We often hear crypto games refer to themselves as nations. Often, they do this to express the sense of community and people coming together behind the narrative. There seems to be little focus on the economic side of a country. Monetary, fiscal and monetary policy, population growth, etc.
From an economic point of view, web3 and web2 games are very different. And we’re not talking about monetization models here. Web2 games are either completely closed or at best semi-open. They are centrally controlled, not particularly financialized (some things may be sold, not everything is an NFT, no global marketplace, no DEX, etc.). Balancing a closed economy, while challenging, is trivial compared to balancing an open economy, which is the web3 game economy. With NFTs and tokens, they are completely financialized and open.
To see how difficult it is to balance an open economy, consider real-world examples of currency devaluation, hyperinflation, and economic collapse. For decades, we have developed economic tools such as interest rates or fiscal policy to help us balance economic cycles. In crypto games, however, there are no economic management tools.
With that out of the way, let’s talk about some important ideas that web3 studios might want to consider.
Utility Tokens as Currency
In this research article, we will focus on the dual token economy. They have a governance token (like AXS) and a utility token (like SLP).
In this framework, governance tokens in a dual-token economy provide 1) access to the resources of the “government” (i.e. the Treasury) or 2) governance rights to the policies of the “government”. It may or may not be offered, in the latter case governance tokens are purely speculative. Overall, governance tokens do not enter the economy in any meaningful way unless by design.
Most real world economies have their own currencies. Therefore, we believe that a game with a dual-token model should treat its utility token as the currency of its economy. Studios should analyze this currency from an economic perspective. For the purposes of this article, Utility Tokens = Soft Currency = Local FX.
For example, what is the money supply growth in the economy? Printing SLP and other gaming FX tokens, like printing new fiat currency, devalues existing currencies. In a traditional economy, things are a little more complicated. The local currency is used for consumption or taxation, there is trade that creates demand for the currency, there are savings, mortgages and interest rates, etc. However, in today’s web3 gaming economy, there are very few, if any, ways to spend in-game currency. No trade, limited consumption (all discretionary and non-essential), and certainly no saving appeal. Even if there are consumption patterns, they are driven by the expected ROI and thus end up generating more tokens.
Just like in emerging market (EM) economies, if your currency crashes, so does your economy. In emerging markets, currencies depreciate against the U.S. dollar, often due to political or economic shocks, resulting in a loss of confidence in the local economy and currency. This led to a bank run, with locals rushing to sell local foreign exchange for dollars, causing the currency to depreciate further. Eventually, the central bank stepped in. Their playbook features monetary policy tools (rate hikes or cuts), capital controls, and monetary intervention. You can obviously combine these measures in some way. For example, raising interest rates while implementing some capital controls. This eventually leads to foreign exchange stabilization, usually temporary.
The crypto gaming economy is more reflective and currently uses far fewer tools. With this kind of reflexivity, once the community loses confidence, it’s game over.
Recently, we have seen some examples of capital controls and currency intervention in the crypto game. For example, DG is looking to implement capital controls, and they are already intervening in the market using revenue from primary sales, validator rewards, and even more recently, ad transaction revenue from the purchase and destruction of ICE.
The chain game Heroes of Mavia imposes penalties for exiting the ecosystem. We have also seen the development of OTC/grey markets to avoid capital controls such as lock-in staking.
Open Economy and Global Macroeconomics
One of the disadvantages of open economies is their reliance on external factors. We have learned this from globalization and the enormous interconnectedness of local economies in global economic networks. While emerging market economies may be affected by politics, commodity supply shocks, or other national policies, crypto gaming economies are primarily affected by external cryptocurrencies and therefore have a broader macro environment related to capital flows. For example, when the global macro economy deteriorates, people will switch from emerging market foreign exchange to the US dollar. In cryptocurrencies, people flee from their game economy currency to dollars or local currencies. My guess is that in challenging economic conditions, the percentage of net SLP sold immediately is significantly higher than in good times.
The reason this is important is that the crypto gaming economy will inevitably experience a recession due to global macro conditions. What they should try to do, though, is not to experience a recession when economic conditions are favorable because of the wrong policies of the “government”, aka “studio”. To do this, studios can study economic lessons from emerging market economies and draw on some existing economic models.
Coping with FX Devaluation in the Crypto Gaming Economy
We are still in the early stages of researching this topic.
However, in the absence of any external demand (exports) and necessary internal consumption, it seems fairly safe to assume that most of the game’s native currency going into circulation will be sold. Given the “money-making” nature of crypto games and their open economies, this is likely to happen under all market conditions.
Therefore, the monthly rate of expansion of the money supply (i.e. the growth of the circulating supply) should indicate selling pressure, which in our opinion is a key metric that studios should be watching. This is not the same as the ratio of burning to casting. While the burn to mint ratio can be 0.8, the unburnt 20% could represent any growth rate in the circulating supply, leading to varying degrees of selling pressure.
There are different loops and mechanisms that can help limit money supply growth. Broadly speaking, they fall into two categories, 1) limiting supply growth and 2) increasing demand for local currency. Here are some examples:
Limit supply growth
- Completely reduce the incentive level of payments.
- Design the breeding cycle to be deflationary.
- Suppose 3 lower level NFTs can be combined into one higher level NFT. Items that burn 3 lower level NFTs and have a higher level NFT earn less for the player, but make up for it in other perks/status.
- If not possible, set a certain inflation rate for the breeding process.
- Population control is directly related to the money supply in crypto games. Population control measures including breeding seasons or deflationary breeding cycles are part of this.
- Limits the lifetime earning potential of each NFT, a factor less than 1 applies to earning over time.
Increase in demand
- Mechanisms/incentives for capital internal spending. Although if you advertise Play to Earn (P2 E), players are more likely to seek to cash out. It’s not “making money” unless you can convert to local fiat currency. These must also be non-inflationary.
- Use time as the dimension of the game. While limiting the lifetime income potential of NFTs limits supply growth, allowing players to repair items to extend their lifespans may be a mechanism to increase demand.
- Design the game in such a way that soft currency cannot be withdrawn but needs to be used (crafted, progressed) in the game, and the results of that use can be converted into fiat currency through the market. This could kill the implementation of two tokens, but such a game could have other tokens for materials, items, etc. As an added bonus, this activity can be taxed, and players selling your soft currency usually can’t, unless the studio controls a trading infrastructure like Katana, but even then there is a direct SLP from Ronin to Binance Access to gold channels.
Should the gaming economy ease into recession?
In emerging market economies, recessions always lead to looser monetary policy and greater fiscal spending. However, these measures are somewhat irrelevant, as emerging market economies are largely dependent on the global cycle. For example, the appreciation of the dollar tends to trigger various economic disruptions in emerging market countries. So should crypto game economies follow the same pattern – increasing spending and incentives when the economy is stressed and less when things are good? While counterintuitive, we think that, at least in the beginning, the game economy might be better off going the other way. They have no foreign trade of any kind, nor basic domestic consumption that is not based on economic returns. As such, in-game FX has nowhere to go but into fiat currency, and “ease of monetary or fiscal policy” is unlikely to have any impact. Instead, teams might consider reducing spending and incentives during a recession, waiting for the macro cycle to turn around, and then firing up the printing presses when they know there may be enough money to absorb the new issuance.
For example, in the case of Axie, the team was able to significantly lead the Treasury in 2021 and early 2022. If they choose to follow traditional policies, they can now turn on the faucet, provide incentives and increase spending across the ecosystem. This has to come from ETH in the Treasury, not SLP, and done in a way that doesn’t devalue the SLP further. We could even explore debt financing of these initiatives, backed by Treasury accruals. However, it is possible for Axie to do so because the Treasury is able to grow in good market and economic conditions. Essentially, Axie’s national balance sheet is quite strong.
There are few options for teams that are not self-reliant in good times. In this environment, there is little hope of raising funds to strengthen foreign exchange. Instead, teams can focus on developing products, finding and rewarding true ecosystem contributors, and nurturing communities through a variety of targeted programs and incentives.
Is the dual-token model broken?
From an economic point of view, the dual-token model does not seem to make much sense. Furthermore, there is a potential conflict between governance tokens and soft currencies.
Games using a dual-token model grant the game the right to financial success and control over the policies and resources that govern the token. However, players who make the game financially successful (since taxing economic activity is the primary monetization model in crypto games) have no rights and own a highly inflationary local currency. This structure is actually a value extraction in two ways. Governance token holders extract value from participants and their economic activity. However, players gain value by farming and dumping their local currency. Nothing (3,3).
In this structure, local FX will always be sold. Clever economic design can limit the rate at which the money supply can grow, which can be absorbed by new entrants and can last for a while. But new players mean more money supply, more selling pressure, and more value extraction. The team had to come up with another sink each time, and it looked very much like a dog chasing its own tail.
Another way is to use the income generated by economic activity to balance local foreign exchange. This may be the only incentive that doesn’t inflate the local currency. An example is creating interest rates comparable to local interest rates by allocating a portion of the income to local FX pledgers. However, this would take money out of the governance token, and it’s hard to see how governance token holders will vote for it in any meaningful long-term framework.
We now see two interesting examples. For example, Axie is paying staking yields to AXS holders and will also pay staking yields to landholders. At the same time, its player base is dwindling. Therefore, they choose to reward capital and token holders at the expense of players. On the other hand, Decentral Games is using assets in the treasury to balance the ecosystem. For example, they used validator node rewards to buy and burn ICE, and now use revenue from secondary sales and ad transactions with Mastercard to do the same.
Another limitation of the two-token model could lead to the same conflict between governance token holders and soft currency users. As native FX, these soft currencies require deep liquidity, especially given the fundamental selling pressure of both token economic models. Where does this liquidity come from? A simple answer is that it either has to come from the team (pre-created or purchased with treasury funds) or from the user. However, we know that users need incentives for LPs, and incentives will always lead to inflation unless paid out of revenue, again pitting governance token holders against players.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/managing-the-crypto-game-economy-issues-with-open-economy-local-currency-and-dual-token-models/
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