“That’s Our 2 Satoshis” — Axie Infinity & the Web3 Gaming Thesis

Jeff Dorman, CFA
May 1, 2023
Thats Our 2 Satoshis LogoScreen Shot 2023-05-01 at 11.11.15 AM

This weeks edition is written By Sasha Fleyshman, NFT Portfolio Manager and Topher Macpherson, NFT Research Analyst
A Look Into the Gaming Pensieve
The date is November 11, 2021. You are sitting in your house in the Philippines, alongside your childhood best friends, making over $1,000 per day playing the hottest new video game, Axie Infinity. But you’re not alone—your parents, grandparents, neighbors, and practically everyone else in the community spend their days clicking away, battling fluffy colorful Axies on their phones. And how can you blame them? The current minimum wage in the Philippines is approximately $9 USD per day. As Axie Infinity grew in 2021, this story played out in the Philippines and across the world. The idea of play-to-earn Web3 games as an alternative to arduous, low-paying jobs in developing countries became a disruptive idea. While the term “disruptor” is often overused regarding tech startups, this truly was—the world started to fundamentally change how they viewed gaming and, specifically what this could mean for the livelihoods of people in developing nations. 
If you follow digital assets, you know what happened next. Axie Infinity fizzled out in a major way. The economic flywheel broke, and the game’s native token $AXS is down 95% from all-time highs. Many in the space have written off Web3 gaming and cite that Axie Infinity rose to prominence due to an unsustainable economic model. However, while Axie Infinity has struggled, Web3 gaming still has potential. Others concur—venture capital firms invested over ~$4.49B into Web3 gaming in 2022, which is a staggering number for digital assets considering how small the current user base of Web3 games is. As we embark on this journey to the second generation of Web3 gaming, let’s discuss where we stand today, what we learned, why people are still so excited for the future, and how we move forward.
Where we stand today:
  • Axie Infinity still exists and is making progress on new game modes to expand what Axie Infinity fundamentally is as a game. The long-term vision of the game resembles Pokemon in Web3—an open world to adventure, battle foes, collect items, experience events, and socialize with friends. There is a lot left to be desired when looking at the game’s current build, and it will take a number of years before you can definitively say whether or not Axie Infinity was a one-hit-wonder. The continued weakness of $AXS tells the same story.
  • The Web3 gaming thesis is still alive. The tokenomics issues that were the downfall of Axie Infinity are not a death knell to the sector as a whole. At the tail end of Axie Infinity’s rise, dozens of copycat projects thought the two token play to earn model was the future. At this point, most projects have taken nuanced approaches to tokenomics, specifically with the intention of avoiding the mistakes of previous Web3 gaming projects. The concepts of true digital asset ownership in games, being rewarded for your sweat equity, and shared ownership of the game’s success are as relevant today as 2 years ago.
  • Very few (I’ll say zero) AAA quality games are live for public release. When Axie Infinity and its competitors came to market, the quality of the game was not the primary focus. Projects were focused on getting an MVP with interesting economics to market. Today we are seeing game developers from the largest traditional gaming studios in the world convert to Web3, and they intend to bring quality with them. The downside to investors is that it typically takes 3-5 years for a game to go from inception to public launch. For projects that try to bootstrap their game via NFTs or token sales, it is natural for their audience to lose enthusiasm over multiple years of development. We do expect to see upwards of a dozen well-funded Web3 games release an alpha or beta in 2023.
What we learned:
  • When everyone is a winner, no one is a winner. If a game has an “earn” component, the token is the team’s most precious commodity. In Axie Infinity, users were rewarded simply for playing matches, which became an issue. People were creating Axie Infinity “farms” and setting up hundreds of phones to play the game; one person would go down the line indiscriminately clicking the different phones to complete games and earn their rewards. A user who interacts with a game this way isn’t truly a stakeholder and should not receive tokens. Instead, games should align incentives to distribute their token to the users that deserve it the most—because of skill or sweat equity.
  • Build a game that is fun first. When your user base is more interested in the financial incentives than the actual joy of playing the game, your user base will eventually lose interest and move on to the next financial opportunity. The success of the next genesis of Web3 gaming will rely on truly enjoyable gameplay and experiences. Prioritizing entertainment should allow the original thesis for Web3 gaming to play out organically.
Why people are excited:
  • Successful traditional video games continue to garner attention and demand respect. In 2021, Fortnite generated $5.8B in revenue solely from in-game cosmetic items like skins. Call Of Duty Warzone 2.0 gained 25 million players within a week after its release in 2022. Last month, a record sale in Counterstrike was made: $500,000+ for two in-game weapon skins (purely cosmetic). Lockdowns in 2020 accelerated the idea that the world is progressively moving more and more online; this trend will continue in part due to increasingly immersive video games. When Apple initially released iTunes in 2001, paying $0.99 for a song was a hard pill to swallow. But now that people’s experiences online mean more to them than ever before, willingness to spend money for online goods and experiences has increased.
  • Video game development is experiencing multiple breakthroughs that could lead to games with deeper immersion than ever before. In open-world games today, game studio developer teams must create every scene, character, event, and dialogue from scratch. There is simply a limit to the scale of creativity and replayability of games because of the development cost. There are two ways this is being tackled: AI & open source. AI chatbots are the perfect fit for dialogues with NPCs in games, and they are currently being implemented into new games. Eventually, the majority of content in games—such as maps, characters, items, and storylines—will be generated at scale by AI, resulting in experiences that are magnitudes more immersive and re-playable for the end user. In the meantime, large game studios such as Epic have elected to put the power (and burden) of development back in the hands of users by going open source. At E3 2023, Epic revealed its plan for “Fortnite Creative 2.0”—a game mode that allows users of the game to harness the power of Unreal Engine to create their own maps, characters, and even full video games inside of Fortnite’s universe. Epic also plans to pay creators who make content that is widely used (sounds a bit like a Web3 concept, doesn’t it?)
How we move forward:
There has been a serious disconnect between what Web3 games need to survive/thrive and what Web3 games perceive as needs to survive/thrive. What has become very clear to us over the past few years is that the pendulum has swung rapidly to both maxima:
  •  Web3native maxima
    • On-chain game design
    • Low focus on graphics/game loops
    • Every in-game asset has a token
    • Community governance, democratized decision-making processes
    • Focus on the financialization of the game, whereby the game is more a skin on top of a financial product than a game itself
    • Small raise; token acted as a capital raising mechanism as needed
    • Fast to market (sub 6 months), fast to iterate, underwhelming product due to lack of time to release
  • Traditional bridge maxima
    • Traditional game model and product timeline (3-5 years to full release)
    • High focus on graphics/game loops
    • In-game assets are not tokenized 
    • Centralized control of game with plans to democratize “soon”
    • Kick the proverbial can down the road in terms of synchronization between digital assets and gameplay
    • Large raise (studio level raises, $30-100M post on first round), giving ample runway to build product
    • Slow to market, relative to market expectations
Within each maxima, some parts carry value; separately, neither works. The digital asset space is on an expedited timeline by default, tumbling through time with hyper-iteration and rapid innovation. Gaming as a space is almost entirely inverse—slow and methodical, with no such benefit for iteration (95% mortality rate doesn’t often allow for a re-do). To marry the two spaces together and create a symbiotic product that harnesses the benefits Web3 can offer gaming while still offering a game worth playing/building, one must understand that the two are at odds in terms of how ‘time’ works.
Myriad issues can onset the failure of games within this sector: releasing a token too early pre-launch, phoning in the Web3 aspects of the game, failing to align the game economy to a sustainable model, attrition of assets within the ecosystem, and the big skeleton in the closet—combating the predisposition of traditional gamers that having in-game assets leads to a pay-to-win structure.

However, these problems are reparable. Sure, there will be other problems that follow—after all, we are in uncharted territory. 
The important takeaway we have seen lies within the new crop of games coming to the table. There was a gold rush of sorts in 2020-2021 for gaming, whereby some found flash-in-the-pan success with knock-off slot machine games that incorporated NFTs or tokens into their design. That window of opportunity for low-effort, high reward design has abruptly ended, leaving the space with little to nothing to show for it in terms of product.

The above diagnosis is well understood by the new class of projects entering the fold, and we believe this starts with gameplay and game economies. We attended the Game Developers Conference (GDC) in March, where we witnessed the maturation of this sector of the industry. Discussions with games, guilds, infrastructure, and others were all hyper-focused on iterating beyond the first generation of Web3 gaming toward a more sustainable path. The gameplay was a night-and-day leap from what we saw years prior, and game design was meticulously laid out. The Web3 gaming universe of years prior hardly classifies as a relative to what is being built today.
The capital being deployed into the sector is not without merit; Web3 gaming will work and may even be the biggest beneficiary of the next market cycle. Many have written it off as a failed experiment, but we are unequivocally steadfast in our belief that gaming and digital assets have one of the most natural mutualistic relationships. Accordingly, we sharpen our focus on what is happening and what will unfold. Gaming will be the ark that onboards the next swath of digital asset participants, and it will act as the gateway to further adoption across the industry. The path toward that result has become increasingly clear over the past 12-18 months and will likely catch many market participants off guard. It is time to revisit the sector with a clean slate; there is much to catch up on.


And That’s Our Two Satoshis!
Thanks for reading everyone!   
Questions or comments, just let us know.
The Arca Portfolio Management Team
Jeff Dorman, CFA - Chief Investment Officer
Michael Dershewitz - Chief Operating Officer
Katie Talati - Director of Research
Sasha Fleyshman - Portfolio Manager
David Nage - Portfolio Manager
Wes Hansen - Director of Trading and Operations
Michal Benedykcinski - Senior Vice President, Research
Nick Hotz, CFA - Vice President, Research
Kyle Doane - Vice President, Trading
Robert Valdes-Rodriguez, CFA- Vice President, Research
Alex Woodard - Associate, Research
Christopher Macpherson - Research Analyst
Andrew Masotti - Associate, Trading and Operations
To learn more or talk to us about investing in digital assets and cryptocurrency
call us now at (424) 289-8068.

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