Network Effects in Web3 Games

This article delves into the application and impact of network effects in Web3 games. It underscores how emerging cryptographic gaming platforms create and leverage network effects through their tokens and interconnected projects. The piece also touches upon the potential for gaming platforms to amplify network effects through phase-specific token incentive strategies and emphasizes the crucial role of community power and appropriate incentives in transitioning from small to large-scale network effects.

Introduce

In collaboration with Animoca Brands’ research team, we explored network effects in Web3 games. Our aim was to propose more specific hypotheses regarding Web3 product network effects, starting with the close relationship between product and token economics discovered in our previous writings. In essence, a structural challenge faced by Web3 products is that it hampers the full potential of network effects. Notably, DeFi and Web3 games employ distinct rules in the realms of network effects and token economics to facilitate their growth.

The Evolution of Blockchain Games Away from Network Effects:

Blockchain-based games, commonly referred to as GameFi, have been around for about five years. Within this short span, they’ve seen various innovations, from utilizing NFTs and creating speculative demand through reward redistribution mechanisms to mechanisms for sustainable growth. Axie Infinity and STEPN witnessed explosive user growth, attributed to their user-friendly interfaces, immersive experiences, and financial incentives. However, the sustainability of products solely reliant on speculative demand is questionable. Consequently, these products are steering away from speculation to ensure a healthier token economy. While we won’t dive deep into the pros and cons of this shift here, eradicating speculation altogether has weakened one of GameFi’s strongest suits: its connection with global networks via public chains. Speculation doesn’t produce network effects or sustainability, but it is undeniably a global phenomenon. Unlike DeFi, most existing games lack composability, with player interactions primarily driven by in-game content. As such, GameFi risks becoming a downgraded version of Web2 games. So, how can a product distribute tokens without compromising user experience, ensure customer acquisition cost (CAC) is less than the lifetime value (LTV) of a user, and grow autonomously once a threshold is surpassed? The answer lies in network effects.

Network effects describe the phenomenon where a product or service’s value increases as its user base grows. The more users a product has, the more valuable it becomes. Worth mentioning, there are different types of network effects, such as physical, protocol, platform, and performance effects. These vary in type, category, and phase. For instance, the old-school telephone system benefitted from physical network effects, where a user could only call others on the same network. If one could reach everyone they wanted via a single network, having two phone networks would be pointless. The increased use of a single network enhances its value to users. Given the direct utility it offers, and the requirement of physical terminals and lines for daily use, the cost of switching becomes significant. Competitors would need to offer ten times the efficiency or even better utility to replace it. In gaming, as the number of users rises, matchmaking times reduce, common conversation topics multiply, and virtual societies form in the digital space, enhancing enjoyment for each user.

What Facilitates Network Effects (Nfx) in Web2 Games?

In traditional gaming and tech sectors, as well as during the Web2 era, the main influencers of network effects include ease of use, quality, brand recognition, critical mass, complementary goods, and switching costs:

• Ease of Use & Quality: Intuitive and high-quality products naturally draw and retain more users. Their benefits spread faster via word of mouth.
• Brand Recognition: A brand’s visibility contributes to network effects as users tend to use and discuss products or services from familiar and trusted brands. The dominance of Coca-Cola’s brand has played a significant role in its success. Consumers naturally have a better perception and recall of its products, accelerating its spread.
• Critical Mass: A network needs a certain active user count to make it attractive to potential users, creating a positive feedback loop. Once this is achieved, the network could see accelerated growth and widespread adoption. Social media platforms like Facebook and Twitter become more valuable and engaging as more friends and family join them.
• Complementary Goods: These refer to products or services used in tandem with a particular network or platform. They add allure to the network, prompting users to join or stay, similar to developers crafting apps specifically for an operating system, enhancing its value.
• Switching Costs: These are the financial or non-financial costs users incur when transitioning from one network to another. It dissuades users from switching to competing networks, locking them into a particular network as they become increasingly reluctant to abandon their tangible and intangible investments in it.

How Can Web3 Games Harness Network Effect Advantages?

Web3 games, often constrained by limited budgets and less refined interfaces and user experiences, must leverage the unique capabilities of public chains to entice users. This has led to a divergence in the business models between Web2 and Web3 games, even though they fall under the same category. To delve deeper, consider an application/domain-specific rollup tailored for games. This rollup accommodates on-chain games with discrete mechanics (technically, all digital games are discrete, but we’re focusing on those that are overtly so, such as card games and board games, rather than shooters and real-time strategies). On-chain games store all their logic on the blockchain. This isn’t just for enhanced transparency and fairness; storing core components on-chain brings composability and interoperability. Discrete mechanics games are emphasized because the number of on-chain transactions required to depict game behaviors is limited and manageable. Thanks to zk-technology, games like poker, which necessitate some hidden information, are now feasible.

Such a roll-up solution offers built-in functionalities beneficial to game creators, including random number generation, information concealment, user performance-based ratings, and visibility of on-chain activities. Once a game gains a sufficient user base in a region, a network effect sets in, and expansion to other regions can help grow the user base. It’s worth noting that for synchronous games, only users in the same time zone may influence the network effect. However, for game creators benefiting from expanded user numbers, there are no geographical constraints. Game creators, streamers, and event organizers earn native rollup tokens based on their performance. They should be incentivized for their contributions to the network effect, not merely for playing the game.

The Importance of Incorporating Diverse Network Effects into Products

The main impediment to scaling or self-sustaining (or both) for Web3 projects, especially non-DeFi applications, lies in the product. While many focus on sustainable token economic models, the product itself remains paramount. Web3 games, capable of replicating most Web2 game features, are often “nerfed” due to massive budget disparities, interface and experience constraints, and ill-conceived token integrations.

Many Web3 games either lack a network effect or exhibit only the diminishing returns effect depicted by the green line in the mentioned graph. This effect shows a noticeable utility growth initially but quickly tapers to a certain value. For instance, increasing user numbers in a region might decrease matchmaking time. A drop from 10 seconds to 1 second is significant, but a further drop to 0.1 second doesn’t dramatically increase utility. A product’s value hinges on its utility ceiling. Conversely, the blue line represents network effects stemming from geographically scalable products, token standards, transaction formats for a comprehensive ecosystem encompassing multiple games, tools for constructing on-chain game logic, and a novel kind of wallet ensuring seamless user experiences. These measures might not induce explosive growth short-term but function in a compounding manner.

Integrating multiple network effects into a single product fosters both initial traction and sustained growth. For instance, the aforementioned game-specific rollup operators initially need to create their games and host competitions. Yet, as user numbers swell, a community forms, reducing not only game wait times but also encouraging more users to step into the roles of game creators and event organizers.

The Power of Network Effects in Web3 Games: A Case Study of $MAGIC in the TreasureDAO Ecosystem

Presently, Web3 games struggle to leverage network effects through their platforms. Popular games such as Axie Infinity and STEPN have limited exposure in terms of network effects. However, as crypto gaming platforms begin to create multiple portals and target various player communities with a single token, the dynamics are starting to change.

TreasureDAO is a prime example of this shift. Their $MAGIC token allows users to participate in some metaverse projects within a decentralized ecosystem on Arbitrum. As various projects on the platform engage and are economically connected with $MAGIC, each game acts as a complementary product. This boosts the value of the TreasureDAO ecosystem, heralding the emergence of network effects. To build its metaverse, TreasureDAO adopts a bottom-up approach, offering free game assets to help construct a community and attract more players, aiming to reach a critical mass. Developers, while creating these games, also place significant emphasis on cultural development. Artists and developers can harness community resources to their full potential, enhancing the gaming experience for players.

The design of $MAGIC also connects players from different games to a single community. Players can swap assets between various games using $MAGIC, further reinforcing the powerful network effect. Moreover, an enhanced metaverse experience attracts more users, leading to more developers and subsequently better experiences, creating a positive feedback loop for the ecosystem.

The $MAGIC ecosystem protocols include: Bridgeworld, Smolverse, Tales of Elleria, The Beacon, Battlefly, The Lost Donkey, Toadstool, Knights of the Ether, LifeVerse, Lost Samurise, and Realm.

As illustrated, while TreasureDAO’s ecosystem shows promising potential in the “one-token-multiple-games” structure, the influx of Daily Active Users (DAU) from new games merely compensates for the decline from older games, implying the ecosystem is yet to achieve sustainable growth.

Animoca Brands harnesses its network effects by interlinking numerous projects in its portfolio through shared liquidity pools and cross-project token rewards. The first NFT series backed by Animoca Brands, “Mocaverse”, exemplifies this synergistic effect. By integrating various communities from other projects and subsidiaries in the Animoca ecosystem, its value is elevated.

Beyond these examples, network effects can also be observed in the EVM (Ethereum Virtual Machine) economic model regions and tools, such as programming languages, developer toolkits, node services, token standards, token issuance, and utilities. Creating a new EVM chain will form a decentralized, interoperable ecosystem, bringing about several positive effects like multi-chain product deployments, utilizing infrastructure on other chains, and an increase in potential customers for developers across different chains.

While EVM-compatible Layer 1 solutions focus on horizontal scaling, EVM-compatible Layer 2s based on roll-ups prioritize vertical scaling. Although economic models at the protocol level may differ, both approaches are equally effective for application layers like games. Since each chain and roll-up exert significant influence in specific regions and among distinct user perceptions, one can amplify network effects using strategies similar to how Uber expanded its core services to different regions.

A Vision for the Future Token Economy Model

With the influx of DeFi and GameFi products into the market, management teams need to identify opportunities to establish a user base, hoping to benefit from the growing network effects. A common approach is to use phased token incentives to attract the participation of the initial user community. In these incentive schemes, striking the right balance is essential to fully engage early users until the product matures to attract a broader audience. During this phase, token incentives should be managed prudently to avoid unsustainable economic model issues. While many may disagree, not every product category requires extreme decentralization, and token designs shouldn’t be immutable. For instance, a fixed token issuance schedule means management teams can’t adjust their strategies in response to a changing environment. Unlike some emerging DeFi products that attract users by allocating a fixed budget for token incentives during the initial phase, which then mandates fee payments or purchases as conditions for obtaining tokens and subsequently funnels the proceeds into the treasury. For gaming platforms, in contrast to DeFi, there are more diverse utilities, necessitating token incentive adjustments aligned with platform growth. Initially, liquidity token rewards can be used to stimulate game mechanics and community collaborations. As the platform evolves, modulating these rewards becomes paramount to maintain a stable ecosystem. By seeking alternative strategies in subsequent stages of the game lifecycle, administrators can encourage participation in tournaments, innovative game development, and intense leaderboard competitions, through varied token rewards or even entirely without token-based rewards.

The evolution of network effects from small to large scale entails the need for a strategy that capitalizes on numerous smaller-scale network effects. For instance, once Uber reaches a certain number of drivers in a city, the benefits of adding more diminish. It’s therefore vital to first expand the network to realize small-scale effects and then leverage these to foster larger scale effects, ensuring sustainable project growth. We’ve seen this trend manifest in horizontal expansion models of multiple small networks (e.g., Uber, Tinder) and vertical expansion of single large networks (e.g., telephones, ID verification). This trend is evident in the GameFi realm, as seen with approaches like Axie Infinity and STEPN, initially driving incremental network effects via game-specific token incentives. In contrast, TreasureDAO taps into the small networks within individual games on its platform to enhance the broader token ($MAGIC) ecosystem. For the crypto industry, another alternative to stimulating early network effects lies within its community. As companies expand the primary player base of a game through token incentives, a blueprint emerges: GameFi enterprises can lean on existing communities, starting small and gradually scaling up. This provides a novel path for GameFi companies to quickly amass network effect advantages, eventually broadening their products. This was brilliantly showcased by Yuga Labs’ upcoming game, Legends of Mara, which integrated the Otherside series of NFTs. Having already garnered immense community support through the Bored Ape Yacht Club and subsequent series, they leveraged this to establish an initial user base for Legends of Mara, amplifying its influence through network effects. Hence, for a product to succeed, the desired scale of network effect must be defined. Sustainable development requires flexible governance and token issuance, distinguishing it from the older immutable token design models.

Conclusion

Undoubtedly, Web3 games possess immense potential. However, administrators must fully harness network effects for efficient growth without sidelining the significance of sustainable token economics for long-term success. Successful Web2 projects, and how they’ve astutely leveraged network effects to expand operations, offer invaluable insights and lessons. As GameFi continues to evolve, with correct execution, it promises tangible benefits for its users. Therefore, for product owners, designing games rooted in strong communities and appropriate incentives is crucial to achieving exceptional expansion through network effects.

Disclaimer：

1. This article is reprinted from [The SeeDAO]. All copyrights belong to the original author [HIRAYAMA SHO]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.
2. Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.
3. Translations of the article into other languages are done by the Gate Learn team. Unless mentioned, copying, distributing, or plagiarizing the translated articles is prohibited.