How We Invest in the Future of the Metaverse

“Did you win your sword fight?"
"Of course I won the sword fight," Hiro says. "I'm the greatest sword fighter in the world."
"And you wrote the software."
"Yeah. That, too," Hiro says.”
― Neal Stephenson, Snow Crash

Even if you can’t yet provide a clear definition for the metaverse and its varying characteristics, you (or your kids) have more than likely interacted with it in some shape or form in the last decade. Today, the metaverse is colloquially thought of as the creation of virtual worlds, like that pioneered by Second Life in 2003. However, we contend that the open metaverse will eventually be loosely defined as any interactive, digital recreation or commerce that resembles either real–world or fantastical experiences, and is interoperable with bitcoin, stablecoins, or other digital assets. This definition will come to comprise video games, AR/VR experiences, ecommerce, social media, collectibles and digital advertising. We assume 30% of traditional digital commerce in these market segments will integrate with the open, crypto–denominated metaverse by 2030, with the most relevant blockchain protocols capturing a 2% take–rate. Compare this to Web 2.0 corporations with their 5–70% marketplace hauls, and the open metaverse may look like a good deal for creators and consumers. Many cryptocurrencies, currently down 60–90% from their peak, are call options on the vast disruptive potential of this digital transformation.

Metaverse applications have long been centralized and lacked any interoperability, resulting in a suboptimal user experience. Some of the most popular applications that have dominated the space include Roblox, Grand Theft Auto and Fortnite. All of these games have brought in billions of dollars in revenue, yet they don’t provide their users with the basic freedom to actually own their items indefinitely outside of the game environment, let alone use them in another game. This is changing with the maturation of high–throughput layer 1 blockchains.

Now, game developers can store in–game assets on the blockchain as NFTs, which would give players the ability to take custody of items they have purchased. Interoperability would permit endless opportunities for end–users that previously were unattainable, whether they want to trade/sell their game assets once they are done playing a game, use their Fortnite skin while playing Call of Duty, or even lend out their level 62 Fire Mage to a new player at a fixed APR. Due to these benefits, we foresee blockchain games playing a pivotal role in onboarding the first billion users onto blockchain technology, a fraction of the estimated 3 billion gamers worldwide.

Metaverse Token Performance and Leaders

Since the beginning of the crypto winter, metaverse tokens have struggled compared to other cryptocurrencies. The bear market revealed flaws in early models like Axie Infinity, where gamers’ earnings chiefly consisted of speculation and inflation of the reward token, SLP. Since the crypto peak last November, the MVIS CryptoCompare Media & Entertainment Leaders Index is down 85% vs. Ethereum –71%, DeFi leaders down 80%, and infrastructure leaders down 80%. Performance since the June bottom has been better, but the metaverse coins have often been the most volatile sector we track, highlighting a lack of stakeholder conviction in the eventual winning model.

The top open world metaverses by land sales are Otherside (APE), Decentraland (MANA) and The Sandbox (SAND). Of these virtual worlds, Otherside has outperformed in almost every metric. We assume this outperformance is due to a combination of the tightly knit community of BAYC and MAYC, potential future benefits from holding (owners were airdropped thousands of dollars each of APE during the token generation event) and multiple pop culture endorsements. That said, the Otherside product is barely formed, with only a beta offering and video trailers hinting at eventual functionality. So far, these platforms have traded more on anticipation than on real utility/activity, despite the $1.6B in cumulative land sales.

Source: VanEck, OpenSea, Dune.

Monthly Land Sales ($ millions)

Source: VanEck, MetaMetriks.

Our Approach to Investing in the Metaverse

When analyzing the best way to position our investments to capitalize on the evolution of the metaverse, we are chiefly concerned with understanding which layer 1 tokens and infrastructure providers have asymmetric upside, given widespread metaverse adoption. Accordingly, we are most interested in Binance Smart Chain, Ethereum, Polygon and Solana, as over 90% of the current 1,614 blockchain games have launched or plan to launch on these four chains. Despite the number of games on these chains, 50% of Web3 gaming activity still occurs on Wax, but its dominance is declining. We expect this decline to continue as AAA games are released on the leading layer 1s and their sidechains. Furthermore, the top virtual world metaverses are all on Ethereum or Polygon, indicating that a significant amount of long–term traffic will settle there.

Game Distribution by Chain

30 Day NFT Sales & Change

Source: VanEck, Playtoearn.net, Cryptoslam.

Flow blockchain is another competitor attempting to be the go–to chain for NFT projects and games that require quick, low–cost transactions. Flow was developed by Dapper Labs and is the exclusive home to NFT collections including NBA TopShot, which boasts over 1.5 million users. Additionally, their recent partnerships with Ticketmaster and Instagram could lead to sticky demand and mainstream visibility for Flow NFTs. Flow currently ranks fourth in all–time NFT sales and third in the last 30 days (as of 15/9/2022).

NEAR is a younger layer 1 that may have a disruptive impact. NEAR utilizes Nightshade sharding to achieve fast and scalable consensus for users of the chain. Nightshade sharding differs from other sharding models in that it creates shard chunks rather than shard chains. In this model, the list of transactions in blocks are split into chunks for each shard, and members of the network are only responsible for maintaining the state for the shards that they validate for. NEAR just launched phase 1 of Nightshade sharding, which increases the number of validators and marks a key technical achievement. Additionally, the protocol’s JavaScript SDK opens the door for millions of developers to build decentralized applications (dapps).

One of the most recent exciting developments on NEAR is the migration of Sweatcoin, a popular Web2 move–to–earn game that rewards users for their steps. With a proclaimed userbase of over 110 million, a successful transition would make it the largest single application movement to Web3 to date. Launched on NEAR on 13 September, Sweatcoin had over 600k users interact with their smart contracts in their first week. With a massive initial userbase by blockchain standards, Sweatcoin has established itself as the top blockchain game by weekly active users.

Beyond layer 1s, we are searching for projects that solve problems in the space that fundamentally hinder blockchain gaming and metaverses from reaching their full potential. One of these possible solutions is ImmutableX. ImmutableX is a layer 2 project that aims to solve the issue of fragmented NFT liquidity. ImmutableX acts as an aggregated liquidity layer for NFTs, that inherits the security and decentralization of Ethereum. By utilizing StarkWare’s ZK–STARK technology, ImmutableX is able to provide users with gas–less minting and trading of NFTs, which is imperative for games such as Illuvium that will potentially mint billions of NFTs. Their technology also allows for game developers to easily sell assets in their own metaverse. This means Web3 metaverse users will no longer have to go to OpenSea or Magic Eden to purchase items, although they still can choose to do so. With a liquidity layer like ImmutableX, assets can be listed on multiple marketplaces.

Evolution of Game Monetization Models

In order to forecast the future of the gaming industry, it is important to understand how game monetization has changed over time. To this point, we find that there were four different models that describe monetization of games and believe that we are now transitioning into a fifth stage. These models are as follows:

1. Pay Per Play: Think of this as the arcade era. Gamers would go to their favorite arcade and use quarters to pay for every time they wanted to play a game. If they were good enough, there were opportunities to acquire free plays or extra lives through reaching a certain level or defeating a boss, etc. The notorious games of this era included names like Pacman, Pong and Space Invaders. The games produced in these days were without a doubt fun to play, but lacked key social elements as multiplayer games were limited to 2–4 players at most.
2. Premium Play: In the console/PC era, gamers would pay an upfront cost for a device that would let them game at home, and then an additional purchase for each game they wanted play. Console leaders in this era included Nintendo, Xbox and PlayStation, which created the hardware enabling AAA games like Call of Duty, Super Smash Bros and Grand Theft Auto.
3. Free to Play: Also known as the “freemium” model, mobile games and MMOs (massively multiplayer online games) dominated this era of gaming. By allowing users to play for free, game publishers onboarded massive user bases who could enjoy the game before making any purchases. This model allowed players to validate the quality of the game and incentivized in–game purchases, since there were no upfront costs. League of Legends, Fortnite, Roblox and Zynga were all massively successful with this model.
4. Play to Earn: As the first edition of blockchain gaming, this shift was jumpstarted by users who were eager to profit from their gameplay even though they weren’t esport–tier players. Users purchased NFTs that allowed them to play specific games in which they could earn cryptocurrency and cash out their earnings, hopefully recouping the costs of NFTs and then some. However, this model quickly fell apart as token dumping and buying became drastically uneven and earnings fell below meaningful amounts. Axie Infinity was the most popular game of this era as it infamously provided the middle class of the Philippines an alternate stream of income during the pandemic.
5. Play to Own: Hypothesized as the next wave of revolutionary gameplay, play–to–own incorporates the most successful aspects of the freemium and the play–to–earn models. Games bootstrap community through free NFT mints, which attempt to align the incentives of the ecosystem. Players aren’t focused on immediately extracting profit, and the value of their NFT will never fall below mint price, because it was free. Players are therefore incentivized to ensure the success of the game if they want to profit from their NFTs. Additionally, this model removes the upfront revenue the game producers receive from the mint, which has historically led to rug–pull behavior and reduced incentive for the developing team to put out the best game possible. This model is currently being led by Limit Break, who recently had their wildly successful DigiDaigaku and DigiDaigaku Spirits mint following a $200 million funding raise.

Breaking Barriers to Web3 Gaming Adoption

The successful onboarding of 3 billion Web2 gamers to Web3 games requires a few key developments to overcome the hurdles of using new gameplay technology.

One of the most cited issues with this transition is that traditional gamers have a distaste for NFTs. The main reason for this is that they regard NFTs as another way for companies to siphon money from the pockets of players and deliver a subpar gaming experience. To be fair, the first generations of NFT games did exactly that. However, we believe the industry has internalized this criticism and is evolving to alleviate players’ antipathies. The development of free–to–own games eradicates the upfront costs for users and simultaneously realigns the incentive structure of game development to promote the best outcome for gaming communities.

Another key barrier to adoption of blockchain games is that they require users to know how to set up a crypto wallet, manage private keys, and purchase gas tokens to begin interacting with the dapp. If Web3 games want to migrate players over from Web2, then the onboarding process must resemble that of the previous gaming era. Projects like Web3Auth are doing exactly that by creating frictionless signup portals that allow players to login with an email or social media account and automating noncustodial wallet generation and transaction signing on the backend of the dapp. Tools like this may eventually enable social media–type experiences, with the potential for more direct monetization for creators. Abstracting away all of the interaction with the underlying blockchain and creating a frontend experience where the user doesn’t know the game or app is utilizing blockchain technology will enable Web3 game adoption to reach escape velocity.

Sources: Dappradar, Coinmarketcap.com, protocol websites & interviews, VanEck research, Cryptoslam, MetaMetriks, playtoearn.net

Opinions are current as of the publication date and are subject to change with market conditions. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results.