games should depend on the value players derive from entertainment and financial returns.

4. Gradual Democratization of Games

To extend the lifecycle of games, developers should make decisions collaboratively based on the opinions of invested and reputable stakeholders in the community. A well-managed community-owned game should reflect the community's viewpoints, thereby enhancing engagement and retention.

In cases where the gaming economy is large enough for nation-state actors to potentially participate in censorship, planning ahead is crucial. A decentralized technology stack is essential to ensure the longevity of games and maintain uncensorability. This may apply to more mature games.

Open-source game code is also vital to ensure the community has the capacity to fork games if developers are perceived as poor managers, maintaining continuity in the virtual economy. We envision that different development teams may be hired to create content and maintain operations in real-time for games, allowing players to vote at the end of each season on whether they are capable of developing the game and retaining players.

7. Our Evaluation Framework

The success of a game is driven by a competent team and is a function of product, sales, and economic balance. This is the facet of our evaluation process:

1. Team pedigree. We like to see a perfect blend of gaming development and crypto talent, along with a strong vision for the game.

Successfully launching a game requires the ability to attract and retain talent, allocate resources effectively, and coordinate functional teams such as art, music, and technology (often exceeding 100 people). Given the complexity, it is not surprising to see games delayed for long periods and unable to launch.

Additionally, understanding distribution channels (publishers and marketing partners) and establishing methods for generating hype are key to a successful launch. Even after launch, maintaining the rhythm of real-time service is important, such as generating new content and updating game patches to extend the game's lifecycle.

For Web3 games, crypto-native experiences play a role that varies with different business models. Teams should have in-depth knowledge of how to launch, drive token and NFT appreciation; manage treasuries and incentive programs; and utilize mechanisms provided by smart contracts (such as staking) that Web3 games can leverage to kickstart flywheels and accelerate growth. Community building should be second nature, maintaining clear communication and accountability to foster a passionate and trustworthy community of players, contributors, and game owners.

Essentially, the team creates the foundational layer for the ecosystem's prosperity and is the steward of the grand vision. Experienced individuals who have actually launched games while being passionate about Web3 are crucial for success.

2. Product and Distribution. An engaging game that can attract a broad user base willing to spend money.

One question we like to ask ourselves is whether we can envision spending time and money on this concept without potential returns.

Before formal release, the game should be tested and iterated until there is sufficient confidence in the game loop. In this regard, an open iterative approach to game building with community involvement is very helpful. Differentiated game loops should be designed to cater to different stakeholder groups, with each stakeholder optimized for their own definition of winning.

• Casual players who spend time and effort for fun
• Hardcore players who raid the toughest dungeons and compete for player vs. player and guild vs. guild leaderboard positions
• Creatives who contribute to designing and building in-game areas and experiences
• Merchants and traders of speculative economic resources and meta-gameplay

Understanding the target player base and how to capture them through the most effective distribution channels is crucial. Advance planning for marketing partners, launch events, and community building efforts is necessary to ensure a successful launch.

To improve the onboarding process and retention rates of games or mobile applications for higher conversion rates, developers also need to abstract the blockchain experience when necessary. Players in the game client need to be able to easily access tokens and game assets.

3. Economic Sustainability: Managing Inflation and Mitigating Economic Volatility

We believe that the health of the economy is crucial for the longevity of games. As blockchain unlocks the virtual gaming economy, it is essential to simulate faucets and sinks within the game and build adjustable macro-levers to balance token inflation with player growth.

Controlling speculators and economic value extractors and transforming them into consumers will be an important task. In the long run, having high-quality content that inherently stimulates consumption is the only way to build effective reception to mitigate the impact of inflationary rewards.

Significant changes in game loops and economies should be delicately balanced and communicated with community stakeholders' opinions. Developers should strive for reasonable token designs to ensure that all fungible and non-fungible tokens within the ecosystem have clear utility and value appreciation.

8. The Best Games Will Form the Metaverse

We believe that, on a technical level, the underlying blockchain technology is ready for games targeting mainstream audiences. What needs innovation now are user experience issues (asset custody, gas payments, cross-chain requirements, etc.). Developers should attempt to educate users on the differences between on-chain and off-chain assets, abstracting complexity while gradually introducing on-chain elements for more advanced users.

Due to the depth of economic and social game loops, the most obvious types to leverage Web3 elements are MMORPGs (Massively Multiplayer Online Role-Playing Games) like World of Warcraft and 4X (Explore, Expand, Exploit, Exterminate) strategy games like Clash of Clans. The use of blockchain technology will also lead to innovations in game design from 0 to 1 and create new genres due to the possibility of storing assets and game logic on-chain.

By studying the current game design space and recognizing the different challenges encountered by each approach, we are excited about both "top-down" and "bottom-up" methods of building Web3 games. Below is a typical overview of both approaches:

In line with our theme, we invest in games and supporting infrastructure, such as guilds and game discovery platforms. We avoid building short-lifecycle casual games and "GameFi," which we define as zero-sum games with the sole aim of achieving maximum financial returns, essentially a gamified front end of a Ponzi scheme.

Our approach is to actively support long-term projects that provide engaging content and experiences, focusing on sustainable gaming economies and executing all value propositions of Web3 games. The most successful games will ultimately form a core part of the metaverse, significantly impacting the digital reality of a vast player base.

Conclusion

From the level of talent entering this space, we have reason to believe that the next generation of defining franchises will be built on Web3, reversing the prevalent negative sentiment towards Play-to-Own games using NFTs.

We believe that building games on an open peer-to-peer network will unlock greater economic value and significantly expand the addressable market of the gaming industry—projecting a $1 trillion economic output over the next decade.

We are eager to invest in creating a future where virtual value can flow in and out of virtual worlds, where experiences are as real as in the real world, and DeFi serves as the financial tool for these on-chain economies.