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#1 Naavik Exclusive: The Present & Future State of Gaming Venture Capital

In Master The Meta’s latest deep dive, Matt Dion explores the present & future state of gaming venture capital: the macro trends driving the growing interest in games investing, why VCs are seeing game studios as venture-scalable investments, and where the world of games-focused investing will head in the future. We’ve pulled an excerpt below as a preview to the longer essay.

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Last month, Turkish casual games developer Dream Games raised $155M in a Series B round, valuing the company at $1B. This made Dream Games the industry’s latest “unicorn” — an impressive feat for an early-stage games developer with just one title to its name (the massively successful Royal Match). However, what really caught the attention of industry watchers was the speed at which it happened: Dream Games had previously raised its $50M Series A just 3.5 months earlier.

Even more interesting is the fact that Dream Games is just the latest in a string of games industry startups to attract the attention of venture capitalists. In the last year and a half, VC interest in the sector has reached a fever pitch.

In their recent Gaming Deals Activity Report H1 2021, our friends at InvestGame counted 263 closed private investments in the first half of 2021 alone, compared to 161 in H1’20. More than 64% of those private placements came at an early stage, representing roughly $1.1B in total value.

What is it about the games industry that has proven attractive to venture capital firms? Why are we seeing more deals at ever-greater valuations, and why now?

For one, gaming has become increasingly ubiquitous. There are nearly three billion gamers worldwide, representing more than a third of the entire global population. That number is expected to continue to grow over the coming years, and with that massive player base has come greater societal acceptance, particularly as so many people have been stuck at home during the COVID-19 pandemic. Furthermore, gaming has proven itself to be a growth industry. Gaming revenues are already larger than the film and music industries combined, and expected to continue growing.

VCs invest on long time horizons. Most venture funds have a period of 10 years or more during which they invest their capital and return profits to their investors. While the time required to develop AAA games is certainly increasing, it does not necessarily match the timelines of these VCs — many of whom may be wary of getting involved in what’s traditionally been viewed as a hits-driven business. However, gaming businesses are increasingly sprouting up on the bleeding edge of technology, where the macro trends that do fit VC timelines are better represented. Trends often referenced on VC Twitter such as blockchain technology, cryptocurrency, the Creator Economy, user-generated content, and the Metaverse all have roots in gaming. That, in turn, has captured the attention of VCs in search of the next big thing.

#2: An Intro to Tokenomics in Blockchain Games

Blockchain-based projects have exploded in the first half of 2021, with interest and funding reaching dizzying heights. There was $4B in VC funding in the second quarter of 2021 alone across all sectors.

Zooming in on crypto/blockchain gaming companies, startups received $476M during the same period, highlighting excitement from investors in finding ways to gain exposure into this growing market. Blockchain gaming is intrinsically an ecosystem where trust, real ownership, and value is placed into the hands of the user. Decentralized networks and marketplaces create new modalities of play, and give the ability to trade assets and generate revenue without worry of fraud.

This is almost antithetical to current games in the market, where players don’t own their in-game items and most games do not allow for trading of those goods outside of their ecosystem. By marrying blockchain technology — where ownership and participation is not limited to the developers but also to the community — and the value that games bring to players — which is ultimately entertainment value — there is now have a scenario where players gain economic value from it as well.

Today, we’re seeing a new crop of games emerge based on the premise of “play-to-earn”. According to Axie World, Axie Infinity earned $196.8M in July 2021 — a staggering figure. August is faring even better, at $255.4M, and the month is not even over yet. Other studios such as Bright Star Studios, developers of MMORPG Ember Sword, have seen players pledge over $203M from “Land” sales, a type of non-fungible token (NFT) used in their game that confers various benefits to the owner and those that interact within those lands. This is 70x the value of what they were able to raise from VCs to jumpstart their studios.

While there are many parallels that can be drawn from free-to-play games to this new wave of Blockchain | NFT games — multiple currencies, deeper systems designs (e.g. crafting, fusion), dependencies and core loop — there is a need to take a holistic view on the critical roles that non-fungible and fungible tokens play in developing an interwoven token economy which powers the entire ecosystem.

Products like Axie Infinity have driven immense growth via their fungible tokens, AXS and SLP, allowing for scale, volume and revenue through compounding transactions. While most games borrowed elements from crypto games like CryptoKitties, many games in this new wave are developing unique roles, methods and purpose with their tokens, allowing for a rich set of features that integrate deeply into the game genre and community. I personally prefer to use the term “play & earn” because the gameplay and fun comes first but there is potential to earn assets that have utility outside of the fun to create even more value (e.g. economic incentives).

A framework to use to identify the role of various tokens can be categorized as follows:

This is by no means an exhaustive list, as many more ideas and categories are being generated but this helps to create a framework in which to think through token economics as studios build their products. Let’s take a look at a specific example of how this is implemented in the upcoming game, Ember Sword.

Ember Sword provides value through their utility tokens in the following ways:

1. Rights & Functions:

   • The Ember Token, which is the premium currency, comes in the form of an ERC-20 token (the standard token used for creating and issuing smart contracts on the Ethereum blockchain). ERC stands for "Ethereum request for comment," and can be used to create smart contracts to create smart property or tokenized assets that people can invest in.

   • Therefore, the Ember Token provides liquidity and special usage for things like governance, access to exclusive community related content, channels, and other special usage (see more below).

2. Currency & Value Exchange:

   • The Ember Token also acts as a form of payment for trading, allowing for value generation on the marketplace as well as in other exchanges. This is exciting because it gives users freedom and true ownership in how they conduct transactions across a multitude of Ethereum compatible exchanges and marketplaces, freeing them from traditional walled gardens that we know today.

3. Earnings:

   • Some of the unique collectible tokens (NFTs) have specific benefits attached to them, resulting in special perks such as access to early Alpha or participation rights as one of the first cohorts. These methods may be used to get users excited about NFTs and to encourage early adopters to participate in things like “pre-sales”. There are also applications post launch to drive merchandising strategies around content drops and expansions.

   • Owning a Land token provides these owners with a profit sharing mechanism, which is divided for all landowners and those within the immediate region (in which a qualified action occurred and for trading fees), creating added value for those owners. The revenue that is generated from this Land comes in the form of an ERC-20 token (e.g. Ember Token), which creates a cohesive loop and dependency in their token economic design.

While Bright Star may develop and/or iterate even more utility out of their tokens, they’ve done a fantastic job of getting their foundational economics in place to sustain their ambitious product, as evidenced by the overwhelming support and demand for their offerings. The product is currently in pre-alpha with more gameplay focused alphas coming in 2022.

With that said, there is a lot of room for creativity and value construction within token economics that other teams are exploring as well. Various use cases can be formed around, but not limited to:

• Social tokens — provided to users as a reward for engaging with a product, which gives them early looks at new merchandise, acts as a “membership” key, etc.

• Nested tokens — a token within a token creating added value for owners. For example, an NFT asset (e.g. Avatar character) having an interest-generating token within the game, potentially creating a passive income stream of the premium ERC-20 token for that product.

There are so many more ideas and experiments that can be explored on this front. We’re only at the beginning.

Ongoing Lessons:

The token and game economies for each NFT game are different and dependent upon the game’s theme, core loop, and market-making. Therefore, having thoughtful design and game logic is a critical first step when developing product. Furthermore, it’s crucial to create a token economics model that uses NFTs to complement the gameplay, which creates dependencies throughout the ecosystem, primary game, marketplace, and secondary exchanges. NFT games will be increasingly complex. With real-world monetary implications, it’ll be critical to communicate the uses of the tokens inside the game to the users so their intended use-case is well understood, creating transparency and discussion among the community

Ultimately, this understanding is critical to building and scaling a community as the in-game token economy relies on this growth and sustainability for years to come. Developing methods and utility for a community’s involvement in an in-game economy will allow for organic and dynamic growth, and is necessary to keep the ecosystem growing. When designing for economies, keep these principals in mind and follow this formula to stay safe: “Not Financial + Non Equity-esque + Utility Oriented” = Game Token Economics. This is subject to change based on rules and regulations to follow but it may also help kickstart thought exercises on how to tackle the space. (Written by Chong Ahn, VP Product at Mythical Games)

📚 Content Worth Consuming

Investigation: How Roblox is Exploiting Young Game Developers (People Make Games): Overall, this was a nuanced investigation about development and payouts on the Roblox platform. While there are a few holes to his argument on the value of building on the Roblox ecosystem and what Roblox uses its money for, he provides his findings in striking detail at the intersection of primary sources, creator economics, and platform economics. The description reads: “With Roblox Corporation now being valued at more than $45 billion, we ask whether the kids making the vast majority of its content are being taken advantage of?”. Link

The Video Game Industry is Bracing for Its Netflix and Spotify Moment (Protocol): “Subscription services are coming for the game industry, and the shift could shake up the largest and most lucrative entertainment sector in the world. These services started as small, closed offerings typically available on only a handful of hardware platforms. Now, they're expanding to mobile phones and smart TVs, and promising to radically change the economics of how games are funded, developed and distributed. Of the biggest companies in gaming today, Amazon, Apple, Electronic Arts, Google, Microsoft, Nintendo, Nvidia, Sony and Ubisoft all operate some form of game subscription. Far and away the most ambitious of them is Microsoft's Xbox Game Pass, featuring more than 100 games for $9.99 a month and including even brand-new titles the day they release. As of January, Game Pass had more than 18 million subscribers, and Microsoft's aggressive investment in a subscription future has become a catalyst for an industrywide reckoning on the likelihood and viability of such a model becoming standard”. Link

Spatial Software (1729): “This is our definition of spatial software. It is characterized by the ability to move bodies and objects freely, in a parallel to the real world. This is opposed to traditional software, which uses some other logic to organize its interface. Figma and Second Life are examples of spatial software. They contain worlds where the relationships between objects on a canvas, or bodies in an environment, respectively, are the organizing logic of the interface. WhatsApp is not spatial software. The organizing logic of its interface is recency of messages, not spatial relationships”. Link

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