Penetrating the X-To-Earn Ponzi Scheme: Finding Balance Between Finance, Team Control, and Utility

Written by: Sakurajima Mai

Compiled by: Deep Tide TechFlow

TLDR:

1. X-to-earn is fundamentally different from the Ponzi structure of Web2 in both economic systems and organizational structures; the term Ponzi does not always imply a scam.

2. The speculator effect, lack of timely control, and failure to provide sustainable utility are three core reasons many X-to-earn projects struggle.

Tokenization is a unique tool of Web3 that has stimulated rapid growth in this market. It brings users a stronger sense of participation and interest alignment, while also serving as an incentive tool that grants projects almost unlimited freedom to earn from becoming a protocol or anything else. It is no wonder that X-to-earn has become a hot topic in the L3 (application layer) space.

Undoubtedly, I love X-to-earn: for example, STEPN. I enjoy going to a local restaurant with my girlfriend, and what makes me happy is that I can earn back the money for the meal on the way there and earn back the tip on the way back. I also believe it can help combat the increasingly obese world in a way that resonates with human nature.

However, as I fulfill my VC responsibilities, the more I interact with the development teams in the X-to-earn space, the more I feel something is off. I believe we have not fully grasped the tools we are currently using. This is dangerous both theoretically and practically.

Take Gamefi as an example; by integrating P2E, blockchain games have gained an unprecedented financial tool to guide, incentivize users, and increase revenue. Yet, most development teams seem to underestimate the complexity of designing token-driven economic systems, with some even enriching their own pockets at the expense of the long-term interests of the entire market. I won't name names, but a considerable number of projects are focused on how to more easily put money in their own pockets. These "games" created by teams with pathological intentions and insufficient knowledge are not fun, and often you get nothing from them. In the worst-case scenario, a rug pull occurs, and everything disappears.

Since May 10, 2022, the decline in all token prices has had catastrophic consequences, but it has also cleared out the trash in the market and provided serious project developers with an opportunity to start over. In this article, I attempt to dissect the essence of X-to-earn and discuss why many X-to-earn projects fail based on my observations, hoping to remain optimistic and serve as a guiding light for developers.

The Essence of X-to-earn

It can be concluded with certainty that most of the Gamefi mentioned above are imitators of Axie Infinity. Axie popularized P2E, leading to the emergence of X-to-earn.

Many people say that Axie is a Ponzi. At first glance, it does have some Ponzi characteristics, but we need to remove some ambiguity from this term, Ponzi ≠ scam.

A Ponzi, in essence, is merely a financial structure that transfers the value provided by later participants to earlier participants. Whether it is a scam actually depends on the details within the system.

In fact, from a structural perspective, pensions are the largest Ponzi in the world, yet they are an indispensable positive part of our social security: you pay for those before you, and those after you pay for you. Note that this is an abstract generalization of how actual pensions operate, but you get the gist of what I’m saying.

Now think about all the X-to-earn projects out there. If you read their white papers, you will find a common assumption: the prosperity of the project and token depends on more people using the product.

Now consider this: the narrative of Web3 essentially states, "early supporters believe in a project, participate in its growth, and everyone shares the rewards." I think the former assumption is logical, and the spirit of the latter is commendable. However, when you combine both with supply and demand, you have a Ponzi structure.

In summary, my first thought is: the Ponzi structure is a natural component of any X-to-earn system design.

Current facts:

1. There are many participants in Web3, but they are still a minority compared to the larger internet;

2. Tokenism naturally incorporates the minting rights into the fundamental elements of each project.

These two factors reduce friction and barriers to transactions.

I want to point out this Ponzi nature first because it is simply an inevitable component of all X-to-earn projects, whether these projects aim to make money or intend to navigate the ocean of Web3. However, there is evidence that some X-to-earn Ponzis persist while others cannot last even six months. Why is that? It is also true that X-to-earn Ponzis are fundamentally different from traditional Ponzis; why is that?

Determinants of X-to-Earn's Fate

We can evaluate a project by considering its timing, team, and product-market fit. However, these criteria seem outdated and insufficient for tokenized projects.

I believe the reasons many tokenized projects (of which X-to-earn is a part) fail can be summarized into three interwoven factors:

1. The speculator effect and the consequences of pump-and-dump

2. Lack of timely control by the project

3. Failure to provide sustainable utility

The most common demise of price-driven projects I have seen goes like this: the market is good, speculators come in -> token speculation becomes emotional, prices pump -> speculators sell -> token prices drop -> fear leads actual users to sell -> token prices drop further -> prices fall below a critical threshold -> users have no reason to stay on the platform due to minimal economic returns -> Game Over.

Let’s take a closer look at each.

The Speculator Effect and the Consequences of Pump-and-Dump

When we say a token is pumped up by emotional speculation, essentially, the token's price does not reflect the project's real value. When the rise in token prices is not supported by loyal users or substantial actual usage, but instead driven by speculators, emotional traders, or market exuberance, the project finds itself in a precarious high.

This is where the X-to-earn Ponzi system becomes interesting. Most Ponzi schemes in the real world typically have participation restrictions; you usually need to be introduced by an insider before entering.

This creates a barrier to entry and a closed economic loop where value is highly retained unless participants in the system intentionally exit. This almost presents one outcome: the risk of a Web2 Ponzi is discontinuous; if the system collapses, early participants face minimal risk, and they have no economic incentive to reinvest in the system.

However, because X-to-earn is naturally nested in a free trading market and based on digital assets, the value transfer system is no longer like a traditional pyramid.

In an X-to-earn system, the value cycle is no longer closed, nor does it strictly move upward; transaction friction is relatively low, early participants can re-enter the game, and value can easily exit the economic system. This means speculators can participate only in the "earning" part without engaging in the "X," allowing them to buy and sell easily, which disperses risk among everyone, making it possible for early participants to lose money while later ones profit. This is unimaginable within a traditional Ponzi.

To address this speculator effect, protocols have designed preventive systems to varying degrees. Stablecoins and DeFi protocols have often invested considerable effort in this area: a stablecoin protocol called TiTi uses simple game theory design to prevent decoupling during tough times.

I believe that for these finance-centric protocols, preventive systems are normal because you wouldn't expect a financial service institution to frequently and arbitrarily adjust sensitive parameters. However, on the other hand, X-to-earn projects often lack these measures, which may be a core reason why some early "Write to earn" and "Comment to earn" projects quickly faded from the scene.

However, there are exceptions; the currently popular project Stepn, while not necessarily having an algorithmic preventive system, has proven through special in-game events that it can indirectly adjust the supply and demand of tokens, as evidenced by its effectiveness in stabilizing GST and GMT from April 27, 2022, to May 5, 2022. Although the overall market has been declining since then, and GMT has also dropped, that is another matter. Let’s see how the team responds, especially after Mable Jiang recently joined as CRO (Chief Revenue Officer).

Despite all the practical discussions, we must acknowledge that on a psychological level, it is difficult for entrepreneurs to detect/resist such erroneous price pumps: no project team can refuse to see their project grow by dozens of times.

I know that Web3 has some unknown disdain for Web2, viewing them as exuding the stench of the old world. But returning to the stock market—TradFi's core—we have observed countless times overvalued companies fall into a hollow death spiral caused by overvaluation. In this more turbulent Web3 market, pioneers should certainly learn from their lessons.

Lack of Timely Control by the Project Team

Axie Infinity is an example of this. The team's strategic adjustment to integrate with the Ronin chain to sustain the game has potential to break free from the Ponzi shackles, but it is not enough; the token price has not been strictly regulated, and the bear market since November 2021, coupled with security vulnerabilities, has pulled the project further away.

Some projects influence token prices through direct inflows/outflows of funds from liquidity pools, while others adjust them indirectly through technical operations. It is best to study individual examples to understand how to best execute control details.

Here, I want to discuss something deeper, addressing a philosophical dilemma faced by some founders: the centralized control from the team contradicts the ideologically upgraded DAO management model, as it goes against the spirit of Web3.

Of course, DAOs are a novel, popular, and democratic model that resonates with Web3. I think it is not wrong for people to adopt this model to varying degrees. However, the same fact is that when founding teams do not strictly define what can be managed by a DAO and what cannot, they often fail to establish a truly sustainable financial system.

In short, I believe that trusting the crowd on the most important decisions is an unstable behavior, especially when the decisions involve the core of token economics.

The Web3 community seems to share a common trait; we tend to talk more about the bright side of DAOs rather than the serious side. This sends a dangerous misleading message to founders, as even if a project operates largely on a DAO model, the founding team, rather than the crowd, bears ultimate responsibility for the project's fate (voluntarily or under public pressure). The excessive decentralization of power from the management team can actually harm the long-term prospects of the project, especially during bear markets, where it is crucial for founders to maintain a balance between team operation and decentralization.

Decentralization means dispersed responsibility, and like in other situations, we cannot and should not blame the crowd.

Essentially, the debate over how much control should be exercised centrally versus how much should be exercised by the DAO is akin to comparing constitutional democracy and majority democracy. While building a Web3 project is different from governing a nation, once a founder decides to take the democratic route, he/she must continuously collaborate with and contend against the crowd, adjusting his/her governance philosophy around the crowd.

The United States chose to become a constitutional federal republic, while Stepn decided to lean towards centralized governance. Nevertheless, both retain appropriate powers for timely control over the underlying financial system and indeed exercise control. Regardless of the ideology under which future X-to-earn projects operate, founders should pay more attention to the importance of timely control.

Moreover, I am not saying that DAOs are bad, but founders should first have a solid and comprehensive understanding of what they are going to use before attempting it. Perhaps centralization is not as "evil" as it seems?

Failure to Provide Sustainable Utility

This is actually quite a tricky issue because humans tend to be overly optimistic about the short term but excessively pessimistic about the long term. In the context of Web3, we are saying: people praise Web3 projects regardless, especially when they embody paradigm shifts, while the sustainability of the logic/trends behind this paradigm shift tends to be overlooked.

This issue was reflected in the SocialFi/ContentFi narrative a few years ago: people said that token protocols like Rally.io, Chilliz, Decentralized Social, WhaleShark, Obyte, SocialX, ForeFront, etc., marked the advent of a revolutionary era of Web3 social.

I agree that tokens are a good way to allocate benefits and connect fans with creators, but if you analyze the data, you will find that the enthusiasm surrounding these utility protocols has understandably diminished. Indeed, unsustainable utility is not the only reason for their decline. We fundamentally lack a reputation layer to discern people, the adoption rate of cryptocurrencies among the public remains low, and we lack other foundational infrastructures and protocols.

But no one denies the fact that it is quite common for creators to stop using these token protocols after trying them, as the return on usage is not sufficiently incentivizing: the promises are appealing, but in reality, the utility output is vastly overestimated and exaggerated.

However, I still believe in SocialFi and ContentFi; I just think they need more experience to truly define future trends.

Now back to X-to-earn, I am still trying to build an argument around what actual long-term utility any X-to-earn project can provide. Perhaps ultimately X-to-earn is just a great way to get more people into Web3, which is the achievement of Stepn, but I am not sure.

I firmly believe that even if an X-to-earn project can become a unicorn, if it lacks a clear, previously undiscovered, sustainable utility and chooses to remain a bubble, it will eventually fade from the historical stage.

However, when we set aside the issue of sustainable utility, we also face the problem of the leader and its imitators.

Axie Infinity is undoubtedly a leader, with countless people claiming, "We improved Axie," creating games that imitate Axie, but of far inferior quality. With Stepn's daily active users exceeding 530,000, 7-day active users over 1.1 million, and monthly active users over 2.3 million (data from May 5, 2022, sourced from MateRun Dao), countless imitators have created similar games, and even Adidas has joined this track.

Imitating good projects is a natural phenomenon, but most X-to-Earn projects currently, regardless of the order of their emergence, are essentially token mining machines with different yields. If it is an imitation, it already has a temporal disadvantage; if it does not have a truly unique advantage to attract players to voluntarily switch or does not strive to maintain a higher yield, it will be quickly eliminated.

I think there is no need to study how these three reasons (speculators, control, utility) intertwine: in the face of any speculator's impact, an X-to-earn project without strict financial control from the team is overly fragile against the speculator effect.

In summary, whether in Web2 or Web3, entrepreneurship is no different. Aspiring entrepreneurs still need to build a meaningful product. Compared to Web2, founders need to have more vision and courage, be able to exert control, and resist the dangers disguised under charming bubbles. Risks are more common in Web3, but as long as one becomes a friend of time and patience, on the path of ascent, one will ultimately leave their mark and legacy.

Conclusion

This text has already been long enough, but before I end, I want to share some scattered thoughts.

The failure of any X-to-earn project is always multifaceted. Besides the three reasons mentioned above, sometimes we face situations where Citadel shorts the entire market, and no matter what remedial measures we take, we are ultimately powerless. In this bear market, some newly launched tokens may not even experience the phase of a spike and drop, and this situation is becoming increasingly frequent. How should we resist these large hedge funds and mitigate the negative impact of trading activities on project building? It sounds like a question that transcends the scope of Web3.

Regarding the ethics and attitudes towards Ponzis: I believe readers should decide for themselves whether to associate with X-to-earn Ponzis. My current personal view is that Web3 is a once-in-a-lifetime opportunity; in an uncertain world, we are all dark horses, and not breaking the rules in the gray area while accumulating wealth is a decent choice. Just ensure 1) do not gamble with money you cannot afford to lose, 2) do not be a jerk or a scammer.