(Originally published Nov 2022)

Overview

In the aftermath of the bull market speculation is being washed out of the market and attention is turning to the fundamentals of projects. Inseparable from these projects are their tokenomics. Tokenomics can be considered the economic characteristics of tokens that ultimately affect their supply and demand, and in turn their price. Fundamentals are fundamental, and no project will succeed long term without them; yet sound tokenomics can be the difference between the success and failure of good projects in creating flourishing micro-economies and sustainable communities.

This reports primary objective is to examine the tokenomics of $AXS and $SLP and their prospects. Native tokens of the Axie ecosystem, both are down over 90% + from their bull market highs. Tokenomics being a nascent field and empirical data historically narrow, an overriding framework against which to judge a project is not yet consensus, as are metrics when valuing equities. Fields of game theory and traditional economics can be leaned on however. This reports assessment of Axie’s tokenomics will be guided by two primary criteria provided by Baker and Shah (2022).

• Tokenomics should coordinate common goods that participants would struggle to provide efficiently and economically on their own.

• Tokenomics should channel value towards those who create that value, prioritising value distribution (aligned with value creation) towards high-utility groups over value transfer between participants.

Brief Background

$AXS (Axie Infinity Shards) is the governance token of the Axie Infinity ecosystem and $SLP (Smooth Love Potion) is the in-game asset. Released in March 2018, Axie Infinity is a Pokemon-inspired NFT based play-to-earn game founded by 3 people who met via playing CryptoKitties. They founded a for-profit software company, Sky Mavis, who is the games developer and leads the Axie roadmap.

Players mint Axie NFT characters to dual with in-game against other players, during which they can earn cryptocurrency. The project uses a dual token model. $AXS utilities involve minor gameplay features, governance voting, and staking; $SLP is used to upgrade existing Axie NFT’s and is paid out for winning duals. The ecosystem is on the Ronin network, an ethereum sidechain. $AXS and $SLP cryptocurrencies are ERC-20 tokens and in-game NFTs are ERC-721 tokens.

$AXS Token Allocation, Vesting & Emission

The initial public sale in October/November 2020 distributed 29,700,000 AXS for $0.10 a token, raising $22,970,000. This is 11% of the 270,000,000 maximum supply of $AXS. There had been a private sale in June 2020 in which investors bought 4% of the maximum supply (10,800,000) at $0.08 per token. There was a 20% unlock of these privately bought tokens at the initial public sale, the remaining private sale allocation vesting up until the recent unlocking on the 25th October 2022.

The public sale was the unlocking event at which the initial circulating supply of $AXS was set at 59,985,000 - 22.22% of the total supply. AXS is in the process of being unlocked in a pre-determined schedule which lasts for 65 months from the public sale. The current total supply of $AXS is 103,000,000.

Below are allocation percentages of $AXS and their vesting periods.

Two Token Model

In the spirit of crypto, the developers of Axie have been innovative in the tokenomics design. Launching the game in 2018 with just the one token, $AXS, developers recognised a conflict of incentives around $AXS. Players wanted to spend their $AXS in-game and enjoy the network, yet simultaneously desired to participate in the capital gains enjoyed by holding it. This has the effect of reducing a networks growth by discouraging network participation.

By employing a one token model, the Axie network was also at risk of a death spiral in token value if growth slowed. New users would convert USD to AXS that could be spent in-game. With earnings in-game dependent on AXS and its price. If an entrant bought 100 AXS at $1 per AXS, and after buying NFTs to play earned earned 10 AXS but valued at a higher USD value thanks to more players and hence more demand for AXS, he would be earning a USD premium on his returns. This growth model relied on reliable growth and a downturn in users could see a quick reverse in the price of AXS, encouraging sell-offs and ultimately destruction of ecosystem value. Steady growth outside of a bull market on top of a floor of venture capital money prevented this and Axie ran on this one token model for a year.

Axie’s two-token model aimed to overcome the conflicting incentives at play and potential armageddon. Introducing the $SLP token in December 2019, Axie shaped its network around a utility token and a governance token. $AXS’s in-game utility was largely removed in favour of it being the governance token. $SLP became the utility token, decoupled from ownership of the network, and could be earned and likewise spent in-game. Holders of $AXS would now not be penalised for spending their $AXS and taking part in the growth of the axie network. This issue was addressed before $AXS staking became available, so that $AXS holders could stake without reduction through use.

$AXS Tokenomics

In game Utility

Despite its primary status as Axie’s governance token, $AXS is a feature of gameplay. Having purchased an Axie NFT for in-game play for Ethereum via the Axie marketplace, AXS is required to breed these Axies into descendant Axie NFTs. Since December 2021, the AXS required per breed is 0.5 AXS and this full amount goes to the Axie treasury.

The effect of this is a deflationary force on the circulating supply of AXS, removing it from circulating supply. The treasury is currently under the control of Sky Mavis, but there is a roadmap to decentralise governance of its use to AXS holders. Until then, which at a minimum is 14 months, the treasury funds will be untouched.

$AXS enters circulating supply within the game as rewards for tournaments and season rankings. Axie is played in ‘seasons’ lasting between 6-8 weeks, followed by short off-season periods. Axie has recently rebranded from Axie Infinity to Axie Origins, commencing Season 1 on September 14th 2022. This is meant to eclipse its predecessor, Axie Infinity (concluding with Season 21 in June 2022), and provide a superior gameplay that the developers hope will stimulate player growth. Below are the rewards for Season 1 rankings with a prize pool of 112,000 AXS tokens, 6,750 of those going to the first-place finisher.

Both $AXS in-game supply and demand distribute $AXS into the value creators of Axie. Breeding fees technically channel AXS into holders of AXS, those that care to own the ecosystem. In-game supply rewards the game’s most active players and scores highly with Baker and Shah’s second criterion that:

“Tokenomics should channel value towards those who create that value, prioritizing value distribution (aligned with value creation) towards high-utility groups over value transfer between participants”.

$AXS rewards are distributed from the play-to-earn fund (see token allocation section above) to the community members that have invested the most and spent the most time in the game. These players are incentivised, through their active and invested status within the game, to ‘own’ what they are creating, and thus holding $AXS for its governance is in their interest. This should ensure $AXS is locked up in the form of staking rather than added to the circulating supply and pushing down on the price.

However, Axie’s transition to its ‘Origins’ incarnation, and its skewed rewarding of those at the top of leaderboards has its drawbacks. There is very little chance the average, or indeed onboarding user, can earn much from the game in terms of AXS rewards. There are concerns it has crossed the rubicon into a ‘pay-to-win’ game rather than a play-to-earn’, putting off new players. This would be true if the long-term success of Axie was based on the attraction of play-to-win.

However, I think this criticism is misdirected. The developers of Axie have been firm in their stance that they want to move away from the predatory and mercenary play-to-earn model and shift to a play-and earn. In doing so, Axie Origins redirects $AXS rewards to those highly active in the community, locking up $AXS instead of giving it to those new to the game who would be very well likely to sell earned $AXS on the market before they develop an affinity for the community and want to participate in its ownership structure. The developers are focusing in Origins on creating a gameplay which has very low entry barriers (new players now get three free axies, although they can’t earn SLP from them) and a sense of progression that will entice players deeper and deeper into the community. From there, it can be modelled that players will spend, climbing the leaderboard and earning more $AXS proportional to their activity in the economy - hence playing to win.

I think the intentions of Sky Mavis to redirect onboarding through ‘play-to-earners’ is a good thing, focusing on the long term by building a sustainable and engaged user base that is heterogenous in its aims, but that rewards those providing most value to the ecosystem. This is nothing to say about the quality of Axie’s gameplay, though! It should be good enough to attract users in the first place and kickstart the flywheel.

Staking

As of October 2022, there is currently 40,098,797 $AXS staked at an APR of 45%. Rewards are distributed from the staking rewards fund. Staking can in many instances provide the ‘common goods’ that Baker and Shah mention. The security of the system can be enhanced in proof-of-stake networks by a large and heterogenous set of stakers, whilst in layer 2 applications such as Curve, veTokenomic models reward stakers with governance voting power.

AXS staking provide little in the way of common goods since governance is not dependant on staked AXS. The high APR attracts attention to the project, channeling AXS to AXS community members that are staking as well as short-term yield farmers, who are likely to sell AXS when the yield declines.

$AXS APR is still high at 45%, though declining, which may eventually deter short term yield farmers. Only in October, Sky Mavis (the developer company) staked 11,475,000 $AXS decreasing APR from 60% to 44%. This was a controversial move and not popular with the community. In doing so, Sky Mavis retains the right to say they have never sold their AXS fund on the market, but may well do so with the staking rewards received.

Governance

Axie governance up to now as been centralised with all decision making being done by the developer, Sky Mavis. It is the roadmap to eventually decentralise governance, yet narrow governance has, according to Sky Mavis, been required for efficiency. They refer to this policy as progressive decentralisation.

As visible from the figure above, once governance is actively assumed by those in proportion to their AXS holding, there are many uncertainties as to the direction of the game. It is imperative there is a strong community around the game by then in order to action a successful decentralised roadmap. Sky Mavis are aware of this and are in no hurry to decentralise, stating they have not even found product market fit with Axie and so are in the earliest stage of decentralisation. One criteria to move into stage 2 of their decentralisation roadmap is “an Axie game that has over 10 million DAU (daily active users) and average weekly growth rates of 5% for 6 consecutive months or 8 months out of 12 over a 12 month period”. If this is not achieved by the end of 2023, “Sky Mavis will lead the formation of a steering committee or similar vehicle to discuss a path forward.” Given that at the time of writing Axie’s Weekly AU's stand at 70,000 based on the new season leaderboard, 25,000 having earned 300 pts (suggesting a much lower DAU figure), decentralised governance will not proceed as planned, increasing uncertainty.

If Axie has a strong economy when decentralised governance arrives, generating healthy revenue, then this ownership and governance is valuable. Governance will preside over the Community treasury, revenues come from a combination of breeding fees (0.5 AXS per breed), marketplace fees (4.25%), and primary sales (land). More recently, revenue is also coming from minting runes/charms, and in the future additional revenue sources have the potential to be added.

The current status of the treasury is, however, uncertain itself. Axie was exposed to the largest hack in crypto history in March 2022, hackers exploiting the Ronin bridge and stealing 173,600 wETH and 25.5M USDC. Many Axie players lost funds, though have been reimbursed by Sky Mavis. The treasury lost 56,000 wETH and now stands at 1,487 wETH. The treasury’s wallet address can be found in the references at the end of this report.

Although the wallet says it contains 57,487 wETH, 56,000 of this was lost in the Bridge attack as ETH and the wETH is worthless. $30 million, about 10% of the stolen funds, was recovered from the hack in September 2022 and Sky Mavis representatives have confirmed that all of the recovered funds will be put back into the Axie DAO treasury. If the remaining funds are not recovered within two years the Axie DAO will vote on what to do with this treasury. The wallet also contains 22,000,000 AXS.

$SLP Tokenomics

Launched in December 2019, the current circulating supply is now 42.76 billion, with an uncapped maximum supply. SLP is the in-game utility token and is minted, entering supply, only through successfully playing the game.

A maximum of 14 SLP can be earned for each win, decreasing in line with matchmaking ranking (MMR) of the player. A middle of the leaderboard MMR win will earn 5 SLP.

In terms of demand, $SLP is required to ‘breed’ axies. Players pay $0.5 AXS and a variable amount of $SLP to breed two of their existing axie NFTs to create a new one. Axie NFTs can breed up to a maximum of 7 times and the required amount of SLP depends on the breed count of the two Axies that are being bred. The higher the breed count of the Axies that are used to breed, the more SLP is required.

When users grew rapidly in 2021 SLP surged in value as boarding users demanded it to breed Axies as a requirement to play. Minted SLP then surged as a result of new users earning it in-game. Those onboarded were primarily concerned with playing-to-earn and sold the SLP immediately. As growth slowed and demand for SLP decreased, just as minting was increasing, $SLP plunged in value as the mint/burn rate was completely out of balance. Axie developers twice increased the cost to breed Axies in September (below left) and in December (below right) to address the volatility of the in-game economy. The December increase tripled the breeding fee in SLP and halved the AXS fee from 1 to 0.5. The tokenomics was further out equilibrium since the AXS required to breed reached 80% of the total fee, far too much for what is designed to be the governance token.

If the quantity of new players grows → the purchase of new Axies grows → Axie prices go up → breeding profitability goes up → SLP/AXS demand for breeding increases → SLP/AXS prices go up

If the quantity of new players declines → the purchase of new Axies decline → excess supply of Axies → breeding activity decreases → reducing SLP/AXS demand and price

By February the increased SLP breeding fee had done little to support the collapsing price of the token and Axie developers acknowledged “the Axie economy requires drastic and decisive action now or we risk total and permanent economic collapse”.

Commencing in Season 20 that month, Axie implemented the biggest change in SLPs tokenomics to date. The games developers cut emission rates associated with several game features, such as “adventure mode” and “daily quest,” were reduced to zero from over 130 million SLP daily. This reduced the daily SLP token supply by 56%. Since, players have only been able to earn SLP in arena mode (PvP) when battling.

A lot of automated SLP farms were active, in which machines would earn SLP by repetitively completing mundane, simple non-competitive, player versus environment tasks. Pictured below, SLP was being minted in large quantities in the environment mode, because a maximum of 100 SLP could be earned per day.

By stopping this, SLP could only be earned through gameplay by active users, ensuring tokens were channeled into those providing value to the network. This was an area of tokenomics which was severely broken in Axie prior, leading to the large supply of SLP and the value extraction of its ecosystem by bad actors.

The launch of Axie Origins also commenced another SLP sink via the purchase of ‘power up’ Runes and Charms for axie characters. These cost SLP, along with another in-game item called Moonshards, and are removed from a players inventory and the end of each season, meaning repeat buying is necessary.

At present, the mint/burn ratio is negative, the circulating supply decreasing by 5-10 million a day for the last month. Looking ahead, the price of SLP will rise when the growth rate of economic activity exceeds its inflation supply rate, and this must be managed carefully. The developers have stated the importance of a large enough circulating supply of SLP in order to soak up demand surges from new onboarded users and repeating the price shock of 2021, which in-turn led to mercenary play-to-earners that value extracted from the economy, a feat Axie developers do not want to repeat.

Summary

The developers of Axie have been clear in their vision for Axie, which is to pivot from Play-to-earn to Play-and-earn. They are attempting to materialise their vision though the launch of Axie Origins, onboarding new users progressively from free features to the tokenisation of their experience. In a sense, Axies relative lack of decentralisation under the control of its developers offers a clearer framework to value Axie in the short to medium term.

Despite all the indicators of success appearing red currently, including DAUs, marketplace volume, and Axies minted, the tokenomics are in better shape than at the beginning of 2022.

Foremost, SLP is being channeled to those providing the value to the network, the players, with SLP farming of experience gameplay addressed. It is also incentivising the type of gameplay which is most addictive, PvP battles. Providing players find gameplay attractive, the increasing rate at which it can be earned in battle depending on matchmaking rank, should incentivise players to earn, and thus spend to mint better Axies, which are bred with SLP.

Once an engaged community member, it is then up to the player on their level of investment in the game and the community, though the incentive is there if they want to spend more. AXS rewards for high leaderboard ranking are provided in the thousands and a pay-to-win model is emerging. Whether this will be exclusionary for lesser players time will tell, but there are many examples of games employing this model and thriving. The additional benefit being that those ‘winning’, rewarded in AXS, have an opportunity at governance in the network. If however, the ‘progressive decentralisation’ roadmap is not implemented competently and in good time, the highest value adders of the network and holding AXS, may lose faith and exit the network.

Crucially, if there is not a governance feature of AXS and its staked APR continues to decrease, selling could occur because of its limited utility. This is even likelier to occur with no lock up period in place for staking. The staking pool stands at 78 million, 18 million AXS being unlocked yearly in staking rewards at its current rate.

At present, SLP is deflationary, with burning exceeding minting by 5 million a day. However, damage has already been done as circulating supply is 42 billion, and the deflationary rate may take a long while to impact price upwards.

With SLPs inflation under control, price increase will require economic activity on the platform. As always, fundamentals are fundamental, and whether Axie can onboard users in the ‘tens of millions’ as desired will be greatly consequential. If that growth occurs, SLP inflation will have to be managed with the creation of in-game assets to match growth to ensure runaway inflation doesn’t reemerge such as in 2021. Features such as Runes and Charms, as well as Land in its ‘Lunacian’ metaverse, are the assets being introduced.

All in all, Axies tokenomics stabilising, it is now the decisive moment regarding the onboarding of news users. Axie Origins promises this, though on-chain analysis will be the judge.

Resources

[1] https://jumpcrypto.com/token-design-for-serious-people/

[2] https://www.footprint.network/@Leslie/Axie-Infinity-Dashboard

[3] https://decrypt.co/109286/investigators-recover-30m-stolen-crypto-axie-infinity-hack

[4] https://explorer.roninchain.com/address/ronin:245db945c485b68fdc429e4f7085a1761aa4d45d

[5] https://axie.substack.com/p/community

[6] https://jessewalden.com/progressive-decentralization-a-playbook-for-building-crypto-applications/

[7] https://www.axieworld.com/en/economics/charts?chart=treasury

[8] https://www.playcore.io/games/axieinfinity

[9] https://twitter.com/jihoz_axie/status/1492212004219727876?lang=en