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Source: Troyguild.io

The Evolution of NFT Models

Ever since gamified NFTs came to the market, there's been this ongoing quest to figure out which model works best in this new gaming paradigm of digital ownership that allows buying, selling, and trading of game assets freely. Sky Mavis' Axie Infinity pioneered the Play-To-Earn (P2E) paradigm and made P2E a thing. With Axie Infinity’s meteoric rise and fall, aspirational blockchain gaming studios are now eager to learn from the game and seek modified/alternative variations of the play-to-earn NFT model to win.

Some initial variations (in name) were to move away from the "earn" focus as that's what ultimately drove up Axie Infinity but eventually also led to its downfall, since it was not sustainable. No economy, be it real or virtual, is able to defy the reality that 1+1 could ever be greater than 2. If everyone can get out more (monetarily) than they put in, then that economy cannot sustain. Thus, new terms like Play-To-Own and Play-And-Own started to take hold. But these models still implied buying an NFT in order to play or "renting" an NFT to play and eventually "earning" enough to buy your own.

A more recent model that has been growing in popularity is Free-To-Own. With the recent success of Gabriel Leydon’s (ex-Machine Zone co-founder) Limit Break with DigiDaigaku, many people are looking to see if this turns out to be a viable model to pursue.

This model takes an approach counter to the current NFT pre-sale culture in the same way Machine Zone side-stepped the race to $0.99 mobile games with F2P innovations many years ago. Free-to-own evolves the idea of free-to-play with free NFTs, fully embracing the concept of democratizing digital ownership at scale. Limit Break kicked this off with the stealth mint release of its DigiDaigaku NFTs, which have since skyrocketed in price on secondary markets. We covered more of this in our September 5th, 2022: Market Update.

Free-To-Own: What Is It?

In some ways, free-to-own is similar to the evolution of free-to-play from premium games. Previously in gaming, the dominant model was to sell your game for a fixed price to as many players as possible. True, there were Shareware and Freeware models out there, but they weren't too popular to rely on when building a gaming business. And without any follow-on income, as a developer, you were highly incentivized to get as much as you could with the initial sale (although later on DLC came offering future income streams for studios).

Then enters Free-To-Play, giving everyone the ability to play but with micro-transactions. Now you could play the game for free, which lowered the barrier of entry to the masses while generating revenue through micro-payments for players who wanted to gain a competitive edge (more time, better boosts) and/or premium content (badging, skins, emotes).

Free-to-own for NFTs is similar. The NFTs are given freely (you just pay gas), and revenue is primarily made from secondary royalty sales (plus perhaps extra in-game items). At least this is in theory.

So, is this really a new sustainable model, or is it just a clever marketing model to capture mind share, and the real money is still in the tried-and-true gaming IAP models?

Major Benefits 

• Access: Lowering the bar by making the initial mint free opens it up to people who otherwise might not have had the capital or might not have been able to take the capital risk.
• Marketing: Offering a potentially valuable asset for free definitely draws multiple eyeballs. This can create the viral hype that nascent projects/games need to make a splash and grab market share. With greater audience appeal, it’s easier to recruit ambassadors as cheerleaders for success.
• Lower Expectations: Since the mint is free and there’s zero cost to players (except for gas), then they will tend to expect less as, after all, it's a free game asset. If the game is delayed or doesn't live up to its hype, the playerbase may be more "forgiving" vs a paying player who would be demanding much more for their “investment.”
• Recurring/More Sustainable Revenues: In a prolonged bear market, a model with a low upfront entry would be more receptive. This would appeal to a wider audience such that the revenue on the backend would offset any loss in the upfront sale. Additionally, from a game design perspective, having players regularly “upgrade/trade up” their NFTs would be a healthy and desired long-term behavior.
• Less Onboarding Friction: In one such implementation, players could in theory establish an account where NFTs are freely airdropped, completely removing any wallet onboarding or fee requirements and streamlining adoption for new players.

Major Risks

• Delayed Revenue: Given the initial mint is free, there is no immediate revenue coming in but instead relying on the long tail of secondary sales. Consequently, studios must be more capitalized upfront in order to wait for the revenue to come in.
• Enforcement of Royalty: Probably the biggest issue is being able to control/enforce the royalty model. Especially if the value of the digital assets increases significantly, the financial incentives become much greater to circumvent the system. Additionally, open exchanges have now been dropping royalty fees and making them optional to traders. The most recent is Magic Eden — the largest NFT exchange on the Solana blockchain and even on OpenSea (the largest NFT marketplace) — announcing it’s visiting this royalty enforcement too. If this trend continues, it’ll require studios/projects that rely on the free-to-own royalty model to create their own marketplaces or white-label one to have complete control in order to ensure that royalty fees continue as expected.
• Fair Distribution: A major ethos in blockchain/crypto is equality and fairness. With a free distribution, the challenge is how to make it equitable and not have a bunch of bots take ownership and then dump on the community, extracting the most value early on. There’s various ways to address this, i.e., creating a random unannounced drop, a whitelist based on community involvement, and/or a raffle/lottery system. Another tactic is requiring KYC or verification to reduce fraud. Yet all of this is not without pushback. Otherside’s Otherdeeds did this, but it backtracked a bit, with existing BAYC owners wanting to buy. No solution is perfect, and this one is far from ideal, but it does raise a significant concern, because if the community doesn’t feel the system is fair, it won’t continue to support the game/project.
• Royalty-only Model Adoption: Since the royalty-only model is still uncommon, the playerbase can be hyper skeptical with a "what's the catch?" and "there's no free lunch" mentality. Here education on the vision, purpose, and team/project’s reputation comes into play to easily overcome these concerns.
• Mobile Platform Risk: Apple and Google are continuing to adopt their rules for NFT usage in their ecosystems. For now, if the NFT transactions can occur via IAP and the 30% platform fee can be collected, that seems to be a viable path forward. 30% platform fees in crypto may seem insane; however, the free-to-play model has succeeded quite well on mobile, and it can be an acceptable trade-off in order to get mass adoption and reach more players. Additionally, from the recent court ruling on Epic vs Apple, alternative web-based payments/stores are allowed, which are not subject to the platform fees, so there are creative options.

Financial Modeling

Let's look at the financial side and how the math works in this model. As the initial mint is free, this relies very much on secondary sales to generate a long-tail royalty stream, which implies a robust trading marketplace, since royalties are only made on trading.

Let's say, in the traditional NFT model, we have an initial mint plus a royalty model. To keep it simple, let's assume a $100 mint with a 5% royalty, which is typical for many projects (excluding any marketplace/platform fees).

In a Free-To-Own model, there is no initial mint, but since it's a free mint and the royalty side will make up for it, the royalty fee can be set higher to 10%, which is what Limit Break's DigiDaigaku currently has (Note: this creator/royalty fee can be freely adjusted).

So what's the break-even between these two? How many trades are needed to make up for the loss in revenue from the initial mint?

To keep things simple, let's say the value of the digital asset is roughly $100 and stays constant, although we know in reality this value can greatly fluctuate both up and down, but for the sake of this discussion we'll leave it out for now.

So in order to get to the same amount of revenue in the normal free-to-play model, the secondary trades need to be 15 at 10% royalty and $100 value to be equivalent. Or in other words, 50% more secondary sales will be needed to just break-even. Even if the value of the asset increases and decreases (assuming similar behavior in both models), the 50% additional secondary sales/trades hurdle still remains. I do want to note that this is an overly-simplified example and mainly meant to give a sense of the major levers required for a play-to-own model to succeed.

The Reality

But how realistic is a 50% increase of additional trades, and can a game studio really bank on it? What is happening is that the free mint aspect is the hook/catalyst to bring market attention, so much so that there is an increased interest/demand, which will drive the additional secondary trading required with a possible appreciation of the NFT asset value.

A similar tactic is often deployed in real estate, where a seller may intentionally price below market, hoping to create a bidding war resulting in a higher sale price that otherwise wouldn't have happened.

An additional consideration for a free-to-own model is it may lead to more NFTs required than usual, since NFTs are free. However, this forces creators and devs to focus on making their NFTs desirable, which could include collecting, burning, tier base, and special seasonal drops. Animoca Brands’ Phantom Galaxies did a free NFT drop for its early adopters, and looking at the data, a majority of these players eventually traded up to higher-value paid NFTs in the game.

How to Make a Free-To-Own Model Work

• Viral Demand to Increase Pricing Appreciation and Trading: The appeal of the free mint must draw enough interest and demand, which would support secondary sales to drive the royalty fees. If the NFT asset value remains the same as in the play-to-earn model, then secondary trading volume will need to increase by over 50%; this also assumes a higher royalty fee. The exact increase in trading volume can be greatly impacted by the royalty rate and price appreciation. Whatever the exact amount needed to break-even, a significant increase is still required.
• Royalty Fees Must Be Enforced: Since the initial mint is free, revenue must come from somewhere, and in the free-to-own NFT model, it comes from the royalty residuals. But for this to work, the marketplace must honor and enforce the royalty fees.
  • OpenSea, the largest NFT marketplace, just recently announced a new collection contract that will offer on-chain enforcement to blacklist other marketplaces that do not honor the royalty fees. Unfortunately for existing collections, they must wait until December 8th for a final decision if OpenSea will continue to require the royalty fee. This serves as a good lesson on the real risk in blockchain/crypto of relying on third-party marketplaces/platforms where things can quickly pivot/change, wreaking havoc to even the best well-planned business models.

From data on x2y2, a rival Ethereum marketplace to OpenSea by Proof Director of Research Punk9059, when royalty fees are optional, it becomes too tempting to not pay them. It should be noted that in a deep crypto winter, the motivation to pinch pennies is likely a contributing factor. Nonetheless, once traders have established a behavior of paying no fees, it will be hard to reverse it.

Does It Really Address What’s Needed?

The bigger question for the free-to-own NFT model is if it adequately addresses the key ingredients of what’s needed for a sustainable economy and game. To that end, sadly, it does not. Free-To-Own is just another tool in the design tool box, so at minimum, it’s a nascent trending revenue model, and at best — a clever marketing gimmick to drive more demand and interest in a project/game. However, it doesn’t in itself lead to a successful game or game economy. For that, much more is needed.

That being said, the potential for free-to-own to usher a new era of how gaming NFTs are released to the general gamer population should not be undersold. The current mindset is “you need to be “rich” to play.” Free-to-own can fix this by lowering the entry barriers for the masses with easy onboarding and zero (or near zero) fees to start playing while having digital ownership. It can be the gateway to introducing digital ownership to broad audiences, where once they experience it, they will want to engage more and trade up to higher-value NFTs.

At the recent GAM3R FORUM conference hosted as part of SF Blockchain week, there was a lively panel discussion titled “Don’t Launch An NFT, Yet!” hosted by Naavik’s own Lawrence Hsieh. In it, we argued what needs to be considered before launching an NFT first. Specifically, the following were called out as critical things to consider:

• Community - A community of passionate players who are drawn to the mission or vision of the project and can then be the golden cohort of ambassadors to advocate and grow the game.
• Utility - The NFTs cannot merely just be a pre-sell funding trophy (they could, but it won’t last). Instead, careful thinking and planning on what the NFT represents and how it will be used are paramount for the future success of the game/project. Will it be a pure cosmetic or will it have utility, and if it has utility, how does it impact the overall balance of the game? NOTE: Apple’s most recently updated policy seemed to imply that NFTs that unlock utility would not be allowed, meaning pure cosmetics NFTs would be allowed. However, special NFTs with cosmetics and utility that could still be bought via IAP may be allowed as long as the platform fees (30%) can be collected. No doubt this is definitely a consideration when launching on mobile.
• Purpose - What does the NFT ultimately mean to the community and game? For long-lasting success, it should have an emotional connection to the players and community. Players need to care about it vs just holding it for price speculation.
• These points will not guarantee sure-fire success for a project, but giving them careful consideration will increase the likelihood of starting off on the right foot.

Conclusion

As blockchain gaming continues to evolve, various NFT models will continue to be experimented with. Free-to-own has been popularized of late, namely by successes like Limit Break’s DigiDaigaku. However, with crypto winter unfolding, the entire NFT marketplace is experiencing a sea change of rethinking the creator/royalty fees, which seriously undermines the free-to-own model. On the Solana blockchain, Magic Eden made royalty fees optional, whereas OpenSea took the opposite approach and created a new on-chain enforcement collections contract which blacklists trading the collection NFT items on competing royalty-free marketplaces. OpenSea, after facing tremendous pushback from creators, has announced (via Twitter thread) it WILL BE enforcing creators fees. These recent events further emphasize that private marketplaces should be strongly considered by devs/studios to achieve a free-to-own model where royalty fees can be controlled and guaranteed to be enforced based on the devs’/creators’ needs and not a third-party exchange.

Even if royalty fees were guaranteed, the financial model assumes making up for the lack of the initial mint with a significant increase in future secondary sales at least by 50% vs the traditional model. This means that the success of free-to-own lies in creating enough marketing hype that it will drive more demand that will lead to higher price appreciation and more secondary action for it to be a superior approach — both substantial headwinds, but in this current market, challenging the status-quo could be more accepting.

However, free-to-own is not the silver bullet that leads to a sustainable game economy. Instead, at best, it’s another useful tool when designing a game/economy. Also, given the current marketplace forces, relying that the royalty structure will be a given is quite the gamble. Developers/designers would benefit the most by viewing free-to-own as one approach of many to modeling NFTs. The end result may be a mix of different NFT models for building a successful game/project/economy, and as there is no defined playbook in blockchain gaming, experimenting with various models would be best. But what is more important is a deeper focus on the community that will adopt and support the NFTs, the utility of the NFTs in its various forms, and the purpose of the NFTs to ensure the best chances of success. Focusing on those areas will yield bigger dividends to the future success of a game/project vs figuring out which NFT model is superior.

A big thanks to Lawrence Hsieh for writing this essay! If Naavik can be of help as you build or fund games, please reach out.