P2E is unsustainable, how to find the next Axie Infinity?

Author: Alex@IOSG Ventures

"Even if blockchain had not been invented, I still believe that the gaming market will experience breakthrough growth in the next decade."

Starting from Maslow's Hierarchy of Needs

At the bottom of Maslow's pyramid of human needs (Maslow's Hierarchy of Needs) are physiological and safety needs. The higher-level needs include emotional and belonging needs, esteem needs, cognitive needs, aesthetic needs, and self-actualization needs. The gaming industry is essentially about the consumption of higher-level needs, and it manifests in various stages of these higher-level needs.

In games, these higher-level needs are constantly being satisfied. For example, the guilds that first appeared in "World of Warcraft" fully reflect players' strong desire for emotional connection and belonging. The annual consumption of skins exceeding one billion in "Honor of Kings" also reflects esteem and aesthetic needs. Games like "Dark Souls" and "Sekiro," which are known for their difficulty, satisfy the needs for knowledge and self-actualization to the extreme.

Looking at the development of human civilization, we are currently at a very special turning point.

If we randomly select a few historical years and take a cross-section of the entire population structure, we would see that the vast majority of the population is struggling to meet physiological and safety needs, while a very small number of elite individuals occupy the upper levels of the pyramid, obtaining more spiritual needs. This ratio has remained unchanged. Yuval Noah Harari, the author of "Sapiens," mentioned that we are transitioning from a society with scarce productivity to one with surplus productivity.

With the rapid development of industrial civilization, the disruption of production relationships by the information revolution and blockchain revolution, and the overflow of productivity for all humanity, we believe that this cross-sectional ratio will undergo a significant adjustment for the first time. An increasing number of people will genuinely escape poverty and begin to move up the pyramid. More and more individuals will no longer be trapped by basic survival issues but will seek spiritual consumption. Where will they go? Culture, art, and various fields are all great, providing a place to soothe the soul. But the most efficient and quickest destination for spiritual satisfaction will undoubtedly be gaming.

Why are we optimistic about blockchain games?

Blockchain games are essentially a bottom-up revolution regarding production relationships.

As we all know, today's Web 2.0 world is increasingly becoming inefficient and monopolistic, especially since the natural economies of scale in the internet are destined to trend towards monopoly. This is true for social media as well as the gaming industry.

Under monopoly, the average customer acquisition cost for games has skyrocketed from a couple of dollars to hundreds of dollars within a few years. Both game producers and consumers are being ruthlessly exploited. Quality independent game developers struggle to break through, and countless players are fed with nutritionally void "gaming experiences." The only beneficiaries are those monopolistic platforms. a16z has also stated, "Your cut is my opportunity." The success of Web 3.0 game Axie Infinity is the prologue to the uprising of the lower classes against the giants of Web 2.0.

In traditional gaming, there is a relationship of mutual dependence yet mutual opposition between developers and players. The mutual dependence arises because developers need players, and players need developers; the opposition arises because developers want to exploit (continuously selling stronger equipment, diluting players' wealth), while players want to play for free. In blockchain games, NFT ownership and token economics largely resolve this issue, allowing players to become true owners of the game, and for the first time, players and developers stand in the same camp. This alignment of bilateral interests may unleash the true potential of blockchain games.

What stage is the blockchain gaming industry currently in?

Although we are extremely optimistic about the future of blockchain games, their development is just beginning, and there are many issues to address. We believe that the development of blockchain games will go through three stages.

Stage One: Revelry

We are currently in the first stage.

In addition to its inherent anti-monopoly attributes, blockchain games' high topic relevance and liquidity make them targets for capital pursuit. When high liquidity first emerged, speculators and traders quickly became the first batch of revelers. Just like the Chinese stock market in the early 1990s, speculators were already bubbling before value investors entered the scene.

According to unofficial statistics, there are currently about 700,000 real active players in Web 3 (data source: MixMarvel), and the number of speculators is easy to imagine. The actual number of real players (the true demand side) is not as high as we think. However, the profile of the demand side determines what kind of producers will be chosen by the market. Therefore, simple and crude Ponzi mining games like CryptoMines and BinaryX are leading the way, attracting everyone's attention. The essence of staking rewards in DeFi is to provide liquidity for DEX, while many blockchain games start offering astonishing staking rewards even when DEX is absent, which is clearly illogical.

Stage Two: Collapse

Mining games will continue to be pursued by capital, the bubble will grow larger, and eventually, it will burst on some day. Perhaps the SLP rewards will fall below the average salary in the Philippines (as of the time of writing, reports indicate that the daily income of ordinary players in Axie Infinity has dropped below the minimum wage in the Philippines), or perhaps a mining game with a billion-dollar market cap will be wiped out in a matter of days. The market will fall into panic, speculators will flee in disarray, leaving behind a wasteland.

In this stage, mining games will collectively collapse, and the outflow of liquidity may happen faster than expected. In contrast, those teams that held their ground, adhered to principles, and worked diligently during the revelry phase will experience minimal losses. For example, free-to-play games like Sky Weaver and EdenBrawl will continue to attract real users (players) and grow steadily.

Stage Three: Rebirth

In fact, only after the bubble bursts can true value investors, creators, and users genuinely participate. To some extent, we look forward to a pullback. Because this will be the best baptism and training for revolutionaries. The Axie Infinity team started their project in 2018, and they have experienced countless failures and setbacks, gradually rising from the ruins of the bear market. Sky Mavis is also a team that can withstand risks, endure loneliness, and truly has ideals.

In contrast, many current projects can gain immense profits merely through a white paper, and we remain highly skeptical about whether such teams will survive after the storm. The bear market will wash away those indecisive fools and fraudsters, while leaving behind the resolute revolutionaries.

In this stage, the economic model of blockchain games will also undergo structural changes, transitioning from a Ponzi mechanism that attracts speculators (like Cryptomines) to a gambling mechanism that attracts "gamblers" (like BinaryX betting cards, Dream of the Red Chamber pet merging), and finally settling on attracting players through game mechanics (such as skins in Honor of Kings and other non-investment paid content).

Is Play to Earn sustainable?

It is impossible to discuss blockchain games without mentioning P2E (Play to Earn). The core of P2E is similar to Didi's early strategy of exchanging profits for market share, but its cleverness lies in introducing financial and even Ponzi elements, allowing companies to avoid burning their own money to acquire users, instead using speculators' money to do so. P2E is a great marketing tactic, but it is definitely not the core driving force for the long-term development of blockchain games.

There is a fable:

An elderly man living alone enjoys his peaceful rural life. However, one day, a group of children comes to kick a soccer ball in his backyard. The noise from the children makes the old man very unhappy. So, he comes up with an idea and tells the children: "I really like you playing soccer in my backyard. If you kick the ball for an hour every day, I will reward you one dollar." The children are very excited and come back every day to play. A week later, the old man tells the children, "You can continue to play, but I don't want to pay you anymore." The children leave dejectedly and never return to the old man's backyard.

This story is backed by a psychological theory called the Overjustification Effect. Everyone strives to make their own and others' behaviors seem reasonable, and thus always looks for reasons for their actions. Once enough reasons are found, people tend to stop looking further, and when searching for reasons, they usually start with the most obvious external ones.

Therefore, when external reasons are sufficient to explain behavior, people generally stop searching for internal reasons. The old man cleverly utilized the Overjustification Effect.

Returning to P2E, when players engage in games for economic benefits, but eventually, the returns will diminish (Axie returns have already significantly retracted), even if the game itself is very interesting, will they not gradually leave, just like those children who originally loved playing soccer?

Gameplay and P2E are to some extent incompatible; P2E greatly reduces the marginal utility of gameplay. Therefore, projects that overly fantasize about achieving both gameplay and profit may face the dilemma of transaction volume not surpassing mining games and user numbers not matching traditional games.

From an economic perspective, P2E is clearly unsustainable. Axie's P2E is built on the premise of rapid capital influx and Axie's monopoly. Looking ahead to 2022, as the already limited traffic is divided among thousands of blockchain games, and as liquidity injection begins to slow down, the vast majority of games will face a deadlock where Ponzi schemes can no longer thrive, and mining rewards may not even reach the average salary of the third world.

In fact, many bubbles have already quietly vanished, such as ArmzLegend, which rose to fame relying on U-based oracles, quickly collapsing after reaching its peak due to selling pressure.

It is worth mentioning that although Axie Infinity quickly rose due to its relatively Ponzi breeding mechanics, after A16Z's heavy investment, we may soon see a non-continuous qualitative breakthrough. Early Axie relied on subsidies from large holders to attract users and build IP. With the support of capital, Axie may soon be able to break free from its reliance on the logic of wild Ponzi growth and truly capture the value created by the game through high-quality content and a developer ecosystem.

What is our investment logic?

We believe that the three main contradictions within today's blockchain gaming industry are:

1. Real players find it hard to enter
2. There is a shortage of dual-skilled talent in gaming and blockchain
3. There is a lack of quality game content

According to incomplete statistics, acquiring users from Web 2 communities to blockchain games incurs extremely high losses; registering wallets, exchanging fiat currency, downloading games… each step turns away a large number of players. The funnel rate ultimately does not exceed one in ten thousand. Such data cannot even be described as subpar within the framework of internet products; it can be said to be a blank sheet.

How to enable more Web 2 players to enter blockchain games is our first investment theme/logic. Currently, guilds themed around communities and esports serve as a very good link. Guilds provide players with assets and accounts, significantly lowering the entry barrier. In the near future, DAO-based guilds may develop into the largest traffic entry point in the Web 3 gaming world.

The second aspect we value is the developer ecosystem. The most imaginative part of Web 3 is converting more people into content creators. How to empower developers to form a healthy and sustainable creator economy is also a huge direction.

We need platforms and engines like Enjin, Ultra, Forte, and MixMarvel to empower traditional game developers, helping them understand blockchain technology, tokenomics design, and the architecture and rules of Web 3. On the other hand, Sandbox and Decentraland also bring greater imaginative space. Those heavy gamers who do not understand programming may also become key builders of the gaming ecosystem in the future.

We believe that teams that truly love games and deeply understand the historical significance of blockchain games will remain. The games they create will be epic. The entry of liquidity will also shift from chasing Ponzi schemes to gambling and game content consumption. Perhaps the market is not mature enough now, but we will also support high-quality works like Illuvium that are somewhat ahead of their time.

Although there are currently many issues, we are confident that the blockchain gaming market in 2025 will definitely be a trillion-dollar market.