Investment themes in web3 games

An updated investment thesis for web3 games, covering potential investible propositions across the web3 games value chain

Even though we’re still early in the cycle of web3 games (remember that mobile free-to-play took at least 10 years to go from inception to maturity/saturation), we’re now seeing a range of investment themes across the sector of web3 games. While many of these reflect analogous opportunities that currently exist in web2 games, it’s worth thinking through how blockchain brings something new to the space, how similar needs may be as yet unmet in the web3 games space, the potential success factors, and how these propositions may be valuable in the long run.

1. Infrastructure/tools

   Many investors prefer to invest in infrastructure and tools for web3 games because it may seem (relatively) easier to identify strong infrastructure propositions and easier to go-to-market with infrastructure than content - the classic picks and shovels strategy: in a gold rush, even if you don’t know where the gold is, you can make a fortune selling picks and shovels to people digging for gold (while you wish them luck). This is not to say that infrastructure is easier to build than content. It’s often a lot harder to build good infrastructure and tools, but the hit-and-miss nature of games content makes the risk of unsuccessful outcomes higher for content. Ultimately, the success factors and risk profiles of infrastructure versus content are different and investors tend to focus what they know better.

   1. Protocols

      Layer 1 and layer 2 protocols (or chains) are the most basic layers of infrastructure that a web3 game needs to execute and record transactions (changes in web3 game state). This underpins the verifiable ownership of portable assets, potential composability of smart contracts, token incentive network and ultimately the externalised economy on which the game operates. Key considerations would be liquidity (both active user/player liquidity as well as token liquidity) and games-orientation/specialisation. Investors would be looking at which chains have been able (or have the potential in terms of functionality, expertise, go-to-market strategy, or third-party ecosystem) to onboard the most games in order to pool together a critical mass of players and enable network effects that will help grow both the number of players and the number of games. Here, a high volume chain like Ethereum offers a large (and potentially growing) volume of potential players for games to acquire, but scalability, transaction fees and speed have been hurdles for complex games to build natively on Ethereum. Enter layer 2 chains, rollups and EVM (Ethereum Virtual Machine)-compatible chains such as Polygon, Immutable X, Arbitrum, BNB, etc. which help to address scalability and transaction cost/speed while relying on Ethereum for decentralised security and consensus and/or providing compatibility with Ethereum smart contracts. Next up are layer 1 chains that offer features targeting games or enable easier onboarding of web2 users to web3 (which would help games and other mass market propositions) such as NEAR and Sui. As all of these protocols are still working hard to attract games to their ecosystems, the game at the protocol level isn’t over yet, and we may still see new, innovative protocol-level solutions arise (such as the recent Immutable zkEVM chain).

   2. Game Software Development Kits (SDKs)

      Game SDKs like Forte, Stardust, Nefta and Moralis Metaverse simplify the development of web3 games for developers by providing tools for adding web3 elements (NFT support, asset/token economy management, web3 wallet support, in-game marketplaces, etc.) into games without developers having to build these elements themselves from scratch. While the basic premise of adding web3 elements to a game has become quite standardised and difficult to differentiate, the more promising products in this space try to offer unique value such as cross-chain support (allowing developers to easily select blockchains to build on and even support multiple chains in their game), customisable (or support for custom) smart contracts, regulatory compliance services (including Know Your Customer/KYC, Anti-Money Laundering/AML, etc.), ease of creating and managing both web2 and web3 game assets and economies with a single toolset, ease of integrating with web2 game engines such as Unity and Unreal Engine, and more granular technical features such as cross-chain communication, etc.

      The challenge in the SDK market is that, as these unique features are released, they often get adopted by competitors and the range of differentiation becomes narrower. Conversely, there’s some degree of stickiness to the SDK business, as once a game is built using a particular SDK and launched, it can be risky and costly to switch underlying SDK infrastructure, especially if the initial set of unique features offered by the SDK are deeply embedded in the game (and the operation of the game). The latter becomes something useful to look out for if we’re considering investing in an SDK, as well as the product’s Go-To-Market strategy and its ability to (or traction so far in) onboarding a large number of game developers through strong partnership/business development efforts, ease of integration, or a very compelling initial feature set.

      Even as differentiation among SDKs narrows as the space matures¹, another interesting angle to look out for is how an SDK might expand its business horizontally, utilising its acquired advantages (e.g. game/gamer data from large numbers of developers using their SDK) to offer adjacent valuable services such as game economy management and simulation, game analytics, user acquisition (more on these later), etc. outside of the typical SDK business.

   3. Ancillary game-related infrastructure components

      Beyond the core game SDK providing the necessary web3 features and integrations for a game that wants to take advantage of the blockchain, there may also be ancillary pieces of infrastructure that developers may need and possibly want to exist outside of their own game, such as identity systems, wallets, etc. In web3, it somewhat defeats the purpose for gamers to have different user accounts and game-specific wallets for each game, and while some of these things could be offered by SDKs, the potential breadth of these propositions suggests that there might be value in offering some level of specialisation (in technical expertise) and aggregation (across a large number of games built on many different SDKs).

      For example, gamer identity systems like CARV enable gamers to build their own decentralised gamer identity based on credentials and achievements accumulated across the games they’ve played, and get recommendations for in-game friends and new games they might like, while game developers can use the platform for player retention and new user acquisition. Here, specialisations in identity and reputation systems, meta-game engagement, and handling data in a privacy-preserving manner make such a proposition more suited as an ancillary infrastructure component than part of a broad game SDK.

      The example of gamer wallets as ancillary infrastructure might be more contentious because, while specialisation in end-user experience would be beneficial in building an extremely easy to use wallet with gamer-specific features that can effectively onboard millions of new users to web3, gamers will also need a wallet to participate in a game, and so it also makes sense for SDKs to offer a user-friendly gamer wallet, just as Sequence has done with its Sequence wallet. At the same time, we see the most popular wallet MetaMask offering an SDK for game developers to integrate it into their games to provide just the wallet functionality, essentially coming at this opportunity from the opposite direction, which makes me think the gaming wallet space is still wide open.

      I believe we’re still early in our understanding of what decentralised identity and wallets can bring to games, and from an investor perspective, there’s opportunity to let the specialists deep dive into these areas (as well as other forms of potential ancillary infrastructure) and experiment, and come back with new valuable offerings for both game developers and gamers.

   4. Game analytics solutions

      Over the past decade’s evolution of free-to-play (F2P) mobile games, we’ve learnt that game analytics is a crucial part of a game developer’s business, necessary to turn the huge volumes of player data relating to in-game activity into actionable insights for optimisation of all aspects of the game including game mechanics, monetisation mechanics, live operations, pricing, etc., impacting user acquisition, retention and monetisation. Generally speaking, analytics help a developer understand what to optimise and how to optimise it. In mobile F2P, this has become an established sector with a range of solutions in the market, including mobile platforms (iOS and Android) offering analytics in their respective developer consoles based on the data they have and the benchmarking they can perform across all the games on their platforms.

      Like mobile F2P games, web3 games need analytics solutions too. They could (and do) use web2 solutions, but none of these has added web3 data to their offerings yet (and until web3 games become mainstream, have little incentive to do so). But for web3 games to become successful (and mainstream), they need to learn what and how to optimise the web3 components of their game mechanics and game economy, especially given their more complex problem of operating within an externalised economy. In this context, web3 game analytics solutions could extend further to web3 game economy management and simulation solutions. Furthermore, with game data being publicly recorded on blockchains, these new solutions may yet uncover and offer new layers and techniques of analytics and optimisation.

   5. User acquisition tools

      New user acquisition is the lifeblood of games, and marketing tools that help games acquire new users at a CAC (Customer Acquisition Cost)² that’s less than the LTV (LifeTime Value)³ of a user are what ultimately enable a game to grow in users and revenue.⁴ These include mobile ad networks such as AppLovin, AdColony, and Admob which essentially help to market a game by displaying ads across their ad publisher network (websites, other games, etc.) providing targeted advertising using search intents, lookalike cohorts, etc., as well as platforms like IronSource which provide tools across the stack for analytics, user monetisation, conversion, acquisition and optimisation. As with game analytics solutions, most web3 games already use these web2 ad networks, albeit without much augmentation of web3 user data, and the question remains if new web3 advertising tools (using web3-specific advertising techniques) or supplementing existing ad networks with web3 data present new opportunities in the space.

      This isn’t an easy nut to crack though, because a marketing platform needs to have access to a large volume of users (e.g. social media platforms like Facebook, TikTok, Twitch; search platforms like Google Search; or ad networks like AdMob which amass the users of all the ad publishers (websites, mobiles apps and games) in their network) or be able to deliver marketing campaigns across platforms that have the users, and established web2 ad networks have a serious advantage in this area.

      Questions to noodle on that might give web3 user acquisition tools a chance are: Is web3 data potentially richer? Are there new channels for web3 game marketing e.g. vampire attacks, and what are the ways these new channels can be optimised? And more interestingly, given the nature of web3 and token incentive networks, might there be a model for a web3 ad platform to share advertising revenue with players (similar to web3 social platforms sharing financial value derived from advertising to users) which might enable it to surpass web2 ad networks?

2. Content/IP

   On the other hand, some investors believe that without great content (i.e. great games), web3 games will never take off and infrastructure will be useless (or at least highly underutilised). At the stage that we are currently, we’re still figuring out the right economic models and game mechanics for web3 games and the best ways for blockchain to add value to the game experience. These best practices are far from having been established yet. It’s like comparing the state of mobile F2P (economic models and game mechanics) today with its early days when developers were questioning the sanity of giving away their games for free or selling in-app purchases just to unlock levels in a game. Based on this perspective, some investors might consider it too early to invest in infrastructure because how do you provide the right picks and shovels when you don’t yet know exactly what you’re looking for or trying to build?⁵

   At a high level, solid propositions for web3 game content need to have great gameplay that’s either competitive with the best web2 titles in the genre or that brings novel/innovative ideas or game mechanics to an existing genre⁶, and a great team with the right expertise and experience to build and operate a game, no different from what you’d look for in web2 games (or movies and other forms of entertainment content in general, which are fairly characterised as a high risk, hit-driven businesses). On top of these two basic requirements, we want to see how the game plans to use one or more of the fundamental primitives of blockchain (verifiable ownership of digital assets; portable data and portable identity; composability; and a token network/economy to align incentives) in ways that improve the game experience⁷. I’ve explored this in a previous article on web3 game design patterns that use blockchain to enhance the core gameplay experience, summarised as⁸:

   1. Add-value-to-earn (instead of Play-to-Earn)

   2. Earning built into the game narrative

   3. Ownership of assets and Play-to-Own

   4. Reward skilled play and Play-to-Win

   5. Reward players’ time by sharing ad revenue

   6. Staking as game subscriptions

   7. Reward the creation of User-Generated Content (UGC)

   8. Game as ecosystem/platform (or an ecosystem of games)

   9. Align incentives of players and investors

   In addition to the above, web3 games face the added challenge of managing an externalised game economy⁹, so we would also need to be convinced that the game economy is (or at least has a chance of being) sustainable in the long term, looking at key factors (also elaborated in a previous article on sustainable web3 game economies) such as:

   1. Does the game have sufficient levers that can be used to finely balance the economy and does the developer know how to use them?

   2. Does the game have sufficient (and well-balanced) faucets and sinks to balance production and consumption activity in the game?

   3. Are there enough players spending in the game and is there a balance between spenders and earners?

   This also points to the need for economy design (particularly, game economy design) expertise and experience on the team. If you need to assess in detail the sustainability of a web3 game economy, you can use this due diligence checklist for game token economy design that I published earlier.

3. Discovery and distribution platforms/destinations

   Perhaps the holy grail of content-related industries (games, video, music), or at least where the most money has been made, is in discovery and distribution. In web2 games, a small number of winners have dominated each platform - Steam and Epic Games Store for PC, Google Play and Apple App Store for mobile, the respective gaming consoles’ online stores, etc., all of which are multi-billion dollar businesses owing to the 12-30% revenue share they take from all games distributed on their platform, which becomes a hefty figure once they’re able to aggregate a large number of games¹⁰. Broadly speaking, game distribution businesses can take the form of game marketplaces like the platform store examples above, game publishing businesses like Electronic Arts and Fenix Games, and hybrid game publishing platforms like PlayEmber.

   On the one hand, with web3 games in an uncertain and precarious position on web2 game stores, there’s a clear need for a distribution platform for web3 games today that can help users find the best web3 games more easily (and in one place), and there’s an opportunity for a web3 game-specific distribution platform to establish a dominant position before web2 game stores open up to the space (if ever). Historically, a key success factor of a distribution platform is its ability to aggregate users (often through some other adjacent advantage they might have) and present them new games. For example, both iOS and Android have the advantage of a large mobile phone/OS user base that naturally use their app store, gaming console stores have their own proprietary user bases that they alone can gate access to, and Steam grew from the user base of its most popular in-house developed game, Half-Life. Taking this approach, NFT marketplaces and web3 wallets, both with the potential to amass large numbers of users and offer them to game developers, could move into this space.

   But coming from another direction, it’s also worth thinking about what a new web3 distribution platform can bring to the space, or what it can use to its advantage that may be unavailable to web2 competitors. How can web3 change the distribution business and what new models of distribution could emerge? For example, is there a way to design a web3-native distribution protocol with token incentives that might be more effective than, overcome the network effects of, and/or break the silos of existing web2 distribution businesses? And could such a platform also distribute web2 games profitably for both platform and developer?

With the range of propositions above, an additional consideration is to look for potential combinations (e.g. an SDK that additionally offers analytics and user acquisition solutions) and extensions/progressions of an initial business (e.g. how Epic Games initially built Unreal Engine/Unreal Tournament, which eventually gave rise to Fortnite and the Epic Games Store).

This has been a fairly extensive overview where we can invest across the web3 games value chain, but even so, I think there’s a lot more depth we could go into for each of these propositions. I’m sure each of these areas will evolve over the next few years, and it’ll be exciting to see how it all pans out.

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1. And, to be frank, we’re not there yet.

2. Determined by the cost and effectiveness of the acquisition channel.

3. Determined by the game’s monetisation mechanics and user retention.

4. Although web3 games are also exploring how web3 monetisation mechanics could increase LTV through higher retention and/or monetisation.

5. This is an oversimplification and we do know by now what are some of the broad characteristics of web3 games that we’re trying to build. But the argument still holds that, where high value infrastructure/tools are meant to help you optimise the development process, if we don’t yet know exactly which models and mechanics work for web3 games, the infrastructure may not yet be as helpful to optimise the most valuable (and as yet underdeveloped) aspects of this process, especially at a granular level.

6. Ultimately, it needs to be a fun game that people will want to play, and has a chance of attracting them away from games that they’re currently playing.

7. If not, why bother making a web3 game in the first place?

8. In the interest of space, I’ve just headlined them here. Please check out my previous article for details and examples of web3 game design patterns that I think make sense.

9. As if managing an in-game economy without external influence and participants wasn’t difficult enough.

10. In 2022, there were almost 500,000 games available on Google Play.