If games drive crypto mass adoption, they will be grassroots

There’s a meme that games will drive mass adoption of crypto. Fred Wilson and Chris Dixon have said it1. People coming out of ETH SF this year seem to believe it. Smart contract protocol ecosystem funds have been paying for games2 and investors have been funding them.

The data tells two separate stories3. First, games do account for the majority of non-exchange transactions. And second, total usage is still disappointingly low. Unfortunately, projecting adoption from current trends does not get us to mass adoption.

Believers of the “games driving mass adoption” narrative anticipate something big and new to happen. Something like a AAA game company swapping all their assets out for ERC20s and ERC721s (e.g. Fortnite using crypto). Or an original crypto game going viral (e.g. “the next Fortnite” using crypto).

Fornite V-Bucks as ERC20 & Fortnite skins as ERC721s would instantly add 80m crypto users (3x Coinbase)

The tech is here, no scaling required

Fornite may never do this, but the next Fornite might

There are many positive black swans for crypto if you know where to look

— Ryan Sean Adams (@RyanSAdams) October 8, 2018

There are compelling reasons why gamers would prefer cryptogoods and cryptocurrencies. I argued this in “Sound digital goods”4. All things equal, a gamer should prefer ERC721s or ERC20s to rows in a company’s database. But, as I noted, all things are not equal:

While users should prefer sound digital goods like they prefer sound money, incumbents are unlikely to support adoption

In this post, I explore why incumbents like Fortnite are unlikely to support crypto and what “the next Fortnite” could look like.

Epic incentives

The dominant and fastest growing business model for games is in-app purchases. There’s usually a currency or two (e.g. V-bucks) and some in-game items that are earnable or purchasable.

Take Fortnite as an example:

• Users can earn and buy items (cosmetics and emotes)

• To buy items, users first buy the Fortnite in-game currency, V-bucks

• Items non-transferable and tied to accounts

Epic makes money when users buy V-bucks, so their incentive is to drive purchases of V-bucks. The demand for V-bucks is driven by the demand for the items V-bucks can purchase.

There is no sanctioned secondary market where users can sell their stuff to other users, but rare Fortnite stuff has real-world value. You can even find Fortnite accounts for sale on the women’s clothing marketplace Poshmark.

However, Epic does not allow these secondary market trades and will ban accounts if they believe a secondary market trade took place.

These restrictions are among the common complaints Fortnite players have. Others:

• I can’t get my items from one account to another

• I wish I could sell my stuff

• I’m frustrated they are selling more of a previously rare item

• I wish I could buy something that’s not currently for sale

Liquidity, ownership, and scarcity–perfect problems for crypto to solve.

But these restrictions are not accidental5. They are the foundation of the Fortnite business model. By controlling supply, Epic can maximize sales of each individual item. By preventing liquidity and secondary markets, Epic ensures (virtually) all transactions are with them.

Solving these user pains with crypto are against Epic’s interest.

Let’s go through some examples. Imagine that a game is selling a skin to its users. They decide to sell some number of them for some price.

To start, they sell S0 of them for P0 dollars. Total revenue is the product of S0 and P0.

A game sells a skin at a price, P, and supply, S

They sell out quickly, and realize that demand was greater than they expected! D represents how much a user is willing to pay for the skin at a given quantity.

It’s important to note this curve is hard to perceive prior to gathering market data, which is why pricing is such a hard job6.

But selling out quickly and observing unmet demand suggests that, wherever the curve is, it’s above where the game makers thought. They left money on the table.

To maximize revenue, they should raise prices or raise supply (or both):

• If they raised prices (brown arrow) selling the same quantity, they’d have revenue of S0 * P1. Unfortunately, it’s hard to go back to customers that already bought it for P0 and ask them to pay more.

• If they raised supply (purple arrow) while keeping the same price, they’d have revenue of S1 * P0. This is easier to do after the fact, but they risk upsetting customers that assumed a fixed supply of S0.

Okay, enough Econ 101. Can you guess which strategy Epic takes? They increase supply.

The key here: for Fortnite skins, supply is fake scarce. They can and do inflate the supply to maximize revenue.

For something that is real scarce, you cannot raise supply. You’re stuck at S0. Think tickets to a show (fixed number of seats) or priceless paintings or Bitcoins.

For the firm, adjusting the price is harder than adjusting the supply, especially for digital goods. Switching game assets to scarce cryptogoods prevents the firm from adjusting.

So no, ERC721 Fortnite skins are not coming to a PC Bang7 near you.

Secondary markets

What if Epic took a cut of all secondary market transactions? Could that make it worth switching to crypto?

Here’s how it would work:

• You sell something for price P0

• The market is actually willing to pay P1

• A volume of transactions, V, occur on the secondary market

• If you control the secondary market, you take a fee, f, on each one

• So in addition to the retail revenue, S0 * P0, you also get secondary market revenue, V * P1 * f

• So your total revenues are retail revenue + secondary market revenue

If these total revenues (retail + secondary) are greater than what you would have made if you had optimized your initial pricing to P1 (optimal retail revenue), then a secondary market is worth it.

By and large, a secondary market is good for things that have real scarcity and not as good for things that have fake scarcity. A secondary market has been shown to substantially decrease profits from direct sales8. But a secondary market may also lead to transactions that would have otherwise not occurred.

This is why we’ve seen Ticketmaster (real scarcity) try to control the secondary market for their tickets. In apparel, startups like GOAT and StockX have seen massive success, so I’d expect fashion retailers to seek ways to capture value from their secondary markets as well.

Most retailers don’t capture value from the secondary market9. In cryptogoods, it’s even harder to imagine the creators controlling the secondary–though I have seen many projects attempting to program cryptogoods so that each transaction kicks back a fee to the creator. It will be interesting to see whether users adopt this10.

So while secondary markets are very interesting, they work best for real scarcity, and Epic isn’t motivated to add real scarcity to their game.

Path to mass adoption

In sum, there’s no reason for Epic or any other incumbent game company to replace their game items with cryptogoods or their game currency with cryptocurrencies. If the “next Fortnite” has similar business incentives, they will not want to use cryptogoods or cryptocurrencies either. So if games bring crypto to the masses, they will have different business models.

For example:

• A collectibles game like CryptoKitties

• An economic/ game theory game like FOMO3D/ Pixelmaster

• A gambling game like EOSBet

These games either have real scarcity or economic games at the core. They’re designed with the benefits and cost of crypto in mind.

Some people play these games even though they are inconvenient to play11. For these players, the benefits of using crypto outweigh the substantial inefficiencies. I wrote about that relationship here.

More people will play games like this when they’re more fun12, but finding more fun might not be enough to reach the masses. Cryptogames still face substantial headwinds in basic UX (e.g. key management) and distribution (e.g. a cryptogoods game can’t distribute in the App Store). But these are solvable problems.

There’s spectacular velocity of experimentation in the crypto gaming space. Many talented artists, designers, and producers are leaving AAA game companies to build in the space. Mass adoption could happen from this grassroots community if they can find the fun, reduce the pain, and overcome distribution challenges.

The environment for cryptogames is the same as other crypto use cases. Incumbents aren’t likely to embrace it. It’s inconvenient to use. Most ideas are bad. But if you can find something fun and useful that can’t be done without crypto, you might have something awesome.

1. I think they discuss it in this podcast ↩

2. But as I wrote in “A red ocean for smart contract protocols”, I’m dubious of the efficacy of these efforts. ↩

3. https://dappradar.com/ ↩

4. “The “owner” of a pre-crypto digital good faces massive liquidity and trust risks. Pre-crypto digital goods are issued by central authorities that manage custody of the digital goods, can inflate the supply at will, and often limit the trade-ability of the items” ↩

5. This seems awful! How do game companies get away with this? Because they can. Gamers play games because they’re fun. The economies are usually secondary to the core game. By and large, a gamer will pick a fun game with a wack economy over a wack game with a great economy. ↩

6. For instance, I priced my membership at $100 a year because it was a round number and Ben Thompson uses it. I actually don’t know how increasing or decreasing the price would impact total revenue. ↩

7. https://en.wikipedia.org/wiki/PC_bang ↩

8. A Caltech paper called When Do Secondary Markets Harm Firms? found that, “we find the net effect of opening the secondary market is to decrease new car manufacturers’ profits by 35 percent.” ↩

9. This is a fascinating category that someone else should write a whole post about. Tesla controls some of their secondary, but most car manufacturers do not. Ticketmaster controls some of their secondary, but most ticketing companies do not. Supreme/ Yeezy control none of their secondary, but some big retailers are buying secondary apparel platforms. Amazon sells directly and hosts a platform for secondary sales. Retailers have been trying to get more exposure to their secondary markets, but success is limited in part because a secondary market is in a sense permissionless. So no matter what, they’re unlikely to own 100% of the secondary market for their goods. ↩

10. There’s actually no empirical evidence that permissionless secondary markets for cryptogoods will eat proprietary secondary markets. Almost all secondary markets for cryptogoods today are provided by the issuer (e.g. Decentraland, CryptoKitties). ↩

11. You have to figure out how to use a crypto browser, deposit some crypto (which is way harder than you’d expect), and then once you’re all set up, deal with concepts like gas and confirmations. ↩

12. This generation of games won’t last without substantial changes to the rules13. Most can be described as greater fools games. But something like it (just more fun) could work. ↩

13. CryptoKitties are conducting lots of experiments in trying to find the fun around their collectibles like the KittyVerse ↩