NFTs & Gaming - Part 1: Are Games Crypto's Canary in the Coal Mine?

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Part 1: NFTs & Gaming - An Origin Story

This is a brief two-part overview on what NFTs are in the context of games, and where the future of crypto-gaming may be going. If you're interesting in this space, follow me on Twitter or drop me an email oliver (at) rlc (dot) ventures.

So what's happened so far?

Since Ethereum's arrival via ICO in 2014, both cryptocurrency enthusiasts and sceptics alike have awaited blockchain's first true mass market application.

Sound Money, Smart Contracts, DeFi, and DAO's have all shown promise, but largely addressed the use cases of existing crypto communities and Web 3.0 natives - not yet winning the hearts, minds and wallets of mainstream consumers.

The last 12 months saw vast amounts of innovation occurring atop Ethereum's robust developer ecosystem, resulting in strong price action for Ethereum ($370 1 yr ago → $4,000+ today).

Ethereum Price Action throughout 2021 (CoinGeckio)

Much of this was led (I believe) by the explosion of trading activity seen within OpenSea - the worlds most popular NFT exchange.

The Partyhat - the original Non-Fungible Token?

To understand where all of this is going, we need to turn the clocks back - almost exactly 20 years in fact - to before even the Bitcoin whitepaper was published.

In Dec 2001, Runescape developers Jagex introduced paper partyhats in 6 colours to the in-game economy via a Festive limited time event.

Christmas Crackers were dropped from the sky, and if players interacted with them they received a randomly coloured paper hat. These items provided 0 in-game stats or benefits, but were freely tradable between players as festive cosmetics.

Following completion of the Christmas event, they were discontinued and unattainable, a decision that would prove tough for Jagex going forward.

RuneScape on Twitter: &quot;Someone offers you a party hat &amp; asks what colour  you want. Which do you go for? Vote here: http://t.co/tzkXh2PTb1  http://t.co/FghGBvWKKz&quot; / Twitter
The Purple, Yellow, Green, Red, Blue and White Partyhats - Runescape's rarest items.

As players quit or were banned for breaching in-game rules, the circulating supply of the partyhats diminished, and they slowly became increasingly rare.

It is not known exact number of partyhats in circulation today, but as of October 2021 the blue partyhat (the most rare of all) is worth in excess of $10,000 on secondary (illicit) markets.

Wealthy players can be spotted wearing partyhats to signal of status, displayed on their character for all passing players to see. They give other players social context within the in-game community, and are also a store of value away from the inflationary in-game economy.

Partyhat | Old School RuneScape Wiki | Fandom
Partyhats modelled on Runescape characters. (Runescape Wiki)

Expensive, pixelated and useless? Are you describing NFTs?

Not exactly. Whilst they may invoke similar dynamics to Non-Fungible Tokens, they are interchangeable/tradable (or fungible) and not interoperable between contexts outside of Runescape, despite the best efforts of gold farmers and real-world traders. (They also aren't ERC-721 tokens issued on the Ethereum blockchain).

Partyhats are similar to NFTs in their scarcity. Due to the items being discontinued, no more can ever be obtained again (on Runescape 3, OSRS is a different story). Whilst Jagex could technically issue more partyhats and inflate the supply, they won't - and the digital scarcity and shared value between players continues to support the high prices two decades later.

It is worth briefly noting that Real World Trading (RWT) is illegal, and any accounts found to be doing so will be banned, effectively deleting all their items and years of in-game progress.

Partyhats and other rare in-game assets (CS:GO skins) in this context have certainly exhibited some of the features of NFTs, and gave us a glimpse of how provably scarce, in-game assets can unlock exciting dynamics and incentives for players in live digital economies.

The Epic Story

Runescape (as well as EVE Online, World of Warcraft and Ultima Online) showed us that vibrant in-game economies can exist, and how desirable pure cosmetic items can be to player-bases. If these early MMORPG's showed the world the opportunity, Epic Games proved it.

In May 2021 Epic revealed that it sold 3.3 million NFL-branded skins throughout November and December. At 1,500 V-bucks a pop, (roughly $15), the company would have earned around $50 million from a single set of skins... pretty astonishing for an item with near perfect margins.

But with the context of crypto, where digital ownership and the migration away from 'centralised' platforms and institutions is key, are players getting a good deal? 

For the 3+ million skin owners out there, they rely on Epic and its 5,000+ employees to access their skins. In the near-term Epic disappearing doesn't seem plausible as long as revenues continue to flow, but as we saw with the high-profile Epic Games v. Apple lawsuit, Epic themselves cannot guarantee their players access to their items at all times, as 3rd party gate-keepers such as Apple and Google control access to their platforms and ecosystems. (Also see, Valve/Steam banning blockchain games on their platform).

The Technological Shifts

Thinking about decentralised and permissionless infrastructure, you cannot help but draw parallels with the world of Web 3.0. As we have covered in our History and Evolution of Video Games overview, each technological 'revolution' across the games industry rethinks how games are accessed and monetised, and the advent of blockchain (via Ethereum mainly) is coinciding nicely with the turbulent narratives playing out across Big Tech today.

Why would I spend £1,000 on Apex Legends skins when they are a one way transaction, instead of an investment? (e.g. I can never transfer, trade or move my items once purchased). In the era of live-ops and constantly revolving content treadmills, developers should be looking to involve and align new updates with their communities more than ever, instead of maximising revenues in the short/near term - web3 ethos (in some cases, not all) place these incentives at the forefront, ensuring long-term alignment and incentives for players and their in-game assets.

Technological Shifts in Gaming (RLC Ventures)

As Steam and Apple have shown, traditional Web2 platforms and stores are resisting (or at least becoming wary of) the changes Web 3.0 users are demanding - and all this is partially why OpenSea has been successful, and may continue to thrive (Coinbase dependent). With completely new business models and ‘bottom-up’ incentives, it may prove hard for traditional games infrastructure to compete with crypto-native counterparts.

What is OpenSea?

OpenSea is a marketplace where users and artists can buy and sell ERC-721 tokens, or as they are more commonly referred to Non-Fungible Tokens (NFT's).

I'm not going to explain what NFT's are as there are plenty of sources online, but I will briefly outline the most interesting features of NFT's in the context of todays focus:

In order to sell or purchase assets from within the OpenSea marketplace, users must have:

  1. A wallet (either MetaMask or a wallet supporting Wallet Connect) and
  2. Ethereum/MATIC balance to cover the cost of the asset + Gas fees.

If you've never done either of the above before, the barriers to entry may seem quite high, but this is all relative to the individual.

OpenSea initially referred to themselves as “Ebay for cryptogoods" and as of Q4 2021 is averaging around $3bn/month in Ethereum volume alone (Dune Analytics).

This is a pretty sizeable volume considering OpenSea has ~50 employees and only around ~300k monthly active users on the platform.

$10bn+ in annual volume is a lot, but compared to eBay's 2020 Gross Marketplace Value (GMV) of ~$100bn, OpenSea isn't quite a mainstream technology platform yet (and these numbers also represent a 95%+ market share).

To contextualise OpenSea's growth within the crypto ecosystem, we can look to on-chain data:

ETH Burn Leaderboard (Ultrasound.Money)

In August 5th 2021, Fee burn was introduced to the Ethereum network. This network 'update' meant that any Ethereum based transaction would result in a portion of the associated fees being 'burnt' or destroyed, reducing the current supply of ETH (although ETH has no hard capped supply).

The leaderboard above shows which contract/application has accounted for the largest amount of ETH burnt since then, and sure enough, OpenSea has seen more activity than anything else on the network in this period.

What has driven this crazy volume on OS?

In short, Digital Art in the form of PFP's (profile pictures) and collectibles.

Digital communities with their shared identities & pecuniary displays have ascended fast, existing across Twitter and Discord. Your chosen avatar may show how early you adopted crypto and NFT's, how soon you discovered a project, joined a community or how much disposable ETH you have.

The avatar or profile picture you display provides your wider social circle or audience with context on you as a person - pseudonymous or not.

All of this has led to the rise and rise of well known digital collectibles such as CryptoPunks and Bored Ape Yacht Club (BAYC) - both of which have seen hundreds of millions, if not billions, in transaction volume.

All Time Trading Volume by Collection (Opensea)

I loosely follow the logic that owning a £300,000 JPEG offers wider reach for social signalling than driving a vintage Aston Martin or wearing a limited edition Rolex, even though a CryptoPunk can't get you from A to B or tell you the time.

It is worth noting that physical collectibles are not a market to be sniffed at, worth ~$350bn globally. Within the context of collectibles alone, NFT's must be worthy of a small slice of that larger pie, and that's not to mention digital art. (Some personal favourites: The Currency by Damien Hurst & THE FIRST 5000 DAYS by Beeple)

Some NFT's as art and PFP's will retain their price as symbols of status - commemorating a crucial sliver of human-kinds cultural & digital tapestry.

OpenSea's exponential growth originated from very humble beginnings, and is a great startup story. If you want to dive deeper, I suggest you read the "OpenSea: The Reasonable Revolutionary" by The Generalist here.

So what can we conclude?

NFT's as art and collectibles are pretty interesting, and seem to have found some form of product-market fit within the web3 ecosystem. But will they be the trigger to bring crypto mainstream? Probably not (even if Visa now owns a Punk).

Thinking back to Partyhats at the beginning of this piece, digitally scarce assets (ERC-721 or not) can be valuable given their social/cultural context, and this has been reflected via the PFP mania seen on OpenSea this year. But what happens if you take this concept a step further, adding layers of utility and a complex economy built around these fundamentals?

I think that is where games will have their catalysing moment, although it may not be as close as some believe...

In Part 2 of this piece, we will look ahead to 2022 and try to identify which game ecosystems are embracing these ethos in the most exciting and innovative ways.