The Memetic Power of Play-to-Earn
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Thanks to Mason Nystrom, Accelerated Capital, and Gabby Dizon for feedback and comments.
The concept of play-to-earn has been getting a lot of attention over the recent weeks and months. However, most of the coverage has been focused on the basics of play-to-earn and some of the mechanics. While helpful, this presents an incomplete picture.
We believe that, as a trend, play-to-earn is powered by social and not necessarily fundamental factors. While the ability to earn is expressed through in-game items and tokens, their value is subject to social consensus. We see current demographic and social trends as supportive to the development of play-to-earn as a viable economic activity, and part of the future of work narrative.
As tokens become the new financial memes, taking the mantle from stocks and bonds, we wanted to explore the inherent differences between tokens and equities.
So without further ado, let’s dig into this.
What is play-to-earn?
At its core, play-to-earn is the next step in the evolution of gaming. From arcades and pay-per-use to Fortnite and free-to-play, we cover the subject here.
There are two main aspects of play-to-earn: open economies and non-fungible tokens (NFTs). Open economies mean that in-game items and currencies can be bought and sold transparently without intermediaries and rent-seekers. This is vastly different from existing games. Accelerated Capital covers this beautifully in the “gold farming” section of his article on play-to-earn. Blockchain is the underlying infrastructure for these open economies, and NFTs are the tool used to “establish and authenticate true, digital ownership” and represent value.
“Utilizing blockchain technology and seeking to reinvent the ownership model of in-game items, Play-to-Earn gaming embraces these natural economies and brings value creation to the forefront.” - Accelerated Capital
Beyond the evolution of gaming business models, play-to-earn fundamentally changes the distribution of economic power among different stakeholders in the gaming ecosystem. Specifically, it puts more influence into the hands of the gamers who, arguably, make a game valuable in the first place. In traditional gaming, players spend their time (effort) and sometimes capital in exchange for entertainment. However, with play-to-earn based games, the effort becomes monetizable and can be easily converted into an ownership stake. Gaming has always been a massive business, projected to exceed $287bn in revenues by 2026. With play-to-earn, most of the value will accrue to the players, putting NFT gaming into the “future of work” category powered by blockchain.
Fundamental value vs social value
There are, of course, fundamental reasons why players can earn an income while playing video games. Beyond the fundamentals, however, there is a social layer. We would argue that while many things in the world have some fundamental value, perceived or otherwise, most of the overall value of an item is social value.
We can use Amazon stock as an example here. While discounted cash flows (DCF) and other financial models are helpful, the actual price of the stock is determined through social consensus. We collectively agree that a share of AMZN is worth $3,300 and express that agreement through buying and selling the stock. A lot of TradFi professionals will argue against this, pointing at their fundamental models. But those models are again just another form of social consensus. Based on subjective assumptions and estimates, these models often incorporate the socially agreed-upon range of outcomes for things like top line and bottom line growth, expenses, etc. The stock itself can often deviate significantly from the models as trading reflects second-by-second social consensus while the models are lagging. In essence, stocks are just memes, albeit with an overtone of regulatory validation and approval stamps from the boomer generation.
What does all of this have to do with play-to-earn? Let us explain.
Meme-based thesis for play-to-earn
First, there are fundamentals. For example, in-game items having actual in-game utility. Think of items like armour, weapons, Axies, or NFTs on Enjin that have the actual ENJ token bonded to the NFT, providing a fundamental price floor for an item. For in-game tokens like SLP, their fundamental value comes from the token's utility in the game. For example, SLP is used for breeding new Axies. The attractiveness of that proposition depends, partially, on the relative cost of breeding new Axies vs. buying them. We can expect there to be some demand for SLP for as long as it's cheaper to breed Axies than buy them. There are certainly some interesting supply and demand dynamics here. In some ways, SLP is similar to a commodity used to produce a finished good, and its price might be more fundamentally driven as viewed through the macroeconomic lens.
So yeah, a portion of the "earn" in play-to-earn comes from fundamentals. But we think the majority comes from the social premium, which we expect to increase over time. And that's where things get interesting. For the boomers, Gen X and a large share of millennials, stocks, bonds, and real estate are the rightful owners of that social premium. They are the financial memes of those generations that accrue value because of social consensus.
This status quo is unlikely to persist. Whether you believe in the Strauss–Howe generational theory, also known as the Fourth Turning theory, or not, it is rather clear that things are unravelling around us and have been for some time. This includes social consensus on a lot of things, including financial memes. Some millennials and certainly most of Gen Z assign a much smaller social premium to traditional financial assets, be it bonds, stocks, or gold. We believe that this social premium will increasingly manifest itself in tokens. To put it simply, tokens are the equity equivalent for younger generations - digitally native assets for the digitally native generation.
Some early research on the subject confirms this hypothesis. Based on transactions made between February 2020 and February 2021, a study by Stilt shows that "94% of all cryptocurrency buyers are Gen Z or Millennials."
What's even more interesting is that some countries might skip stocks and bonds, the old stack of finance, altogether. This would be similar to China skipping desktop and going straight to mobile or Africa mitigating the lack of banking infrastructure through M-Pesa.
Another area of changing social consensus is the value of digital vs. physical. With Fortnite, it became apparent that skins and in-game cosmetics are a big business. Heck, this digital version of a Gucci bag recently sold for more than its physical counterpart.
To bring things a tad closer to the metaverse, we recently spoke to Decentral Games about NFT merchandise. They told us that during the Atari casino launch event, customers claimed 2,000 Dillon Francis sweaters. And while sweaters were free, claiming them did cost an average of $50 in gas. Had they instead priced the sweaters at $50 and transacted on Polygon, this one event could have raised $100,000 in NFT sales alone.
In addition to digital goods, digital concerts and events in Fortnite and Roblox, and the growth of the esports industry, are all signs of the social consensus starting to shift towards digital-first experiences.
To sum things up, we believe that the play-to-earn trends are supported not just by fundamentals but also by the changing social consensus towards tokens and the value of digitally native experiences. In combination with the demographic trends, these factors point to the ongoing development and growth of the play-to-earn model. With blockchain infrastructure as well as NFT and VR technologies, the sky's the limit. However, we expect these developments to take many years to play out fully.
Are tokens structurally better than equity?
While unrelated to play-to-earn, we wanted to briefly touch on the subject of tokens vs equity. As mentioned above, we believe that tokens will be the equivalent of equity and bonds for the next generations. What we, in crypto, call TradFi is still just finance to a lot of people. Similarly, what we now call DeFi will someday become just finance and cryptoassets will someday be just assets.
From the perspective of their inherent design, what are the main differences between tokens and stocks, for example, and is it a good thing at all that the younger generation will be increasingly exposed to tokens? We believe, unequivocally, that token ownership is better than stock ownership. Let’s explore why.
First, tokens represent protocols. For the sake of simplicity, we’ll quote Mark Cuban here and say that a protocol is “just another business that happens to be using a blockchain and smart contracts to host and program their business processes.” From the business perspective, protocols are simply better than your average C Corp. We are early, of course, so this isn’t a blanket statement. But protocols are more efficient, have much lower capital requirements, and are easily scalable without capital investment.
“So where a crypto based business competes with a traditional business, the crypto business may have a significant cost of capital and cost of operations advantage. There are a lot of financial institutions that should be concerned.” - Mark Cuban
That's why some of us believe that the total addressable market for Ethereum and blockchain is everything. Another point worth making is that due to their operational efficiency, protocols need to retain a relatively small share of their earnings. The rest will likely be distributed to contributors who work for a protocol, token holders, liquidity providers, public goods funding, etc.
Second, tokens offer a much more transparent and clear path to value accrual. Blockchains are public and open. If a protocol collects a transaction fee for its service, it will be easily verifiable on-chain. Revenue accruing to the treasury and the treasury balance is public at all times. So are the outgoing expenses. This is real-time financial reporting, in the open, with no ability or a need to inflate EPS for the quarterly reporting cycle. Whether token holders directly benefit from the revenues accruing to the protocol depends largely on governance decisions.
This brings us nicely to the third point – token governance. With equity, shareholders certainly have the right to vote on corporate matters. They can vote on executive compensation, nominations to the board, stock splits, M&A, and some other administrative issues. The frequency of voting is usually annual, but votes can be more frequent.
Contrast this with token governance. Token holders can generally vote on any matter related to a protocol. They can do so at any time, given there's enough urgency and consensus on an issue to bring up a vote. Lastly, token holders often play an active role in crafting governance proposals. While this can be done in the equity land, this privilege extends only to those "activist" investors with significant stakes in the company. Now, we are not by any means suggesting that token governance is perfect and is ready for mainstream adoption. We are merely saying that the inherent qualities of token governance are superior to those of traditional corporations.
While a large portion of this article seems to have little to do with play-to-earn, the crypto ecosystem is interconnected. There are many macro forces in play.
We believe that play-to-earn is here to stay and is likely to grow exponentially over the next several years. While there are some fundamental drivers behind the ability of gamers to earn, we see the majority of value here coming from social factors.
The younger generation will increasingly choose digital over physical, with tokens becoming the new financial memes and accruing the social premium beyond fundamental value. In-game assets and tokens will benefit from this creating a positive feedback loop and driving adoption and innovation in the play-to-earn space.
Furthermore, we believe the preference towards tokens and away from traditional financial memes like stocks and bonds is a positive development. Arguably, it's the representation of the Fourth Turning and a complete break away from the previous structures. With better business fundamentals, transparent and direct value accrual, and better governance structures, we see tokens as the new financial memes ready to supercharge the new generation.