Grease for the glue, not greasy glue.
I started investing in crypto gaming in 2018 in the belief that, once opened, gaming economies and virtual worlds would never again close. Empowered by a combination of content, creation tools, open markets, and tech, the “sovereign individual” hypothesis seemed an inexorable reality. I’ve indeed been surprised at the pace of it all: the industry is running fast … but where?
There have been many times when my belief system has been challenged by scammers, speculators, and subpar everything. Recently, I’ve found myself questioning whether tokens can sustain any fundamental value without properly being considered illegal securities. Now, more than ever, it’s critical to learn from mistakes and acknowledge what hasn’t worked, but not to get so clouded by the noise and negativity that one forgets why this was all interesting to begin with.
The role of long-term oriented, scaled web2 consumer platforms in driving mass adoption of web3 is being underestimated. They are generally ignored because crypto natives tend to overvalue decentralization as an “end” in itself. But, as with privacy, I do not believe decentralization should be considered a goal in its own right; rather, it should be valued as a “means” to the real ends: self-expression, community formation, and financial opportunity. Experienced IP creators have a critical role to play in bootstrapping communities and IP that consumers care about. Those bold enough to take a long-term perspective and give value to get value are going to do well, with economies that have exponential potential relative to their closed counterparts.
In evaluating investment opportunities in web3, a few practical questions are top of mind:
Is adding web3 to consumer franchises actually worth it?
Is the next adoption wave going to be instigated by incumbents or crypto natives?
Are we two steps early, one step early, or one step late to this movement?
Is all of this just another way for retail to get the shaft?
For something meant to enable and empower, why does web3 feel so dehumanizing?
In thinking through these questions, I have come to several observations over the past few months:
The big unlock of web3 is the creation of digital co-ops: (i) transparent governance structures, (ii) facilitating a rewarded ecosystem of creators/developers, and (iii) embedding efficient means to exchange value through digital collectibles.
Transparent governance structures. Having a set of on-chain rules that make it difficult for developers to unilaterally vary the rules of the system. Transparent governance plays an important role in immersion and facilitating open world activity.
Rewarded ecosystem of creators/developers. Create the potential to return fruits of growth to contributors. The role of the open-world game developer will transform from closed-loop designers into founding contributors of an open ecosystem.
Exchanging value from digital collectibles. NFTs have the potential to create “status as a service” businesses around game environments and social structures.
There is a fine balance between creating a rewarded community and a “community” that exists only for reward.
Sustainable economy design.
Token economics boils down to one simple principle: getting to the point where more tokens are flowing into the community treasury than flowing out.
Staking and other supply-side constriction mechanisms (especially when inflationary) are less relevant than demand-generation.
Utility tokens (1 vs. 2 vs. N): the exact model matters less than having a (i) flexible design, and (ii) tokens earned by engagement and not bought.
Separating NFTs as the primary outlet for speculation vs. tokens which are more “earned inputs” is an intelligent way to create engagement/retention hooks, while maintaining the flexibility to design a sustainable economy.
Asia will leapfrog the West in its willingness to experiment with web3 at the corporate level.
Data science-driven approaches to what works and doesn’t (e.g., rate of token emissions, user experience tweaks, etc.) will yield useful learnings for early web3 adopters that are outsized relative to team size or international reach (e.g., Com2us).
Companies doing pre-sales of tokens but only tangentially integrating tokens into their player experience (while preserving most of the economy in fiat microtransactions) are weak implementations of web3, and not likely to succeed, particularly where the token offerings are in the multi-billion valuation range “freeriding” the IP of incumbents, but no real integration into a creator-focused content universe.
Some teams (particularly Chinese studios, such as a Funplus spinoff focused on web3 games that has recently concluded a large token sale) have extensive experience in building “simulation life games” (e.g., strategy games / SLG) that have a demonstrated history of payer conversion and retention by monetizing social status. These teams are likely to build great blockchain games, as demand for “status as a service” is the missing element of crypto gaming today.
Korea is innovating at a rapid clip in web3, and precisely because of restrictions on gambling and fiat trading of virtual goods, and the reputational overhang of retail losses on Terra, corporations in Korea need to implement sustainable web3 implementations across fintech (superapps for payments), entertainment (K-pop remix to earn) and gaming (sustainable creator-driven ecosystems and MMOs).
Pure-play crypto raises are unlikely to provide favorable risk/return dynamics for investors over the long run. We believe the opportunity is in backing the equity (with token warrants for no additional consideration) for experienced development teams building sustainable economies.
There is a structural oversupply of venture capital in pure-play token space, as evidenced by the flood of capital supporting P2E game developers with no real experience in making content.
With projects often reaching multi-billion FDVs on a pre-product basis (e.g., as one case in point, pre-product Illuvium’s token FDV achieved a valuation 50% higher than the $7.5b that Bethesda sold to Microsoft for), investing decisions in crypto are driven more by FOMO and short-term trading decisions than fundamental drivers (e.g., does the 12-24 month lockup justify participating at a 60% discount, as opposed to, is this token actually worth $4b with discount / $10b spot?).
We have yet to witness on a wide scale the materially negative impact that large unlocking token supply is going to have on the spot token prices of many venture-backed projects. For many tokens, buy-side speculative demand will be insufficient to absorb massive liquid supply unlocks.
Teams that have raised large token sales without equity may end up creating structural conflicts between equityholders and tokenholders, to the extent their economies include both fiat-based and crypto-based components. We believe best practice for companies conducting private sales is to sell equity with token warrants, to align the interests of equity and tokenholders.
Regulatory compliance will be a major differentiator for token projects, and drive an increasing number of corporates to NFT-focused web3 implementations.
A big area of web3 value capture in gaming will arise from NFT trading, the royalties and sale proceeds of which flow to equity holders (not token holders).
Given securities law concerns with tokens and structural inflexibility forced by white papers, we see the market shifting increasingly in favor of equity/NFT-based models instead of token-based ones.
Tokens will become increasingly less attractive to scaled game developers because of the need of issuers of virtual currencies to perform KYC/AML on token transfers. These concerns are arguably less relevant in the context of NFTs as digital collectibles, not currencies (although not free from doubt).
We also believe models where tokens can only be earned, not purchased in a large private offering, will increasingly become the norm. The large supply disruptions created by lumpy token sales inhibit flexibility of the designer to create a balanced economy.
Security tokens will become hot, this time with a retail consumer-focused angle. The ability to embed security-based cashflows into tokens for use cases like royalties + fan tokens, particularly in the context of music, sports, film, etc., will play a major role in mainstream adoption. Reg-compliant issuers such as Republic are going to be well positioned for this future.
Because of the utility that retail gets in collecting these NFTs above the pure financial value, security tokens have a stronger chance of succeeding this go-around with the right social contexts and trading games attached to retail ownership within a collecting community.
The key will be to balance the design of digital collectibles so that they don’t become “purely” about Utility (underlying financial value), but Utility+ (with collectible value forming part of a large enough engagement related premium so that the NFTs don’t just “pull to par” in terms of utility value).
Performance marketing will be a pain point in web3 that guilds have the potential to tackle.
Guilds will play an important role in steering users to appropriate web3 gaming experiences, and solving several of the UX challenges associated with crypto (e.g., custody, fiat on and off ramps).
“Single sign on” will be an important concept in web3, for guilds that can marry on-chain analytics with off-chain player data (recorded through SDKs integrated by game developers). We see scope for large publishers to make credible platform plays in creating global “super-guilds” much as Facebook has aggregated a critical mass of consumer attention for mobile apps/games.
Reputation and “soulbound tokens” (i.e., commitments, credentials, and affiliations” that make up the social relations on Web3 networks) have the potential to represent a 0 to 1 innovation in crypto that are critical to effective individual participation in a decentralized economy.
While there has been significant investment in NFT infrastructure, we believe this market is largely oversaturated and there has been insufficient attention on what new financial primitives beyond exchange, lending, derivatives and aggregators can represent real innovations in digital ownership – e.g., uncollateralized lending based on reputation scores.
“Tribal ownership” will be key to redpilling a wider audience into web3 art and digital collectibles. What NFTs are missing today is cultural and historical context. Onboarding traditional art collectors into web3 will lead the next wave of mainstream adoption.
Accessibility via hardware wallets and Metamask is not practical. A Multi-sig DAO inviting “small group” participation in a curated setting is a credible introduction to the space.
As traditional art collectors and museums expand into the NFT space, we believe digital art is the category with the most potential upside given the large market of collectors.
Vertical marketplaces with integrated social contexts for the trading of NFTs will expand significantly, starting with art, and extending into fashion, photography, music, film, and consumer passions of all kinds. The unifying theme is “community” as the creation, curation and commerce engine for digital collectibles, and the collective myths that make these objects desirable forms of expression.
When we consume, we are searching for self-expression: things that represent our values and identity, whether it is fashion items, art, or music. Consumption historically has been unidirectional, a top-down way from seller to buyer. With the promise of digital scarcity through NFTs, now consumption is circular, dynamic and investable.
Art Blocks is the guiding example of what is possible with a top-down curated sandbox of digital collectibles. FXHash as a “community curated” extension of this hypothesis is equally interesting.
The extension of this concept is “Headless Brands”. There are no major UGC-driven brands, and we think fashion brands representing a convergence of physical/digital/social communities are a ripe breeding ground for experimentation.
“While brands have traditionally been planned and designed directly by corporations, the rise of networked media has challenged the coherence of centrally-managed brand identities. New blockchain-based decentralized organizations take this a step further by giving users financial incentive to spread brand narratives of their own.”
To implement these ideas into a practical playbook to guide investment decisionmaking, I’ve found it necessary to distill my thinking into a few guiding principles distilling my worldview.
Trust binds community.
Money binds trustlessness.
Trustless community cannot exist.
Community currency can.
Only so long as it is not conceived in money.
But rather, becoming of it.
Grease for the glue, not greasy glue.
→ Takeaway: Tokens have the potential to accrue significant network value over time, but pre-sales and the pursuit of speculative profit are in direct contravention of this goal. Models where tokens can only be earned and not bought have more potential to accrue organic “moneyness” than short-term ones over-indexed on pre-sales and speculative fervor, while crowding out intrinsic motivators for community formation.
Production over promise.
Participation over possession.
Abundance over scarcity.
Incentivized creation/collaboration over play/grind.
Emergence over grand design.
P+P=P^2 over PvP over PvE.
→ Takeaway: Build the community first, no pre-sales. Emphasize earned engagement over hoarding and scarcity. Creation and payer conversion are more sustainable than robotic “play to earn” grind. Flexibility in economy design is paramount. Emphasize game economies where social connections and user-generated content transform linear connections into exponential economies. PvP is more sustainable than PvE (because of continued buy-side demand for e.g., skills based gaming and status-driven SLG titles), but inferior to flourishing UGC worlds.
Flexibility over rigidity for virtual inputs (currencies, resources).
Rigidity over flexibility for virtual outputs (status goods).
→ Takeaway: Separate instruments that designers need flexibility on for game balance (tokens, resources, virtual currencies) from ones that are intended to accrue ecosystem value (NFTs, financialized baskets of NFTs). Transaction fees should flow back to the community for long-term ecosystem development.
Delayed vesting over immediate liquidity.
Royalty-based alignment over primary sale extraction.
→ Takeaway: Implement long-term value alignment mechanics, such as royalty based streams instead of extractive primary sales. Earned value should be subject to delayed vesting to avoid vampire liquidity and selling pressure.
Friction minimization over maximal decentralization.
Delegated flexibility over structural immutability.
First party first, UGC second, third party third.
Centralized content => democratized tinkering => third party ecosystems.
→ Takeaway: In the early stages of a project, creation of economic opportunity is more important than maximizing crypto tenets of decentralization. Useability and player adoption is critical, and trust should be placed in the IP creators to bootstrap a content ecosystem with vibrant opportunities for UGC. Over time, IP creators can look to progressively decentralize the ecosystems they create, inviting creators and developers to extend the lore of the IP universe. Systems that are fully decentralized from day one are unlikely to flourish given the difficulty of creating compelling content.
One of the projects I am most excited about is Nexon’s MapleStory Universe extending into web3. MapleStory has the potential to be viewed as the “model implementation” for harnessing the power of open economies alongside storied IP. The Nexon team had been looking into blockchain gaming implementations for some time, and were initially discouraged by what they saw, a market rife with speculation and short-term profiteering. Yet, as Nexon Korea COO Kang Daehyun revealed, “We wondered if it would be the right decision to close all possibilities of blockchain technology, simply by looking at the superficial and unstable processes in the early stage.”
After months of diligence, the Nexon team concluded that the core drivers of transparency, open economies and value capture were primitives too powerful to ignore. If the team was going to do it right, they would need to put everything on the line: “In order to convey how sincere we are about this vision (and not that we’re just trying it out because blockchain is hot right now), we must challenge ourselves by using an IP that we can’t afford to damage or lose. That will show authenticity and earn trust.” And so, Nexon decided to take its storied MapleStory franchise (first created in 2003) and rework the IP ground up for web3.
Four applications have been confirmed so far.
MapleStory N, a MapleStory-based RPG;
MOD N, a MapleStory sandbox production platform;
N Mobile, mobile RPG; and
N SDK, a production tool allowing you to create multiple apps using NFTs.
MapleStory N and N Mobile: leveraging IP from the MapleStory universe, acquire items and tokens through gameplay, and convert into NFTs that should accrue scarcity value over time. With ownership, users will naturally create a free market economy. Users will create their own free market economy based on NFT ownership.
Fee for economic activities distributed to ecosystem creators, including Nexon
Based on the principle of “sharing well”, Nexon expects that much greater growth will be achieved through everyone’s contributions and efforts, and that this will expand the entire ecosystem and ultimately grow far beyond its present value.
MOD N: a sandbox game creation platform, using MapleStory NFTs and external NFTs. All games created in MOD N will belong to the creator. Contains 30m assets that have been created over 20 years. Creators get rewarded based on the popularity of their game.
Nexon’s ability to fund the development on its own balance sheet with no pre-sales, while denominating the economy 100% in the native token (no fiat in-app purchases), gives it the potential to build a transformative open economy with none of the negative effects of e.g., 10k PFP drops over-indexed on digital scarcity, or virtual land sales that lead to unproductive plots. By building engagement first then unlocking economic value through market mechanisms, I believe Nexon is going to show the market the art of the possible in web3.
In summary, what I am looking for digital-native “lollapalooza effects” – opportunities that arise from the intersection of content, markets and tech, where the multiplicative effects of multiple intersecting trends is as important as the underlying drivers. As Charlie Munger notes:
“When several models combine, you get lollapalooza effects; this is when two, three, or four forces are all operating in the same direction. And, frequently, you don’t get simple addition. It’s often like a critical mass in physics where you get a nuclear explosion if you get to a certain point of mass—and you don’t get anything much worth seeing if you don’t reach the mass. Sometimes the forces just add like ordinary quantities and sometimes they combine on a breakpoint or critical-mass basis … Really big effects, lollapalooza effects, will often come only from large combinations of factors (factors which reinforce and greatly amplify each other).”
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Thank you for this long post. There's a lot I did not understand, probably because I'm relatively new to this space. I'm clearly not fluent in crypto-VC-speak. I did understand a few things that I think are relevant to my own experience, though. Maybe you can help me understand better what you meant through that lens.
I'm a user of fx(hash), a platform you referred to. I'll try to explain what this means for other readers whom might not use or know about it. I publish ("mint") generators of NFTs (which we call "generative tokens" on this platform), so that collectors can buy (also "mint") a hash (a sequence of letters and numbers) that can be used to generate a unique sub-version of a token (so, here again, a digital asset, not a financial item).
I use this infrastructure to build something that is not a game, but looks a lot like one. When a collector gets a hash from one of my generators, they can connect to my website and see that it "unlocks" the use of that hash for everyone. For example, if they "minted" one of my tokens called "Forbidden Cities", everyone using the website can now visit this newly generated 3D space (or, more precisely, version of a space) and use it. The collector who minted it does get their name attached to it. But anyone can use it in any way they see fit, putting frames of their blockchain-indexed JPEGs around or building sheds or structures (like in a sandbox game).
I think you can already see that there is, in a way, a lot of what you call "digital co-op" in that system. However, things are less simple that one might think. Is fx(hash) my third-party, or am I theirs? I said earlier that fx(hash) was my database: that's technically true but conceptually untrue. What would be truer would be to say that they are providing a service that gives me access to the actual databases, in this case IPFS storage (for the generators) and on-chain storage (for the hashes). We can hence both do without the other, since what really matters in a trustless system is the common goods, what we currently refer to as the IPFS/chain couple. So, in a way, I don't think your "third party ecosystem" argument to be as obvious as you imply them to be. The "trustless community cannot exist" is very debatable too. I integrated my platform with fx(hash), objkt.com and versum. The users of these websites are one single community. I can assure you it absolutely is a trustless one.
The second line of argument that is relevant to my experience is the research for a social status being a core driver of purchase. I suppose you anchor this belief in the study of the Korean video games industry and the success of Valve in marketing what they refer to as "skins", or 3D asset variations, for their videogames. I am however not sure this mechanic works in the NFT space. People do not flex their purchases. You will see the occasional unpacking of a plotted Garden, Monolith on twitter, but I'm not sure this can play at the same level as cs:go AK skins. Also, we've been there, we've seen it, people are tired of this mechanic. Making it "earned" (so, more grind?) will make it even worse. If I have money to spend, I don't have that much time to spend on a video game. I want them to be fun and cool, not pursuing another nonsensical AI-generated quest.
People do still play with Garry's mod, though. They build their own experiments and narratives in it without much regard for the original creator's IP. That's a third level I would be a bit critical of: what makes you think that "IP" will be enforceable? If assets are truly "on-chain" (or, more likely, stored on a peer-to-peer network and referenced to by a hash that is itself indexed on a blockchain), then what prevents anyone from building their app around it? Anyone could use the generators I created and published on fx(hash) and rebuild a 3D website and make it their own, with their own rules and systems. How am I going to sue them? And, in the event that I manage to proceed and even win, what guarantees do I have that the agent being sued will be solvable? What happens during the 5-10 years of that process when they'll have made money with their copy and I'll have lost money with my legal action?
So to sum it up:
- I don't understand the "third party ecosystem" argument, since you're only a third party if you are bound to your provider, and in web3 the point is precisely that everyone relies on the same, public, central stream of information (but this is very obvious so I clearly have misunderstood your point).
- I disagree with the "there can be no trustless community" because I'm building something in one and it's going great (well, not as bad as one might think, though some actors did feel a very deep burn recently).
- I don't get the "social status research" as a core mechanic: it was the case to some extent, but I don't see why this should still be the case. The inability of BAYC to deliver anything interesting seems to be pointing to a tentative failure of this model?
- IP enforceability seems to be a major challenge. And all sandboxing that ever succeeded did so without enforcing IP. Counter-Strike was a mod, Gmod had its glory, Skyrim became a legend through its moddability, etc. If success is community, then enforcing IP seems to be the surest way to kill it?
A final remark is that do not mention pornography, which interestingly targets much of the same demographic as video game makers do. This might be outside of your range of investment portfolio, but I'm curious about what you think about how this sector can do in web3.
Apologies if it all seems very naive, as I stated in the beginning I'm relatively new to all this. Thanks again for the great read!
Thanks for the comprehensive analysis.
Very informative, very proactive and very encouraging for Web2 game developers/publishers who are seeking to make full use of Web3 logic and infrastructure in order to improve/evolve game ecosystem.