Is Blockchain Gaming Recession Resistant?
How "Crypto Winter" is impacting Web3 games and some lessons learned this cycle
GM readers 👋,
Happy June again! I was more efficient than usual this month and managed to publish a second post. Josh Chapman at Konvoy Ventures recently wrote a great post about how video gaming has historically held up well during recessions. Between Josh’s piece and articles about blockchain gaming being similarly resistant to this downturn, I decided to share some thoughts and learnings from spending the past 18 months working on blockchain gaming projects.
FYI. The original version of this post was published in Naavik Digest. If you aren’t already subscribed to Naavik’s newsletter, you’re missing out. It’s free, published at least weekly, and helps you better understand the business of gaming. And since gaming is the biggest media category, shouldn’t we all want to become smarter about it?
One final item before diving into the post:
As Alderbrook scales, we are looking for part-time analysts who are skilled writers, financial modelers, presentation designers, and strategic thinkers. This is a flexible, paid role for individuals who enjoy helping companies of various sizes solve challenging problems. Bonus points if you are knowledgeable and passionate about the gaming, music, or Web3 industries. Undergraduates and MBAs are welcome to apply, as are experienced professionals seeking project-based work. Please reach out to contact@alderbrookcompanies.com if you are interested in learning more.
Thanks again for reading. Now, let’s get after it!
Jimmy
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Is Blockchain Gaming Recession Resistant?
It appears crypto winter is upon us. “Blue chip” token prices, like Bitcoin and Ethereum, are plummeting. Protocols, once worth tens of billions of dollars, are going to zero. Several Web3 companies are laying off employees. The market and my crypto portfolio are experiencing the Trough of Disillusionment stage of Gartner’s Hype Cycle.
At the same time, multiple articles published in the last couple weeks have suggested that blockchain games are “resistant” to this broader downturn, referencing recent DappRadar reports:
“The number of game transactions and the number of daily Unique Active Wallets (“UAW”) connected to game dapps decreased only 5% from April’s levels. Still, when compared to DeFi or even NFTs, blockchain games are suffering the least. The top blockchain games continue to maintain their player base, showing real engagement atop the charts.”
For context, the “traditional” gaming industry has held up well relative to other sectors of the economy during past recessions. At a macro level, players engaged more with video games during the Great Recession that began in late 2007. According to Nielsen, average time playing video games increased from 15 hours to 18 hours per week in 2009, reaching an all-time high. Rather than reducing gameplay, Nielsen hypothesized that the recession may have accelerated playtime as “gamers look to get more value out of the games they own.”
From a monetization standpoint, the gaming industry still held its own during the downturn. This was clearly demonstrated in console sales with PS3, Xbox 360, and Nintendo Wii sales all growing between 2007 - 2009. This growth occurred without any major product releases during the period.
Hardware spending extended to console and PC game sales too, with the major publishers’ reporting strong operational performance. Activision, EA, and Take-Two all experienced higher revenue growth than the S&P 500 during the recession. Activision and EA, specifically, delivered strong results, growing at 78% and 17% two year CAGRs. It’s worth highlighting that ATVI benefited from the Blizzard acquisition in 2008.
Despite solid operational performance, the blue-chip gaming publishers’ stock prices plummeted. Only Activision outperformed the S&P 500 between 2007 to 2009.
In summary then, the most recent recession suggests that the PC and console industry are resilient to broader market downturns. However, we’d note that mobile gaming, with its greater dependence on advertising spending, may be less resistant to a recession than PC and console. Do check out Eric Seufert’s great piece on this topic.
Circling back to the original question of this essay: can blockchain games avoid the squeeze too? Let’s consider the following data points:
First, game token prices have plummeted along with the broader crypto market. The NFTI index, which consists of eight NFT – mostly gaming – project tokens, has declined 85% year-to-date compared to the DeFi Pulse Index’s 78% decrease and Ethereum’s 70% decrease.
While gaming tokens have performed no better than its crypto peers, we know from our traditional gaming analysis that valuations don’t always tell the whole story. Has the blockchain gaming industry’s monetization and engagement remained on solid footing during crypto winter?
For monetization, NFT projects’ transaction volumes are experiencing a rapid decline in June 2022. According to Cryptoslam, seven out of the top 10 blockchains have seen volumes fall 35%+ over the past thirty days. Ethereum and Solana, the top two blockchains and 60%+ of market share by transaction volume, have seen volumes plummet 76% and 63%, respectively, over the period. Sky Mavis’ Ronin blockchain, which facilitates Axie Infinity transactions, has seen activity decline 64% in the past 30 days. Simply put, monetization via secondary market transaction fees is plummeting.
In terms of engagement, Unique Active Wallets (a proxy of users) are starting to wobble. The moderate sequential decrease in daily UAWs, noted by DappRadar in May, has been followed by a ~25%+ decline to ~860K daily UAWs in June. One main driver of the June decline is the game Splinterlands. The game reset its reward system earlier in the month to combat botting but resulted in a 70% decrease in UAWs. So, while gaming UAWs had been hanging in over the past few months of broader crypto market fallout, engagement does appear to be wobbling now.
Putting this analysis together, the short answer to “is blockchain gaming recession resistant” appears to be no – at least for this cycle. With the crypto pullback extending to games, I’ve read several posts contemplating what lessons can be learned and what might come next. So, I thought I’d throw my hat in the ring. Here are a few learnings / thoughts on how the industry might be able to better withstand the next crypto bear market, after spending the past 18 months going down the rabbit hole.
1. Build for contributors, not extractors. Before discussing this learning further, I’ll admit that the “make more fun games” discussion point is played out at the moment and has reached meme status. Also, I’ve never built a video game, so I’m hesitant to opine on the topic of making fun ones. I will say that typical metrics to gauge a game’s health (e.g., user growth, retention, and ARPU) can be misleading when a meaningful percentage of the player base is primarily interested in the extraction of value.
The first generation of popular blockchain games have been too reliant on these extractors. This has resulted in volatile, unsustainable economies. Venture capitalist Josh Kopelman is credited as saying “Numbers always ruin a good story.” Quantitative fundamental analysis can lead to greater accountability and discipline. In that spirit, I’ll put on my finance nerd hat and try to explain what I mean by unsustainable economies with an overly simplified example:
Assume a game has 100 users.
30% of users are net extractors that withdraw $10 per day from the game.
How much do the remaining 70% of users need to net contribute per day to payout the extractors (ignoring any marketing, live ops, etc. expenses)?
In our simplified example (depicted below), the answer is spending a net $4.29 per day or ~$129 per month on the game.
For comparison, Fortnite has similar spender vs. non-spender activity – 70% of Fortnite users spend at least something on the game and 30% spend nothing – with an average spend of ~$85 per month. Simply put, Fortnite player spending assumptions would not sustain the extractors in our example.
In order to actually sustain our economy with $85 contributed per month, only ~20% of users can be extractors “earning” $10 per day. As a reminder, an estimated 65% - 70% of Axie Infinity users were scholars, regularly taking value out of the game’s ecosystem, at the game’s peak. In our example, if 65% of users are extractors, contributors need to pump in over $500 per month to balance the economy! It’s difficult to see this economy lasting over the long-run at scale (absent other revenue sources like advertisements, etc.), even with a fancy token design.
In summary then, blockchain game projects need to 1) attract more net contributors and 2) condition net extractors to expect a lower return, in order to sustain their economies over the long run. In the future, I would expect to see reward distribution flowing to the “best” gamers / highest net contributors versus bots / highest net extractors. Meanwhile, I expect that we’ll see investors undertaking greater quantitative analysis to sanity check stories, prior to “ape-ing in.”
2. The strength of network effects and founders’ gaming experience matter. The first wave of blockchain games has embraced financial incentives and DeFi loops to jumpstart network effects. It’s not uncommon for blockchain game founders at this moment to say that one of their key goals is to “create demand for the token.” In my opinion, this is short-term thinking.
It’s tempting to see charts like the one below as a reason to create token demand. Turbo-charge your network effects with financial token incentives! But what happens when most of your users are financially motivated and leave when token prices stop going up? In other words, network effects may come quicker by raining your community with token rewards (i.e. free money). But the downside is often weaker network effects than the good old fashioned model of bootstrapping a great product that your community values irrespective of financial incentives. In the heavily edited words of Al Pacino’s character Lt. Col. Frank Slade in the movie Scent of Woman, “Makers of [games]; creators of [network effects]. Be careful what kind of [network effects] you’re producing!” Going forward, I hope we’ll see more founders prioritize building an amazing product (i.e., game) over creating demand for their token.
Similarly, several early blockchain game teams have lacked prior game experience. I’ll still root for these projects to be successful. But in order to maximize chances of success, I anticipate that we’ll see projects (and investors) prioritize game development expertise when forming founding teams in the future. As my gigabrain colleague Lars Doucet summarized well in a recent Twitter thread: “More nerds, less ponzi pls.”
3. Prioritize security and trust first and foremost. Proponents of blockchain gaming often talk about NFTs providing users with ownership for the first time. But I’d push back on this. I’d argue that trust is perhaps the key value proposition of Web3. And as a result, security is critical and not all blockchains are equal in this regard.
From a technical standpoint, publishers and Big Tech companies can provide gamers the same ownership and token to fiat off-ramps on their centralized servers (if they really want to and choose to take on the regulatory/legal hurdles). In my opinion, the value of blockchain’s system architecture – when truly decentralized – is that users don’t have to trust or receive permission from any one entity / corporation to transact and own their digital assets. As a result, many of the key issues addressed by decentralized blockchains ultimately boil down to trust.
At the same time, users need to be able to trust that their blockchain assets are secure. Unfortunately, there are numerous examples of NFT ecosystems and communities getting hacked, with the most notable being Sky Mavis’ Ronin $600+ million exploit. Looking ahead, I expect teams to prioritize security when choosing where to build. The blockchains that have sacrificed security for scalability will suffer.
Despite the “FUD”-ish tone of this essay, I’m still super excited about the potential of digital asset ownership in games. For starters, the video gaming market is already massive – valued at $300 billion with 3 billion gamers. There are compelling demographic tailwinds with Gen Z rating gaming their favorite entertainment activity. And a large grey market for virtual items (estimated at $5 billion) already exists where participants monetize digital ownership despite the inherent risks. Meanwhile, there are several examples of gaming executives leaving to pursue blockchain gaming projects. And billions of dollars are being invested to support these new companies. In my opinion, many of the ingredients – market size, talent, and capital – are there.
Despite the various remaining adoption barriers (e.g., impending regulation, attracting more net contributors, etc.) that still must be overcome, I’m optimistic that the lessons from this cycle will be internalized and eventually lead to a stronger industry in the future. That said, the journey out of the Trough of Disillusionment to greater mass market adoption is likely going to take a while. In the meantime, I look forward to learning and figuring things out alongside this community.
Thanks to Fawzi and Hannah for the feedback, input, and editing!