What Can Web3 Games Learn From Night Club Economics?
Last month we got invited to a crypto party at NFT NYC. The party was top-notch in terms of production quality, live performance, and venue. Everything was great but there was something unusual. Crypto events/parties are typically known for having a lack of women due to the lack of women in the industry.
Yet this party had a well-balanced female:male ratio. More surprisingly, women attending the party seemed overly attractive and well-dressed compared to the average female crypto event attendant.
Who were they? Why were they there? And most importantly, how would their existence impact the behavior of the average crypto event participant?
We’re going to cover:
- Web2 Game Economics
- F2P Game Economics
- Night Club Economics
- VIP Night Club Economics
- Whales & VIPs
- Paid Participants
- Web3 Game Economics
- Problems with Play-to-Earn & Play-and-Earn
- Gold Farming Problem & Blue Collar Grinders
- Which Players Should Get Paid?
Web2 Game Economics
Before the mass adoption of smartphones and the growth of the mobile gaming industry, a game was sold in a box at retail outlets at a fixed price. You would pay $50 to buy the game regardless of whether you loved the game or hated it, whether you consumed the whole content in a weekend or over multiple years, whether you were willing to spend much more or could barely afford it.
The 2 main actors were the game developer and players. The game developer created the content and sold it for a fixed price whereas players paid for the content to finance the game development & distribution. The relationship was simple and straightforward. The game developer had financial motivations whereas players had physiological motivations.
There were other actors as well such as retail distribution platforms and hardware producers but we will ignore those as they are out of this article’s scope.
F2P Game Economics
The mass adoption of smartphones led to the rise of the mobile free-to-play gaming industry. These games offered some content for free and some were premium. Mobile allowed game developers to collect, analyze and test user behavior which enabled them to optimize what % of content should be free vs paid in addition to what the pricing should be per premium content and per type of user.
The 4 main actors of a F2P game are the game developer, players, whales and advertisers. The game developer creates the content, players play some content for free, watch ads and/or pay to play some of the premium content, whales spend huge sums of money to get access to the premium content, advertisers pay the game developer to show ads to players. The game developer and advertisers have financial motivations whereas players and whales have physiological motivations.
There are also intermediary platforms that facilitate distribution, transactions and payments such as ad platforms (Facebook, Unity), app stores (Apple, Google) and payment processors but since our focus is on the interaction between the players, we will ignore ad platforms and app stores.
For some F2P games, +50% of revenue comes from 0.15% of the players and +95% of revenue comes from 2%. These figures show how crucial whales’ retention and spending behavior is for the financial viability of a game. In other words, whales subsidize the game for the remaining 98% who don’t spend at all or spend relatively less. Advertising revenue standalone is typically insufficient to cover the development and marketing costs.
Not all games have the same revenue distribution, some games might have a spending distribution where the top 25% represent 50% of revenue. There are also games that solely rely on advertising revenue such as hypercasual games.
Night Club Economics
Non-VIP night clubs and bars have straightforward economics. There is a price list for each drink and each client would have to pay a fixed entry price and the same price for any given item on the menu regardless of whether you are a billionaire or a homeless guy, whether you are a 20 yr old supermodel or a 80 yr old grandma.
The 2 main actors of the non-VIP night clubs are the club operator and participants. Club provides a venue with drinks, food and music, whereas participants pay for the entry and drinks/food to finance the club operator’s operations. The club operator has financial motivations whereas participants have physiological motivations.
The club operator doesn’t directly create content but provides a platform that allows participants to create their own user-generated content which attracts/retains other participants just like a social media platform such as Instagram or Twitter. Our definition of content here is every social interaction that results in the increase of certain emotions and physiological chemicals in one or multiple participants.
The glance of one participant to another, the dress one wears, and the way one dances or drinks are all considered content produced by users and have an impact on other participants’ experiences. It affects whether participants have positive or negative emotions associated with the club which will then affect their engagement, retention and monetization.
VIP Night Club Economics
On the other hand, VIP night clubs have a slightly different business model. VIP clubs enable those who want to pay more and have access to premium services to get the physiological desires they seek. The 3 main actors of a VIP night club are the club operator, participants and VIPs.
The club owner provides a venue with drinks, food, music and a rule set of premium and non-premium services. No matter how interesting the venue’s design, music, drinks are, the venue’s own content can only have a limited impact on the participants’ experience whereas the user-generated content created as a result of the rules set by the club operator (such as VIP table prices, bottle service prices, dress requirements, etc.) can have a large impact.
The club operator has financial motivations whereas participants and VIPs have physiological motivations.
The VIP night club economics is similar to a F2P game except there is no advertising. Yet, some F2P games also don’t have ads and some VIP night clubs do have sponsored drinks and billboard ads.
Whales & VIPs
The physiological needs of human are timeless and universal. The caveman from 100k years ago, the lord from 1k years ago and F2P whale today all crave the same physiological needs and are subject to similar compulsion loops.
VIPs are similar to F2P whales — they spend huge sums of money to get access to premium content. Just like F2P whales, VIPs are also human and have emotional needs. Venues, methods and tools might change from physical to digital but the fundamental needs don’t.
F2P whales spend because they want to acquire a desired emotional end-state — even though the game developers might not completely understand which emotions they want or which chemicals are created throughout the process, by conducting A/B tests throughout the game design process, game developers are able to engineer player behavior to maximize retention and monetization.
We don’t have access to the spending distribution curve of VIP night clubs but let’s assume that an average whale spends $10k per night while the average participant spends $100. Assuming the club has a capacity of 2 VIP tables and 198 non-whale participants; the 2 whale tables that represent 1% of the attendance bring in +50% of the revenue.
Now, let’s imagine a case where the VIP club isn’t doing very well in terms of traction — VIP tables are seldomly booked, neither VIPs nor non-VIP participants don’t spend as much as at other VIP clubs. The management thinks about existing options to boost revenue; spend more on influencer marketing, offer discounted drinks/entries, etc.
But there is one other idea…
Club management can pay some potential participants to attend the club with the aim that their existence can attract more VIP spend (thus, higher revenue). Assuming VIPs are typically male, in this case, the potential participants that could increase VIP spend would be young female fashion models.
Club management would need to find and more importantly convince the models to participate. Based on the Economist article, to convince models, club operators offer direct rewards such as money, luxury gifts, expensive dinners and/or indirect rewards such as the promise of social status through access to celebrity VIPs.
For simplicity, let’s assume that models are incentivized with money but there is a possibility that once the night clubs enjoy network effects where top VIPs become regular participants, it is likely that indirect rewards might be sufficient to attract the models without any direct monetary incentives.
So now we have a new category of participants, let’s call them paid participants.
The existence of paid participants could potentially increase
- VIP spenders
- Non-VIP to VIP conversion ratio
- Average $ spent per VIP per night
- VIP retention ratio
As long as the incremental monetary benefits (LTV) of having paid participants are higher than the cost paid to attract/retain paid participants (CAC), then that is an ROI-positive investment for the club operator.
E.g. If the existence of one paid participant which cost $1k per night, makes the VIP spend an incremental $2k more per night then the incentives given to invite paid participants yields a positive ROI.
Keep in mind that the paid participants are not a one-off expense but more of an ongoing expense as paid participants can churn if they are not constantly getting financially incentivized and VIPs can churn if there aren’t enough paid participants around.
After scrolling through Crypto Twitter, we got convinced that the women invited to the crypto event mentioned at the beginning of this article were financially incentivized to participate with the hopes that their existence could increase the experience and retention of the average crypto participant.
Web3 Game Economics
Web3 games enable game developers to reward players with tradable assets (tokens/NFTs) which can be sold for real money on permissionless on-chain exchanges and marketplaces. Thus, the game developer is able to incentivize certain player behavior with direct financial incentives.
The 5 main actors of a sustainable Web3 game are the game developer, players, whales, paid players and advertisers. The game developer creates the content, players play some content for free, watch ads and/or pay to play some of the premium content, whales spend huge sums of money to get access to the full content, advertisers pay to show ads to players. The game developer and advertisers have financial motivations whereas players and whales have physiological motivations.
Paid players on the other hand are a new breed of players. The game developer is able to cherry-pick the players that will be rewarded based on the desired behavior. The idea is that in the long-term benefits from financially incentivizing paid players will outweigh the cost. This could be through either paid players being converted into players/whales due to the ownership or loyalty aspects (and end up spending more than what they had previously earned from the game) or the existence of paid players positively impacting the LTV of other players/whales.
Problems with Play-to-Earn & Play-and-Earn
Arguments around play-to-earn in 2021 have been around players deserving to get paid for their time and effort.
A player who spends months leveling up his RPG character to level 1000 should be able to sell that character/item/gold when he wants to stop playing and should be able to monetize that time and effort.
The proposed argument is that the game developer makes fat margins and doesn’t share any of that with players who spend hours playing the game.
But why does the player deserve to get paid? What value does that player add by spending 4 hours a day playing the game for 2 years and by leveling up a character to level 1000? And more importantly, if everyone is getting paid to play, where does that money come from?
Let’s imagine a case where an OG who leveled up a character to level 1000 has decided to stop playing the game and wants to sell the character to monetize. A newbie who is impatient to play the game for months to level up a character, wants to play with that level 1000 character immediately.
If a newbie pays $200 to the grinder to buy the level 1000 character, how would that affect the newbie’s experience and LTV?
It is likely that the newbie’s progression from level 1 to 1000 is when the compulsion loop kicks in repeatedly to form a strong bond with the player and the core game loop as the player associate the core game loop of killing monsters to gain XP/items to level up with positive desirable emotions.
Thus, most likely the newbie will churn after a few weeks because of boredom. If the newbie went through the full progression curve towards level 1000, maybe would still be playing.
Let’s compare the economics of each scenario
A: The newbie pays $200 to the OG, plays 2–3 weeks, then churns to another game. During this time the newbie doesn’t make any microtransaction purchases and brings in $1 worth of ad revenue. The game developer charges 5% from the secondary sale and earns a total of $11 from the newbie while the OG pockets $190 from the transaction.
B: The newbie starts from scratch, goes through the full progression curve towards level 1000 although makes some microtransaction purchases along the way and plays the game for 2 years. The game developer makes $500+ from microtransaction purchases and ad revenue while the OG doesn’t get any financial value.
In F2P games, the microtransaction items that will enable a newbie to skip the progress and level up to 1000 immediately are priced in a way so that it exceeds the cumulative revenue that the newbie would have brought throughout his lifetime as a player (ad revenue + microtransaction purchases + extended lifetime).
In scenario A, the OG doesn’t add any value to the ecosystem. The game becomes less fun for the newbie who churns and the game developer who is responsible for reinvesting back into game development has less money to spend. Scenario A poses a significant loss to the game developer on a unit economics basis.
Gold Farming Problem & Blue Collar Grinders
There is a famous American quote that got popular in the Great Depression Era
There is no free lunch
Just because someone spends time and effort doing something doesn’t mean that person deserves to get paid. There needs to be a market willing to pay for that specific service. There is a reason why an NFT 3d modeler could earn a construction worker’s 1-year salary in 1 month even though the effort spent is dramatically different. Every service has its own supply & demand dynamics. Time & effort spent to grind to level up a character is typically a low-value add service that could be easily commoditized as it requires almost no barriers to entry and no experience/education.
In a previous article, we argued that the minimum wage for the grinders will be determined by a discount on the poorest country’s minimum income — why a discount? Because the minimum wage is an artificial floor determined by the governments — unemployment + child labor + working at home with little stress is better than driving an Uber are factors that will lead the grinder wage to be lower than the poorest country’s residents that play the game.
The moment there is an opportunity for someone to game the system and make money, that opportunity will be fully exploited until there is no money left to be made.
The sharks can smell blood underwater no matter how far they are
The industrialization of gold farmers has always been a problem for the gaming industry as the nature of the business is based on extracting value. E.g. I find 20k underaged blue-collar workers in Ethiopia, pay them $1 per day to play a game 24/7. Assuming the average worker levels up a character from 0 to 10 in a day and I’m able to sell a level 10 character for $3; I can make $4k a day. The rationale next step for me would be to continue finding more workers and scale the business until there is no opportunity to make money from the game.
Meanwhile, the game economy is messed up because there is massive hyperinflation that undervalues items that normal players earned through playing the core loops which impacts the compulsion loop and progression that makes the game fun. Players feel frustrated as they feel it is unfair that the rare sword that they should be rewarded through gameplay, goes to a gold farmer who sells it on the grey market to another player.
Does that mean open economies within a game where in-game items could be sold for real money on a permissionless exchange will never work and the exchange of items for real money should be banned?
The default approach from the traditional gaming industry has been banning real money trade but we believe there is a way where an open game economy with a healthy secondary market can exist without damaging the player experience but a significantly proactive central bank-ish approach is needed to prevent the mentioned problems and find a balance to the force.
Which Players Should Get Paid?
There will likely be different paid roles in the future of gaming. Content creator streamers/influencers, game developers/mod creators and esports players have already been paid in the traditional gaming industry but web3 gaming might enable them to get paid more and in a more transparent way.
But more importantly, the new breed of paid participants itself will also be divided into 2 main categories; blue-collar paid players and white-collar paid players. Blue-collar players are those that grind to level up a character or earn items — e.g. Axie scholars.
White-collar paid players can potentially add value to a game and can validate the hypothesis that paying players will result in larger and more sustainable franchise value created for games. The main role of white-collar players would be providing necessary (and natural-feeling) social interactions to make other players spend more time and money within the game.
Twitch is the most popular video game streaming platform but “Just Chatting” is consistently the most popular category, bypassing billion-dollar gaming franchises. Social is the strongest retention source and is ultimately the main driver of 10yr+ gamer retention curves. (h/t Igor Bazhanov)
It is likely that jobs requiring social skills won’t be replaced by robots in the near future — we probably won’t need drivers, cashiers, waitresses, real estate agents, pharmacists but we will still need caregivers, psychologists, etc. AI will help guide pattern recognition and more tailored guidance for these service providers but humans will still desire social interaction.
A16z-backed EPal is a great example representing the future of gaming white-collar players. EPal provides a platform where players can pay other players to play games together — EPal calls it teammates on demand!
Disclosure: EPal was a previous client of Vader Research.
Through the VIP night club example, our main aim was not to recommend games to target male players by using female players as baits, the idea behind this article is to optimize the allocation of financial incentives in the hands of the right players to maximize game franchise value.
4X strategy games is a genre where the average whale spend is substantial — players mostly spend because they want to feel powerful, dominant and socially connected. The whales might share a guild with non-whale players where non-whale players are dependent and appreciative of the whale. This social dependency of existing guild members and rivalry between multiple guilds are some factors that make the whale spend more. If there were more of those social interaction resources, would there be more whales, or higher average whale spend?
Metacast podcast host Nico Vereecke gave an example of how he got satisfied when he heard the scream of a player he virtually killed while playing a shooter game. If more of the virtually killed players screamed, would Nico spend more time and money within the game?
A close friend plays Clash Royale regularly and every time she loses a game if the opponent sends a sarcastic emote, she gets frustrated and immediately wants to replay — which increases the average time she spends per session. What if more opponents sent emotes? Would she spend more time and money within the game?
In short, those who should be getting paid either should be the ones that add value to the ecosystem by increasing other players’ retention/monetization so they can numerically justify for what they are getting paid or they should be the ones that will end up spending more than they got paid.
Not all games will have an emphasis on social and in some cases, rewarding competitive players might have a higher ROI impact than rewarding social players. There is no one size fits all rule. This article was written to inspire game developers on how to allocate their limited incentives/resources in a blockchain-fueled open economy ecosystem.
None of this is financial advice. If you want to learn more about Web3 Gaming, follow Vader Research on Twitter and Spotify. If you want Vader Research to consult with your team on tokenomics, economy management and investment management, please reach out on Twitter.