a16z "Arcade Tokens: The Most Underrated Type of Tokens"

Article Authors: a16z, Scott Duke Kominers, Eddy Lazzarin, Miles Jennings, Tim Roughgarden
Article Compiler: Block unicorn

Introduction

We recently organized a brand new, comprehensive classification system for token types, which includes network tokens, collectible tokens, and meme coins. Among the seven types we identified, arcade tokens are the least known and most underestimated: a type of token that maintains relatively stable value within a specific software or product ecosystem, typically managed by the issuer (such as a company).

Essentially, arcade tokens are a form of blockchain-based asset, similar to certain assets that people are already familiar with: for example, airline miles, credit card points, in-game digital coins, and so on. What they have in common is that they are currencies circulating within a market economy that support its operation: for instance, frequent flyer miles and reward points can enhance brand loyalty and can be used to purchase tickets and upgrades; digital coins allow you to buy and sell items in video games.

While businesses have been using such assets for decades, almost all previous cases existed within centralized databases, which limited ownership, transferability, and user choice. In contrast, arcade tokens based on public blockchains are different; they possess openness, interoperability, and composability, which endow them with a range of new market design advantages.

This article aims to answer the most common questions we receive about arcade tokens: what they are, what they do, why they are valuable, how developers can use them, the design trade-offs involved, and the opportunities they present.

What are Arcade Tokens?

From a technical perspective, arcade tokens are essentially digital currencies used within their related application ecosystems—whose supply and demand are flexibly managed to maintain price stability. You can think of them as currency in the digital economy.

So, where does the term "arcade token" come from? Whether or not you have been to an arcade, you may be familiar with the concept: you walk in, exchange cash for tokens (usually physical tokens), and then use those tokens to play a few rounds of Galaga, Gator Panic, or any other game you like. These tokens allow you to participate in the economic system of the arcade.

The arcade metaphor clearly illustrates how these tokens operate: arcade tokens have relatively stable value within their economic system—whether within a single service or across multiple services. The relative stability of arcade token value distinguishes them from other types of tokens, such as those whose value derives from underlying assets (like asset-backed tokens or collectible tokens), decentralized network market operations (like network tokens), or speculative investments in specific entities (like company-backed tokens or security tokens).

Despite the somewhat amusing name, arcade tokens are a powerful programmable economic primitive—they are key to unlocking new realms of cryptocurrency design space.

What are Not Arcade Tokens?

To reiterate, the most substantive distinction between arcade tokens and other types of tokens is that arcade tokens are not intended for investment or speculation. Unlike what people typically hope to achieve by purchasing network tokens or security tokens for investment returns, arcade tokens are meant for consumption.

Sometimes people refer to arcade tokens as "utility tokens" because they are designed to provide practical functions. We avoid using this label because it implies that other types of tokens lack utility, which is not the case. (For more information, please refer to our article on "Token Definitions.") Other names for arcade tokens include "points" (though in everyday language, this usually means that the associated records are kept on a private ledger rather than a public blockchain) and "loyalty tokens" (which refers only to a specific application).

This does not mean that the value of arcade tokens will never change—just as we will describe below, the price of purchasing arcade tokens may fluctuate slightly over time. However, arcade tokens are typically supplied in unlimited quantities at the current price, and they do not provide, promise, or imply financial returns. This means they are generally not suitable as investment products and are therefore usually not subject to U.S. securities laws.

This does not mean that the value of arcade tokens will never change—just as we will elaborate on below, the purchase price of arcade tokens may experience slight fluctuations over time. However, arcade tokens are usually supplied in unlimited quantities at the current price, and they do not provide, promise, or imply any financial returns. This means they are generally not suitable as investment products and are therefore usually not subject to U.S. securities laws.

What are Arcade Tokens Used For? Why Should Developers Consider Using Them?

Arcade tokens enable developers to mint and distribute value in the digital economy. Crucially, this ability to create and distribute value can incentivize user behavior, drive early growth, and generate network effects—without relying on external capital or speculative demand.

The reasoning is straightforward and aligns well with the arcade example: if you run an arcade, you would certainly want to control the supply of tokens to match customer demand. For example, if the number of customers doubles one day, it might be more helpful to issue about twice as many tokens so that all customers can play the games they want (of course, assuming there are no capacity constraints). If you can issue enough tokens, why would you turn customers away?

You might also need to be able to adjust prices: if you make significant improvements to the arcade itself—for instance, doubling the number of games, introducing more advanced and feature-rich machines, or offering more substantial prizes—you might raise the price of each token. In short, you need to flexibly control your economic system to better balance supply and demand (and also to demonstrate the value of your arcade to customers).

In addition to optimizing daily operations, this economic control also helps build lasting relationships with your most loyal customers. For example, you could issue reward tokens to your most active players. More importantly, when people end their day with some tokens left in their pockets, it incentivizes them to return to your arcade because those tokens can be used there.

More formally, arcade tokens support:

• Dynamic pricing and promotions: Arcade token issuers can adjust token prices, modify the purchase prices denominated in tokens, or both. This allows them to discount goods or services during periods of low demand or reward consumption during peak times.

• Network effects: Similar to airline miles and credit card points, users who earn or hold tokens are more likely to remain loyal to the brand. The value of this established user base encourages merchants, developers, and other service providers to engage more in collaboration, thereby enhancing user value—this is the typical platform network effect.

• Incentives and loyalty rewards: Arcade token issuers can offer rewards and other benefits to customers who complete specified actions. They can also leverage issuance rights to reward network participants when they accept or redeem tokens. All of this reinforces the network effects described earlier.

• Economic control: Arcade token issuers can destroy tokens upon redemption, track liabilities on-chain, and implement monetary policies similar to those of central banks—while keeping supply and pricing within predictable ranges.

How Do Arcade Tokens Work?

Economic Dynamics Analysis

The economic dynamics of arcade tokens distinguish them from other types of tokens. Arcade tokens do not grant holders ownership of the underlying ecosystem; rather, they grant holders the right to access or use specific applications or services; crucially, their market value is designed to be programmatically constrained. This does not mean that arcade tokens must be pegged to the price of fiat currency like stablecoins; it merely means that issuers can use certain mechanisms to set price floors and, usually more importantly, price ceilings.

Arcade tokens are typically purchased freely at a predetermined price. Think of the token vending machines in seaside arcade halls: you walk up, insert a dollar, and the machine gives you four tokens, each priced at 25 cents. This token vending machine, often referred to as a "faucet" or "valve," effectively sets a price ceiling, and the market value should never exceed this ceiling. Therefore, arcade tokens do not possess investment value: they are meant for consumption, not speculation.

The value of the tokens can be assessed based on their redeemable value through any "consumption mechanism" (i.e., the mechanism by which tokens exit circulation). In arcade games, the "consumption mechanism" refers to the game's "coin slot"—the place where you must insert a coin to play. If playing a game requires one token, then its value should be 25 cents. Alternatively, the arcade could set a buyback price slightly below the initial token price; this way, the issuer can guarantee that these 25-cent tokens are always bought back at 20 cents each. This sets a price floor, below which the token price should not fall.

Consider the impact of these parameters on the market: if you know you can always buy the same tokens from the faucet (or vending machine) for a quarter, would you spend a dollar to buy a token worth 25 cents from a speculator? Absolutely not—this would be unreasonable! (Or rather, it would be a poor deal.) Someone moving to another city might stand at the arcade door trying to sell their remaining 25-cent tokens for 22 cents each, but no one would pay more than 25 cents for them. Therefore, while some people may choose to sell their arcade tokens at a discount (for example, if they are leaving the ecosystem entirely), the price of tokens should remain relatively stable at any given point in time.

All these non-speculative factors make arcade tokens particularly suitable as the foundation of a controllable market economy. It is important to note that this does not depend on whether the use of arcade tokens is narrow (limited to a single application or service) or broader—it is simply a result of the "faucet/exchange" design of arcade tokens. (Continuing with the arcade example: even if the local grocery store owner is an avid video game fan and chooses to accept the local arcade tokens instead of cash payments, if you can simply walk to the arcade and buy tokens for 25 cents, there is no reason to pay more than 25 cents for each token.)

Why Not Just Accept Stablecoins as a Payment Method?

Arcade tokens conceptually overlap with stablecoins—both are designed to facilitate economic transactions while maintaining relatively stable value. However, arcade tokens offer developers greater flexibility. Issuers can mint arcade tokens on demand (though issuers still need to track the "shadow" value of these tokens on their balance sheets—that is, the value of arcade tokens upon redemption). Issuers can then use these tokens to provide funding and subsidies to users, developers, and other network participants. Additionally, these tokens encourage participants to stay within a specific economic system rather than using funds elsewhere. (There is a reason airlines issue "miles" rather than directly providing cash rebates to frequent flyers; these miles must be used to purchase future flights.)

Arcade tokens also provide developers with more monetization options. Issuers can sell tokens directly to users (at fixed or dynamic prices), bundle them into subscription packages, or distribute them through promotional activities. When partner networks agree to accept a certain arcade token, they can establish cross-promotion and affiliate marketing models—these strategies can expand each partner's reach without external funding.

Crucially, arcade tokens also allow issuers to finely control the flow of value within the economic system:

• Restrict transferability (for example, limited to within the application or between whitelisted addresses),

• Set depreciation or expiration dates (to encourage timely use and reduce hoarding), and

• Link redemption to specific goods or services (to align utility with economic intent).

These features help reinforce the value of tokens as mediums of exchange rather than speculative assets, and they can be encoded through on-chain programming. In short: arcade tokens can help kickstart growth, encourage user engagement, and manage the operation of the internal economy while granting its maintainers a degree of control.

The Power of Interoperability

As we have described, arcade tokens issued on public blockchains are similar to loyalty points or airline miles—but they have one major distinction: they are on-chain, meaning they can be open, interoperable, and composable.

Unlike traditional loyalty systems that confine value within closed ecosystems, blockchain-based arcade tokens can be shared, accepted, and redeemed among multiple participants without permission—potentially even between competitors. Portability is a significant advantage: in this model, users can transfer loyalty to different services, and their status can be easily transferred (for example, unlike the cumbersome "status matching" processes of airlines today). This portability encourages market participants to compete on the quality of products and services rather than simply pursuing user lock-in, and it can transform fragmented loyalty programs into public goods.

So far, the $FLY token issued by Blackbird, founded by the creators of Resy and Eater, stands out as one of the best on-chain arcade token cases. This token creates a loyalty program for restaurants similar to Starbucks' Rewards or McDonald's membership rewards. This may sound familiar, but it is unique: the same token can be used at multiple different restaurants. Customers earn tokens after spending at restaurants within the Blackbird network, which can then be redeemed for discounts and other benefits at any participating restaurant. Because the underlying protocol is based on blockchain, all these operations can be completed without direct interaction between the restaurants. Just as a single restaurant's rewards program can enhance customer loyalty, $FLY can simultaneously boost loyalty across the entire restaurant network.

Consumers benefit from broader utility; businesses benefit from shared network effects.

The result is cooperative competition (rather than traditional competition): for example, your local coffee shop and Starbucks can both benefit from accepting the same token. While it may seem at first that neither coffee shop would want this to happen, a shared membership program enabled by arcade tokens can actually benefit both. Arcade tokens can complement the experiences of Starbucks and the local coffee shop, so that visiting either can provide offers that enhance the value for both. For instance, if one of them offers a free mocha coffee in exchange for arcade tokens, the value gained from purchasing coffee at both shops would increase. Such offers can enhance customer loyalty to the coffee chain network and encourage customers to allocate a larger portion of their budget to coffee.

This cooperative competition can generate more total surplus for the network, which can be distributed according to each vendor's sales. In other words, rather than fighting over slices of the pie, it is better to grow the pie.

Design Trade-offs (and Opportunities)

Arcade tokens are not suitable for all projects. In cases where speculative assets are needed, arcade tokens may be inappropriate. For example, a layer-1 blockchain network with its own native network token typically does not require arcade tokens to function properly.

However, for many projects—especially those with consumption as the core economic model or those integrated with the physical world—arcade tokens may be an extremely attractive option. They offer the following advantages:

• Price stability: achieved through price ceiling and floor mechanisms and controlling issuance.

• Usability: intuitive and stable value helps users understand their consumption.

• Accounting clarity: their cost on the balance sheet is the opportunity cost of what they can be redeemed for—no more, no less.

• Control: issuers can manage them in a manner similar to central banks.

We are also seeing arcade tokens gradually becoming a complement or precursor to network tokens. Blackbird's $FLY token allows users to redeem at any participating restaurant, and this redemption is managed by a specially constructed blockchain layer driven by the network token. For example, a decentralized computing network could use a network token to secure and incentivize interactions between computing providers while using arcade tokens to build network effects among users. Alternatively, a marketplace platform could use arcade tokens to guide user participation and then gradually introduce network tokens as the operational protocol becomes decentralized. In these cases, arcade tokens can serve as an entry point, catalyzing early demand and helping the network achieve initial user growth before transitioning to a more decentralized system in the long term.

Regulatory Outlook

An early example of arcade tokens is Quarters, which comes from the blockchain-based gaming platform Pocketful of Quarters. Players can use Quarters tokens to obtain features and rewards in participating games. Regarding the view that arcade tokens are not investment assets, Pocketful of Quarters received a no-action letter from the U.S. Securities and Exchange Commission (SEC) in July 2019. The SEC stated in the letter that they recognized that people use Quarters solely to participate in games, rather than for speculation or investment.

Despite this positive precedent, the no-action letter for Quarters and many state regulatory mechanisms still have flaws. For example, they are skeptical of interoperability, viewing it as a loophole rather than a feature. Their reasoning stems from a mistaken belief that once interoperability exists, assets become easier to trade, thus possessing characteristics of financial instruments. This perspective overlooks the fact that trading demand still depends on whether the asset has speculative upside potential—just as we explained earlier, arcade tokens typically do not possess such potential. Meanwhile, interoperability is one of the most exciting advantages of on-chain arcade tokens, as it brings numerous benefits to consumers, including reduced transaction friction and increased choice.

Clever design can alleviate regulatory concerns. Arcade tokens do not need to be confined to closed networks. Mechanisms such as price ceilings, faucet-sink models, and redemption mechanisms linked to usage allow issuers to programmatically suppress speculative activity. Consumers can also benefit from interoperability, as it enhances user experience, fosters competition, and creates broader network effects—ultimately promoting innovation and delivering greater value to users without relying on financial speculation.

While arcade tokens are not suitable for every scenario, they are a crucial component in the evolution of crypto networks. Just as stablecoins have unlocked new business models and network tokens have enabled decentralized value sharing and governance, arcade tokens can also drive the growth of the digital economy on a large scale.

As regulatory policies become clearer, we expect more developers and users to recognize the advantages of arcade tokens, as more projects (including those not native to cryptocurrency) explore their uses.

The views expressed in this article are solely those of individuals associated with AH Capital Management, LLC (referred to as "a16z") and do not represent the views of a16z or its affiliated companies. Some of the information in this article comes from third parties, including portfolio companies of funds managed by a16z. While these sources are considered reliable, a16z has not independently verified this information and makes no representations regarding its current or long-term accuracy or its applicability in specific circumstances. Additionally, this article may contain third-party advertisements; a16z has not reviewed such advertisements and does not endorse any advertising content contained therein.