Take a deep dive into the medium-term direction of tokenomics based on past case studies and current mainstream models of DeFi and gaming.
Current and Previous Models
How the Dual Token Model Works in DeFi and GameFi
The table above lists the projects that use the dual token model. The key for all projects is the Utility Token. Maker and Terra respectively pegs $DAI and $UST to $1. Axie's $SLP is not a stablecoin, but an inflationary in-game currency. $MKR and $LUNA differ from Axie's token economics where they may be additionally issued and diluted for their respective stablecoins.
As per Terra’s tokenomics before their debacle, if the price of $UST deviates downward, the protocol issues $LUNA to buy up $UST from arbitrageurs. Since the necessary amount of new $LUNA is minted to buy up $UST, the $UST price is theoretically stable even if the $LUNA price crashes, as long as someone continues to buy $LUNA in the market, no matter what the price of $LUNA is. $DAI is more robust because $ETH is used as collateral, but $MKR will be newly minted if the platform becomes insolvent. Both of these structures transfer the price instability of the Utility Token to the quantity instability of the Backup Token.
Axie's token model is somewhat different: in order not to inflate $AXS, the Axie team has transferred the inflationary element to $SLP. $SLP is therefore designed to inflate. It becomes challenging to offer stable yield to the players. Players are rewarded with $SLP where there might be a desire to have a stable income in USD. However, since $SLP is inflationary, when the price of $SLP falls, the amount of $SLP given to players needs to increase if the platform is to stabilize the yield for them. This accelerates inflation, but as with the $UST and $LUNA structure, stable payments to players are theoretically possible as long as someone continues to buy $SLP in the market. What makes Axie different from Terra and Maker is that the Governance Token is not sold to stabilize the Utility Token price.
This endlessly inflationary token model is analogous to Zeno's paradox. This kind of dual-token model appears to be an elegant solution, but once a certain threshold is exceeded, uncontrollable hyperinflation occurs, destroying the entire system. Also, it is a contradiction in design to split the value and demand into two tokens without rationale and make them work as the dual token model.
After all, token economics is not a panacea. The game with poorly designed tokens will be no different from an unsustainable model, which begins to collapse once the inflow of funds stops.
It is at most important for game studios pivoting to web3 to be careful with their token design and its economics. If they incorporate tokens, they should at least be cautious that these tokens do not trigger a downward spiral. Also, for GameFi's token economics designers, DeFi's token model is suggestive, but they should note that GameFi and DeFi have very different forms of composability and value cycles.
Studying the DeFi case is one way to prevent such unintended consequences from emerging.
Example: The net positive gold sink, also known as delayed inflation, is a severe flaw in DeFi's token model, which if introduced into a game could wreak havoc.
The following table summarizes the token distribution methods for leading DeFi products at the time of writing. Most models employ either simple or delayed inflation models. However, Curve is unique in that the governance token staker receives USD stablecoin, and the locking system realizes net negative CRV circulation temporarily.
Unsustainable Models we are aware of
The left figure above shows a typical DCF and PV in finance. It calculates the present value of a project based on later earnings. The figure on the right shows unsustainable token economics. It adjusts later distributions based on funds currently on hand. Some unsustainable economics designs have the reversed value generation cycle because of the need to create something out of nothing.
Token design becomes much more difficult when players develop avatars or characters over a long period of time and their revenue depends on it. The reasons for this are:
- It is difficult to change the rules without user backlash.
- Wealth transfer from later players to earlier players is likely to occur.
- Positive feedback is so strong that it is less tolerant of ecosystem contraction, even if temporary.
Latest Trends in NFT Economics
Yuga Labs, the developer of BAYC, has made various discoveries and inventions. Those are specifically fundraising through the sale of NFTs, continuous profits through the secondary market via royalty fees, and social media marketing through narratives. For example, Yuga airdropped MAYC to BAYC holders, forming a narrative that adds value to MAYC. If airdropped items have value, then the value of BAYC increases even more, and Yuga successfully airdropped BAKC, APE tokens, and Otherside Land in the same way. The success of Yuga has led to a growing number of projects taking a similar approach, including RTFKT and Moonbirds. They have explicitly declared their commitment to providing returns to holders from the very beginning.
The table above lists methods of fundraising, recurring sales, and user rewards in each area.
An interesting point in the table above is the importance of royalty fees as an ongoing source of income for NFT projects. This phenomenon indicates that the market views NFT as an investment product rather than art and that project teams can make secondary trading a revenue stream. It is also pointed out in the following paper.
Note that the rise of platforms like Sudoswap that do not support royalty fees may make continued revenue generation from the secondary market impossible. Imagine an OTC NFT trade between friends, and you will find that there is no technical way to enforce a royalty fee.
Yuga has also solved the problem of economic scalability. Even if one succeeds in developing high-end NFTs, the market size will inevitably be small if the total number of NFTs is only 10,000. Therefore, Yuga created 19,134 MAYCs, 9,602 BAKCs, 1 billion APEs, and 98,115 Otherdead. The dilution of value due to the increased total number of issues was offset by preferential treatments to existing holders and marketing to the community inside and outside crypto.
Towards Better Tokenomics
Application Specific Chains/L2s are Inevitable
Ecosystems on public blockchains are shaped by interactions between products, while games often form standalone, isolated spaces. This is because games belong to the application layer and have limited composability both vertically and horizontally. Imagine blockchain benefiting from products built on top of it, and DeFi infrastructure benefiting from products built on top of it. Poor composability leads to restrictions on value inflow channels from outside in the blockchain.
We must understand that when in-game NFTs and FTs emit new tokens, products located in the highest layer increase the circulating supply in a Proof of Stake-like manner. This is why, when we design a token tightly tied with game economy, we have to prepare the utilities as a closed economic zone and also we cannot add economic value to a governance token which doesn’t provide financial returns.
When a well-capitalized game studio wants to develop a web3 game without worrying about token design, there is also the option of not issuing new tokens at first and using only stablecoins like BUSD and USDC.
The good news is that the application layer is closest to most end-users, and in the future end-users will be the largest value inflow channel. In the image of the tree above, the tips of the branches appear to be the ends, but beyond that there are a large number of end users.
Therefore, the application layer must establish a profit model different from that of other layers, and inevitably the token economics will also show a different aspect. The important thing is that standalone products including DeFi products that don't have composability or don't need it will inevitably migrate to their own blockchain/L2 after they grow.
This is why application-specific chains such as BAS(BNB Application Sidechain) and zkBNB are on the rise. Needless to say, the token economics of application-specific blockchains will become even more important. Independent blockchains native coins in one system are consumed for transaction fees and shared security fees, in addition to utility within the application.
How to control issuance rate?
If the inflow of value is limited to Battle Pass subscriptions and NFT sales, we must pay attention to the initial token market cap and expected growth rate of the economy when designing the game economy. This is because these numbers cannot be better than expected over the long term due to the lack of composability, although they can be worse than expected.
There are multiple variables that affect the utility token emission schedule. A simplified example format is as follows.
Token in Circulation(Token per event(Event per day, Event per NFT(NFT Supply)))
Why do we need to control multiple variables when we have a single clear target mint/burn ratio? That's because the utility a player gets from a game is not just the number of tokens, but also the experience of playing the game in each phase. Even if the net number of tokens earned in a specific phase is low, players will be happy if the total experience is worth the cost.
In the Metaverse space, which has a complex structure close to the natural world, the emission and distribution of tokens must be dynamically and automatically adjusted according to the behavioral data and satisfaction level estimation of each user in the game.
User Cognition Matters
Some games introduced interesting mechanisms.
By introducing seasons, it implies to players that the game balance will be adjusted each season. Players understand it and enter the game, making it less likely that they will feel resentment toward character and item adjustments. As a result, there is no need to favor existing users, and the rules can be set more fairly.
Players can participate in Play to Earn by using an NFT character. Players can only use these NFTs a certain number of times, and once the limit is reached, the NFTs are no longer usable to earn tokens. Even when the utility token supply is not finite, we can control the issuance rate by capping the NFT supply or token issuance rate.
With the introduction of Season and Durability, players will buy specific NFTs for specific seasons. The development team can extend the longevity of the ecosystem by separating the time frame of the game.
One of the most critical aspects of designing sustainable economies is how to make games with negative expected value popular. Casinos and horse racing are good examples. In other words, they are not just games of probabilities but have a mechanism where players willingly consume coins in exchange for enjoyment and stimulation.
In a casino, players must lose probabilistically, but they go to the casino intending to win. The casino's revenue stream can be described as cognitive distortion and consumption of experience.
Many PvP modes are games with a negative expected value. To contain inflation, the team needs to make this mode enjoyable, use data analysis to reach potential users, and expand awareness through eSport and live gameplay. Furthermore, to increase and maintain the number of users, community funds could be used to distribute invitations to potential users and provide favorable team structures to users who have been continuously losing.
The important thing is to improve the user experience, not just the mint/burn ratio. Teams that know the importance of token economics tend to be so preoccupied with controlling inflation and sustainability that they overlook the innovation and potential of crypto games.
Two things are now evident to all.
- Games will become increasingly important in many industries.
- Many games will try to enter web3.
Nevertheless, the best economics for web3 games have not yet been found, nor has it been proven that Web3 is superior to tradition in some aspects.
The key is to understand that there is a wide gap between what Web3 and traditional games consider healthy. For example, traditional games view Protection by Regulation as sound, while web3 views Freedom with Transparency as sound. In this gap lies the social value and winning opportunity of web3 games.
It is essential to express what only web3 games can do in a user interface that anyone can understand. For this purpose, just incorporating tokens into existing games or ignoring traditional games and creating entirely new mechanisms will probably not work.
We need to imitate the great existing mechanisms humbly and be more familiar than anyone else with the intrinsic differences between the traditional games and the web3 games.
In this way, we find the true value of the web3 games.
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