The Current Crypto Landscape
It's November 2021, and the crypto bull market is in full swing. Bitcoin just clocked in at an all-time high of $69,000. Michael Saylor is on CNBC, telling the world that Bitcoin prices "will just keep going up." Astonishingly, memecoins have eclipsed the market capitalization of multinational billion-dollar companies.
Many believe we're in the crypto super cycle, where digital asset prices rise steadily over an extended period, mirroring the behavior of equities over the past decade. This optimism was fueled by the first deployments in scalability from Layer 2s (L2s), advances in zero knowledge proofs (ZKPs), and Decentralized Finance (DeFi), with overcollateralized lending protocols accumulating billions of dollars and decentralized exchanges (DEXs) reaching trillions of dollars in cumulative volume. Non-fungible tokens (NFTs) also gained traction, cementing themselves in the collectibles community.
While this marked significant progress for attracting crypto adoption outside of speculative trading on centralized exchanges, the collapse of Terra Luna, an algorithmic stablecoin protocol, erased $40B in market value and triggered one of the largest liquidation cascades in financial history. The industry reeled as major CeFi players operating with questionable risk management practices, like Celsius, 3AC, Voyager, and BlockFi, fell like dominoes. And just when it seemed like things couldn't get any worse, FTX, one of the largest crypto exchanges, also collapsed, setting the industry back years’ worth of progress.
Where Are The Apps? Challenges and Opportunities in Gaming
Digital asset prices in aggregate plummeted by over 70%, and venture capital funding dried up, leaving the remaining survivors in the industry wondering: What's left? Where were the crypto apps that everyday people are using? This is a conundrum which perplexed many, especially since most private capital had been funneled into convoluted infrastructure, enterprise, and DeFi projects rather than consumer-focused applications. It is particularly puzzling given the currently limited userbase of decentralized applications (dApps). However, the answer might be found in one of humanity's oldest pastimes: games. Historically, following major technological advancements such as the advent of computers and smartphones, video games were among the first applications to gain widespread popularity.
Unfortunately, the volatile nature of crypto has created barriers and a challenging design space for game developers, overshadowing the genuine potential it brings to the table. In stark contrast to traditional finance—where liquidity events like IPOs often take years to materialize after realizing product/market fit and generating significant traction—crypto often offers rapid liquidity events in the form of tokens, sometimes even before a product is launched. This dynamic has shaped an industry driven more by price and hype cycles than by creating tangible value. At the peak of the 2021 bull market, many VCs and industry thought leaders latched onto the narrative of “Web3”-powered gaming and the metaverse, declaring its revolutionary potential. Consequently, gaming and metaverse-related tokens soared to valuations that traditional asset managers could only dream of. In some instances, crypto games released tokens without an actual game, achieving multi-hundred-million-dollar valuations overnight, drawing the attention of major Web2 gaming companies. For example, Ubisoft, in a seemingly hasty move, introduced cosmetic NFTs for “Ghost Recon Breakpoint”, only to face backlash from gamers already disillusioned by the industry's unrelenting trend of weaving in microtransactions and pay-to-win mechanics.
“Web3 is an evolution of the internet, emphasizing user ownership and control over data and assets. Built on blockchain principles, it’s decentralized, censorship-resistant, and interoperable. This moves beyond Web1’s read-only (static web pages) and Web2’s read-write (interactive web apps) eras by paving the way for a more user-centric digital future.”
In the bull market, the Web3 gaming pundits were not exactly wrong about the potential of integrating blockchains in games, but the crypto market is notoriously impatient. It flits from one narrative to another, often detaching from any fundamental valuation framework in pursuit of the latest trend. This mindset clashes with the gaming world, where quality games—those that resonate with a broad audience—demand extensive development timelines due to factors such as crafting intricate worlds, developing complex mechanics, producing high-quality art, huge engineering lifts, testing, and iterative refinements.
A typical AAA game undergoes a multi-year development process. Take, for instance, Cyberpunk 2077, a dystopian sci-fi RPG created by CD Projekt Red, took $174M and seven years to develop. Presently, many studios are leaning towards multi-year development cycles, aiming to produce games with longevity that can captivate players for decades.
Understanding Web3’s Role in Gaming
While the Web3 gaming narrative might have seemed premature during the 2021 bull market, now, after two years, the reality is that the development cycles for the first true AAA blockchain-enabled games are nearing completion. As the industry matures and hype cycles subside, these games could very well be the first consumer-centric crypto apps to achieve widespread consumer adoption. This, however, begs the question: Why incorporate Web3 mechanics into games at all? Traditional video games have thrived for decades without blockchain integration. Players have enjoyed immersive worlds, competitive multiplayer matches, and enthralling storylines without ever needing tokens or NFTs. Why start now?
One of the primary motivations for game studios or investors to embrace blockchain-enabled gaming lies in its potential to introduce novel business models and creative methods to engage players, leading to increased revenue and user loyalty. However, the average gamer remains skeptical of Web3, often perceiving it as a gimmick or scam. This skepticism isn't unwarranted. Many early Web3 games followed the play-to-earn (P2E) model, leading most game tokens to plummet in value as players “farmed” rewards and sold them on the open market—enriching few and upsetting the community. This approach prioritizes financial incentives over entertainment, ultimately leading players to liquidate their assets and destabilizing the game economy. Such dynamics tainted the reputation of Web3 games but paved the way for a new generation of Web3 games that balance sustainable token economies with pure entertainment.
By eliminating P2E mechanics and focusing on creating a game that is both enjoyable and economically balanced, Web3 can redefine a player’s value, fostering a symbiotic relationship between the studio, its backers, and—most crucially—the player. Traditional business models optimize for value extraction. In these models, studios and their investors dictate the path of a game’s development, revenue model, and in-game economy to maximize profit. Web3, however, shares this power directly with the players, enabling them to become active participants in game production and economics. They can freely earn and trade assets on a blockchain, influence game development, and gain tangible value from the time and effort they invest in the game.
Many gamers today understandably want to avoid crypto gaming elements. However, a truly balanced Web3 game makes these elements optional and additive to the gaming experience, instead facilitating an apparatus to fund the development of higher quality games while giving players a formal avenue to express their desires. By intertwining in-game economies with real-world value, Web3 opens up a novel avenue for funding game development. Instead of seeking traditional funding which can be challenging for unproven or experimental game ideas, developers can tap into the inherent value of in-game assets and economies with token and NFT sales. This approach not only democratizes how games are funded but also allows for more sustainable free-to-play models, with the game's economy itself covering a game’s development expenses instead of relying on initial purchase prices or intrusive ads.
Web3's power in gaming hinges on the genuine ownership of in-game assets, epitomized by NFTs. These digital collectibles, which can be traded and utilized from a crypto wallet across different games and platforms, bestow upon players a new level of economic control.
This tangible ownership deepens a player's connection to a game; assets in an open, permissionless environment inherently possess greater value than ephemeral items on centralized servers. Gamers, who pour countless hours into leveling up characters, unlocking achievements, and climbing leaderboards, have traditionally been at the mercy of centralized systems.
In the past, if a game was discontinued, all their in-game data likely vanished forever. For example, after two decades, Asheron’s Call, a popular massively multiplayer online role-playing game (MMORPG) with a dedicated fanbase and extensive lore, shutdown, leaving fans with nothing more than memories of their favorite game. NFTs help to upend this dynamic. By offering on-chain ownership, they not only elevate the gaming experience but also shield players from the vulnerabilities of centralized game infrastructures. If Asheron’s Call characters were saved on-chain as NFTs, users would have a permanent record of their progress, and any new game in the future could easily give players credit for their old accounts.
Beyond NFTs, game studios are embracing Web3 through fungible tokens or in-game currencies. While in-game currencies have existed for decades, with games like Eve Online pioneering intricate in-game economic systems, blockchains introduce an open economic system. It fosters a player-driven economy where in-game currencies carry value that can be transferred off-chain into fiat currencies. Gamers, by investing time or money, can become genuine stakeholders in their favorite games, amplifying the voices of gamers through token ownership.
Token-based game economies can also shift the current game development paradigm from centralized control and unilateral decision-making by developers to a more holistic approach that directly iterates on community feedback. In this way, Web3 gaming can drastically improve player engagement and retention by allowing users to partake in the game's ongoing maintenance and governance via the Decentralized Autonomous Organization (DAO) model. DAO governance gives gamers a natural path to supporting the development direction of the game, including the right to propose new features and vote on various aspects of game updates based on how many tokens they own. Such deep involvement fosters a loyal and invested player community, ensuring the game's sustained success.
Conversely, a lack of community involvement in game development can lead to a significant disconnect between studios and players, often alienating players from franchises they are most passionate about. A stark example of this is evident in the evolution of the Halo franchise. Originally created by Bungie and celebrated as the highest-selling video game franchise exclusive to Xbox, its development was later assumed by Microsoft’s 343 Industries. This transition saw design choices that diverged from Halo's core elements, cherished by its long-time fans, resulting in widespread community disenchantment and, in its latest installment, a 98% decline of its player base on Steam.
Web3's decentralized governance approach offers a solution, aiming to bridge this divide by fostering a harmonious relationship between developers and players through collective decision-making. While traditional feedback mechanisms such as internet forums have existed, Web3 token models now present an economic reason for players to actively discuss a game’s direction.
Lastly, User-Generated Content (UGC) has become an integral part of gaming, fostering a strong sense of community and increasing player engagement. This, in turn, can sustain a game's appeal over a prolonged period. In Web2 games such as Grand Theft Auto, Minecraft, and Skyrim, dedicated modders have invested thousands of hours creating new in-game content, often without avenues to formal compensation or facing backlash from game studios.
For instance, Take-Two Interactive, the parent company of Rockstar Games, issued cease and desist letters to the creators of OpenIV, a revered modding tool for Grand Theft Auto V. This led to a surge of negative reviews for the game, prompting Rockstar to intervene and dissuade Take-Two from legal action. The absence of a supportive culture and infrastructure for creators to produce UGC has created a disconnect in recognizing and rewarding community contributors' value. However, with the advent of smart contracts and asset tokenization, businesses can encourage UGC in a way that rewards creators for their contributions, such as custom skins, maps, or entire game modes, while retaining some of the upside for themselves.
The Opportunity Ahead
While Web2 gaming giants are grappling with their place in Web3, and encumbered by the gaming communities perception of Web3, crypto-native studios have been quietly building some of the first AAA blockchain-based gaming experiences. The 90s marked an inflection point in gaming, birthing iconic studios like Blizzard, Valve, id Software, Bungie, and Rockstar that profoundly shaped the industry. In a similar vein, we see a new space emerging for studios who aim to rebalance and redefine a player’s influence within games.
Interesting Web3 gaming projects, such as Sanko GameCorp ©’s Dream Machine and fully on-chain games like Dark Forest, Sky Strife, and Primodium are already available to play. Yet, mass adoption of this novel design space might initially stem from games that emulate the experience of Web2 games and gradually introduce Web3 concepts. This approach may draw criticism from the hubris of crypto natives and decentralization maxis, however, two realities stand out: (1) the infrastructure to create Web2-like games with entirely on-chain logic is not yet fully developed, and (2) the average consumer likely does not care about decentralization—yet. In the context of Web3 gaming, achieving mass adoption might require compromising on hardcore cypherpunk values.
Below we highlight a selection of games that we believe to have high potential for retail adoption, offering experiences comparable to blockbuster Web2 games while delicately balancing Web3 mechanics to strengthen the user experience: SHRAPNEL (Q4 Early Access Release - test game footage below), Off The Grid (Q4 Release), My Pet Hooligan (Public Early Access), Metal Core (Q4 Release), Illuvium (Beta Live), Cloud Castles (Release Date Not Yet Announced), Midnight Society (Pre-Alpha Access), BLOCKLORDS (Soft Launch in September), The Watch (Q4 Beta Release), Are You Faster (Q4 Beta Release), and Sipher (Q3 Closed Alpha).
Conclusion
Crypto’s development, marked by dizzying highs and setbacks, underscores a search for use cases beyond financial services. The astonishing growth of 2021 ushered in optimism, only for it to be curbed by the collapse of large market participants and significant price corrections.
Yet, the often-overlooked undercurrent is gaming—an area where blockchain has a chance to redefine consumer engagement. While early ventures into Web3 gaming were met with skepticism due to flawed tokenomics, a shift towards integrating Web3 without compromising the integrity of the gaming experience reveals its potential. True blockchain-powered games offer not just ownership, but an empowered community where players participate in its success. These games don't simply latch onto the crypto trend, but instead weave it into their infrastructure to enhance both gameplay and player agency.
As with any nascent industry, many projects may fail. However, the depth of design and caliber of teams we have met in the last three years suggest that numerous successes are on the horizon. As the industry continues to mature, gaming may finally bring widespread adoption of crypto apps.
Where are the apps? Here, almost.
Disclaimer: This post is for informational purposes only and is not intended as investment advice, an endorsement, or an opinion regarding any specific product or service. The views and opinions expressed are solely those of the author and do not necessarily reflect those of Varys Capital or its affiliates. Varys Capital is an investor in SHRAPNEL, which are mentioned in this post; however, this investment relationship does not influence the independent thoughts and opinions expressed by the author. Varys Capital and its affiliates, employees, or agents make no representations or warranties as to the accuracy, suitability, or completeness of any information presented. Investors and readers should conduct their own due diligence and consult with a qualified professional before making any investment decisions or taking any action based on this content. Past performance is not indicative of future results, and investing involves risks, including the loss of principal. Neither Varys Capital nor any of its affiliates or agents shall be liable for any loss or damage arising from reliance on this information.