P2E Economics Should Learn From Emerging Market Economies, not DeFi
“Those that fail to learn from history are doomed to repeat it.”
- Winston Churchill
Crypto gaming is about adding composability to the gaming economy. Turing a closed economy into an open one. With that come many considerations.
But crypto games today tend to follow the path of DeFi. This does not consider that the game is an economy, the in-game token is a currency.
It is not to be looked at as equity like DeFi Success in the game looks like increasing GDP, not earnings. And the investor or game developer is successful by earning tax revenue.
Example: Axie Infinity
The most notable crypto game is Axie Infinity.
Axie's tokenomics are like the traditional DeFi protocols that pay for liquidity in their gov token. It is more complicated than this, but to keep things simple, Axie is paying for gameplay in its own token SLP.
Ok so more people play and as they play, they earn this token SLP that trades at $$. They think, “hey look, I can play and earn $$! Amazing!”.
...Hold your horses
Net issuance is off the charts. In May alone, we saw a 16% increase in SLP. Holding market cap constant, the price of SLP should decrease ~14%. 16% monthly inflation?? Unsustainable.
Example: Stepn
Another example is Stepn official with its GST inflation.
The difference here is a controlled increase in users via activation codes but this fails to incorporate what if there is a decrease in users.
While this added utility should help keep demand for GST high and thus increase players’ profits from playing, it does nothing to stop the game from entering a death spiral once player growth plateaus.
- Coindesk (source)
Wait, so…
With mass net issuance, the game is fine as along as there is an increase in user activity, but when more people want to leave, it fails?
Did I just describe a ponzi scheme?
Unfortunately this is the norm because it is easy. If I don’t have capital to pay people to play my game, I can just issue my own token. Basically, pay people in equity.
This can make sense initially, but long term, it destroys the network as a loss of belief is built. And long term in crypto is a few weeks.
Once a community loses belief and sees that the coin is getting printed to oblivion, it is over. There might be ways to fix it through token burning but even then, it’ll take a lot of burning to get back. i.e. OHM, TIME, LUNA, etc
“Utility”, sort of
To make things worse, “utility” is added to encourage not selling such as staking while they figure out actual utility.
“lets pay existing holders for not selling while the founder/investor/contributor unlocks happen, and also so we can fake some utility before any is actually built”
– Cobie summarizing the reason for a staking mechanism being implemented (source)
Most do not consider the implications of monetary policy and continue to repeat the mistakes of the past in crypto. And frankly for good reason because it gets them easy funding and they can figure it out later.
Supply now, demand later
But this ignores so much about what gaming in Web3 is meant to be
Why Bother
It makes one asks why do even want crypto & NFTs integrated into games?
Does adding financial incentive ruin a game?
Actually why do we want crypto and gaming to merge is simple. Yet it has nothing to do with the perverse ponzinomics we have seen traditionally in crypto's history.
P2E is great but it isn't a free lunch. Value doesn't appear out of thin air.
The advantages are about sovereign ownership which gives:
Give gamers more control of their user account, content, and gaming assets
Lower the cost of playing these games
Something well articulated by Chris Dixon
The purpose of any game for most users should be to play the game, not earn. Yet adding crypto into a game is essentially adding an economy, adding economic incentives. So a huge consideration becomes how to structure monetary policy.
Monetary Thought Experiment
Let’s do a thought experiment. Let’s assume we have a mature gaming ecosystem. This economy is like a real-world economy where there are resources and capital. What economic model do we want?
It should be one that aligns all stakeholders and prioritizes the gamer. The gamer also seeks asset price stability. If they put in $$ money, they expect it not to go to zero.
The gamer is basically a citizen in an emerging market. If they create a new in-game item, they don’t want its value to inflate away. Or if they spend significant time to earn a reward in the in-game coin, they don’t want the value hyper-inflated away.
Generally they want price stability in the game. Most tokenomics are meant to get the price up or alleviate sell pressure. In crypto, focusing on the price being relatively stable is ironic but this is the point of a currency in an economy.
So why when building an economy, do you use these traditional tokenomics rather than focus on building a currency?
Comparison of EM & Game Economies
Building an emerging market economy is the best comparison I can think of when building a game economy.
The major difference here is that the economy is being built. For example the having to figure out what you do in the game. Also, in the real world, we have a natural demand for certain items like food and shelter. But for a game it is different.
An example is RuneScape. In the game, I need a fishing pole to fish, I need ore to smelt and make armor. In-game items are burned for different in-game items. But these items are only relevant to the game. My RuneScape fishing pole cannot be used to fly fish in Yellowstone. It is specific to the game.
Not to dismiss it but I think this part is more game-specific and generally the idea follows traditional game economics. An article I thought was useful for on this topic:
How to Build A Smart Game Economy
My focus here is the currency in the game. Even RuneScape is having issues with its own in-game gold coin, even a introducing a 2% tax to decrease the supply of gold in the game.
Standard Game Tokenomics
Star Atlas is a crypto game being built. The in-game currency circulation schedule is below. This is what most supply schedules look like for almost every cryptocurrency including gaming tokens.
Let’s take a hypothetical that ETH transactions are the path our game will take when being adopted. It is a good example of how network growth will occur, though every network is different.
From the beginning, transactions are growing but barely. This is typical of games that are being built.
Why hold a currency if there is no use for it? Only a hypothetical use case in the future for a game that MIGHT be successful. So the typical supply schedule of a game has the highest increase in supply at the same time the in-game coin has the least utility. This imbalance does not make sense.
In-Game Currency Stability
For financial stability, we want:
Economic Growth = Circulating Supply Issuance Growth = Supply Growth – Burn Growth
For stability, generally, we want the change in money supply equal to changes in economic activity. Economic activity in a game is best described as the transaction volume of in-game assets. This isn’t a perfect proxy but it is close enough to estimate the economic changes.
To illustrate 3 scenarios of economics activity where GDP starts at 200 and supply at 100:
1) GDP 3% > Inflation 2%
2) GDP 3% = Inflation 3%
3) GDP 1% < Inflation 2%
The assumption that the token is equal to GDP / Supply might not be a great one but it illustrates the idea.
The IMF has a paper on this however, the major focus is on credit and in-game credit systems aren’t a thing (yet?)
“Monetary Policy: Stabilizing Prices and Output” - Source
This is the general idea though. If we get a huge increase in users, in-game economics should compensate with an increase in supply.
However the issue comes when we have more users leave than join.
… hard to not sound a like a ponzi but I digress.
Remember this is like an EM economy Users leaving results in supply per user going up -> Inflation. Supply of in-game asset.
Stability Mechanisms For Games With Negative User Growth
So going back, if a game’s currency is like EM, that means they have several actions to protect their currency and build financial stability:
Raise interest rates
Central Bank Reserves
Capital Controls
But in a game, again, there isn’t a credit system. So it comes down to reserves and capital controls.
I found a presentation from Lawrence Lau at Stanford useful:
“The Prevention of Future Currency Crises”
“Simulations by Lau, Li and Qian (1999) suggest that foreign exchange reserves can be considered adequate (in the absence of capital controls) only if it is approximately equal to 10 months of imports”
Pg 34
“If foreign exchange reserves are low relative to these potential demands for withdrawals of foreign exchange, the currency may be vulnerable to a run”
Pg 35
The point here is that the reserves amount is very important. For a game in development, they should consider when fundraising how much is going to the reserve balance in addition to the funding of additional reserves as the game grows.
As well, the BIS has a paper on EM economies where all these are discussed:
“Financial Stability in Emerging Market Economies”
Here, it is more about how to build trust in the system such as adequate reporting of reserves.
“Also, worries about the soundness of the financial system can trigger a flight to quality by domestic depositors and foreign investors, often in the form of an exchange of domestic for foreign assets with implications for the exchange rate as in Israel in 1983”
Pg 20
Similar to a bank run, a game can have huge capital flight. As of recently, this has been seen in Turkey and various DeFi protocols, most notably Terra.
But really, think about this. In a game, the assets are not used outside the game IRL, making an investment in a foreign country, I own assets that produce something that I could sell internationally. In a game, this is not true making capital flight even worse.
Capital Controls
If the game is composable, capital controls are very difficult. Anyone can build an exchange for your currency and assets.
Though there can be some control of capital inflow. An example is Stepn with activation codes.
However, an idea of controlling capital outflow is to control how many items or coin a gamer can sell for non-game assets. This could be a “creator fee” gauge changing depending on many in-game assets the user has sold in the past specific amount of time (24 hrs, 1 wk, etc).
Reserves
So capital controls might help but reserves are another option, though that is not perfect. e.g. please see where the Terra BTC reserves are.
But the idea on how to build reserves is clear. Simply use a percentage of fees to build reserves and make an allocation to reserves upon receiving funding.
Oddly, my idea is similar to the Terra Foundation, but the key difference is how I build reserves and that my demand of in-game assets is not artificial.
Plus there isn’t a peg I am trying to maintain. I can allow for asset prices to fall some. I just want to use reserves in case too many people choose to leave the game too quickly. Not if a few decide to leave and push prices down for a short period of time.
Ultimately the coin should be allowed to float against other currencies and the only true demand is the desire for gameplay. But allowing some fees to be used as reserves and fees to be dynamic based on the user’s activity will help the coin maintain some value in negative growth environments.
It is also important that the fees all go back into the economy otherwise it should be removed from the circulating supply or money supply. As such building reserves means earning the token and immediately selling it for other assets.
Stability & The Investor
It may be odd to consider all these monetary actions in a game that is meant to be a just a game. But if financial incentives are added to a game, users will consider that with their game actions even if the main reason to play is for fun.
The hope is that this brings financial stability. But wait a second, did I forget about the initial investors and developers? Don’t they need to be compensated for the work and risk they took?
My thought here is that the creator fee is split up between staked tokens, building reserves and possibly adding to liquidity / MMs. But again like stated earlier, this should be removed from money supply if it’s not going back into circulation.
Conclusion
This piece is too long already, so I’ll end with this:
Game devs should be very careful how much of the token allocation is given to purely financially incentivized actors
Token emissions should be in line with game growth even including when the game is being built
The key is financial stability and what is being built is an economy with an in-game currency, not equity
It seems important for those that stake the token to focus wanting to earn transaction fees either through an increase in transaction volume
Once the game is developed, control of the reserves, fee split, and incentives should be controlled by the community
The controller of the game has multiple avenues to control for financial stability:
Net issuance through game rewards & burning
Capital controls
Reserves via creator fees
If you got this far, I applaud you. This is a long winded way to say it is important to consider if your token is a currency or equity and to ignore temptations at ponzinomics.
I don’t know the answers, but wanted to share my thoughts. I would love to hear other people’s takes on the matter.