Dialogue with Huo Feng Chen Yuetian: Only 3% of 167 high-quality game companies have transformed to Web3

Author: Wanwu Island ThreeDAO

On July 30, coinciding with Shanghai's ChinaJoy, Wanwu Island invited Chen Yuetian from Huofeng Capital to engage in discussions about Crypto games with 66 entrepreneurs from S1. As a seasoned investor with 10 years of experience in the gaming industry, spanning the Web1, 2, and 3 eras, and having invested in projects like StepN and Mask, what insights does Chen Yuetian have on the Web3 transformation of China's gaming industry? What are his views on the Web2.5 and full-chain competition? Below are some highlights from the Q&A session:

Wanwu Island: Why do you focus on investing in the gaming sector?

I graduated from Fudan University with a degree in Software Engineering in 2008, just as the financial crisis hit. At that time, many classmates chose to go to investment banks or consulting firms, as Chinese internet companies were not yet strong enough. I received an offer from Baidu upon graduation but chose to join Morgan Stanley's IT department as a management trainee instead. I was one of only two undergraduates in that batch; the others were master's and doctoral students from Tsinghua, Peking University, Fudan, and other top universities, all of whom were excellent. I worked in a research and development role and felt I couldn't compete with them in coding, but I still wanted to continue in finance. So, in 2010, I started studying for the CFA and began sending out resumes. In 2011, I joined CyberAgent in Japan as an investor, and after a year and a half, I moved to Innovation Works.

2013 was the true year of the explosion of mobile gaming in China, as there were a large number of investments and acquisitions in mobile games in the first half of the year. The gaming companies at that time enjoyed significant dividends. I spent that year meeting game producers in a café next to ChinaJoy, and I got to know miHoYo when "Honkai" launched in January 2013. I witnessed their journey from "Honkai Academy" to "Genshin Impact," as they grew from five people to thousands. I have been primarily investing in ACG and the second dimension track since 2013. Starting with my first project, I invested in over twenty companies at Innovation Works, and later co-founded Chenhai Fund with friends, investing in many gaming and pan-entertainment companies. In 2017, my wife began exploring blockchain as she was an LP funding various funds and received pitches from many Silicon Valley Crypto Funds, including Polychain and Paradigm, which she found interesting. At the Shanghai Blockchain Conference that August, we met many friends and witnessed a memorable pitch by He Yi and Zhao Changpeng to Professor Zhang Shoucheng about creating a cryptocurrency exchange, which felt very novel at the time. I then began making personal investments in blockchain.

If you are familiar with the angel investment community in mobile internet over the past decade, you will notice that this group has gradually disappeared. Those who made money over the ten-year cycle have left the circle, while those who did not make money have naturally vanished. I am one of the few remaining individual angels. Therefore, many people know that I continue to personally fund startups, leading to some good projects approaching me, including investments in Mask Network, RSS3, Jay Chou Bear, StepN, and others.

In 2021, I started Huofeng Capital, which is 100% my own institution, allowing me to focus on what I like. When determining the fund's direction, we decided on Crypto Games. During the communication process, I found that many in the Crypto space do not fully understand the operational logic of the gaming industry, so I believe I have a comparative advantage here. In 2022, Chinese gaming startups faced significant challenges, with the issuance of licenses halted for over a year, and overall investment in gaming stopped by the end of 2021. I felt this was a great opportunity to explore China's excellent gaming production capacity through Crypto. In the first half of this year, I have already invested in over ten projects.

Wanwu Island: Do Chinese Web2 gaming teams have a chance to transition to Web3?

Our logic for screening teams is to capture production capacity, so we definitely want to first secure the best production capacity and bring them in. We believe that the best Chinese gaming production capacity has not yet entered Crypto. The best teams have not come in, so we need to find the best teams. In the first half of this year, we focused on finding gaming companies that received investments from NetEase, ByteDance, Tencent, miHoYo, Bilibili, Lilith, and Eagle Horn in 2020 and 2021. We reviewed all the business registration changes and identified 167 companies, reaching out to each one for two-hour discussions to understand their status. After contacting 120 companies, our first impression was that most had already shut down. Of the remaining, fewer than five were fortunate enough to secure around 30 million RMB before or around the Spring Festival of 2023, allowing them to continue operations, with some able to survive until they received licenses and launched their games.

Among the remaining 30 or 40 teams still active, what are they doing? They are waiting for licenses, and their funding is tight, with only a few million RMB on hand, which cannot sustain them for long. Talents in the gaming industry are expensive, averaging 25,000 RMB per person per month. A team of 50 incurs a monthly labor cost of 1.25 million RMB, and if you include outsourced art, it doubles. The teams I interacted with that were waiting for licenses were still quite optimistic, believing they would be among the lucky ones to receive them. I use numbers to speak with them: there are 400,000 gaming-related companies in China, with 80,000 new ones established each year and 30,000 shutting down annually. Assuming there are 20 companies in the supply chain behind each game product, dividing 400,000 by 20 means there are 20,000 game products under development in China each year, while only 80 licenses are issued monthly, totaling 1,000 annually. 95% of gaming teams behind these 20,000 products are destined not to receive licenses.

I don’t understand why everyone is so confident, thinking they will be the lucky ones. I tell them they need to find a way to finish their products and launch them quickly. If they need capital support, first, raising equity financing is definitely difficult. There are already few investors, and even fewer invest in gaming because equity investments in games do not yield returns or dividends, which makes no sense in terms of capital efficiency. During our research, we found that many gaming companies from 2020 and 2021 that secured 40 to 50 million RMB in investments, or even over 100 million RMB, could not sustain themselves. The development cycle for games is too long, and labor is expensive. The situation where 6 million RMB could fund the development of "Dota Legends" in half a year back in 2013 no longer exists. We advise these gaming companies to seek new directions. I say if they want funding, they should consider transitioning to Web3 because capital is relatively abundant in Web3. However, they cannot simply create a Web2 game and expect to raise Web3 funds; they need to find ways to integrate NFT and Token models into their business models. Secondly, they need to study on their own; I can't teach them. If someone can create a new gaming business model through Tokens and NFTs, it would be a world-class innovation, similar to how Cygames in Japan invented the core mobile game business logic of card drawing in "Bahamut's Rage" in 2012, which led to a wave of successful companies like Lilith and miHoYo.

Your core business model needs to break through. Tools like Crypto are available, but no one knows what kind of product to create with them. Do you want to be the person who creates world-class innovation? I have encountered many gaming companies willing to try, but they are often insincere, thinking that as long as they have money to support product development, they are fine with us giving them money. Therefore, we observe the teams for a period; they must show progress, have new ideas, and embrace change firmly before we select the best among them.

Out of those 167 companies, only about 6 have transitioned to Web3, and the main barrier is still awareness. They fundamentally do not believe this is feasible or have misconceptions that stigmatize Web3, leading them to feel that it’s better not to pursue it. From another perspective, the pressure they face is not enough; they have not been pushed to a point of desperation where they must find a way to survive. Their dreams are not firm enough, their will is not strong enough, and the pressure is not great enough. They also accept many hearsay ideas from outsiders without truly engaging with, entering, or transitioning to Web3.

Currently, there is a clear trend of acceptance of Crypto among independent games. The independent game booths at this year's ChinaJoy have grown significantly compared to previous years. Many people may have been laid off from gaming companies but still want to make games and express themselves, so they gathered a few friends to continue. However, as mentioned earlier, the pressure has forced them to turn to Web3 for survival. There is a group that genuinely sees opportunities in Crypto and decides to enter.

Our experience is "do not persuade." You can mention Web3 to them and observe their reactions. Persuasion is useless; if you force them in without their belief, your money will ultimately go to waste.

Wanwu Island: What is your view on the relationship between Web2.5 GameFi and on-chain games?

Earlier, we discussed that all the projects Huofeng invested in before were called Web2.5, mainly using Tokens and NFTs to change their business models. Recently, a new path has emerged: full-chain. The computational performance of the entire chain is still improving, but the enhanced computational performance does not have products to utilize it; there is a lot of redundant computing power and funds. The new public chain ecosystem needs applications, hence the narrative of full-chain is being pushed by some. However, in my understanding, it does not mean simply porting existing well-performing and operationally sound games onto it.

The current public chain performance is roughly equivalent to a 90s 386 machine or even lower. From this perspective, it is possible to port older games or emulator games onto the chain. When I encounter independent game or emulator game teams that do not have high requirements for graphical performance, I suggest they consider launching on the chain. The TPS is destined to keep increasing; this is an irreversible trend. China is the largest gaming market in the world, surpassing the United States. The largest gaming company globally is Tencent, far exceeding Blizzard and Nintendo, with even Nintendo unable to catch up to NetEase. Tencent is followed by Google, Microsoft, Sony, and then NetEase, with two of the top five gaming companies in the world being Chinese. We are about to see the emergence of a third, miHoYo, so China has the best gaming production capacity in the world, and everyone is exploring in various directions, with some of that capacity able to enter Web3.

I believe both investors and entrepreneurs need the ability to envision the future. Both Web2.5 and Web3 full-chain need benchmark products to attract more Web2 gamers; otherwise, it will just be a continuous cycle of mutual cutting, which is meaningless. We need to bring in more users and assets to complete the Web3 world and establish a more meaningful application ecosystem, whether through Web2.5 or Web3 full-chain approaches.

Wanwu Island: How do investors judge the timing of a sector?

Regarding the issue of timing, I have progressed from being a front-line analyst to an investment manager, then to an investment director, and then to a partner, equity partner, and founding partner. I know what an investment manager/analyst should specifically do, so I teach my subordinates very structured and systematic content. I want my team to be able to replicate my work so that I can focus on other tasks.

Our requirement was that each investment manager should at least identify 200 projects a year, which should not come from third-party referrals but rather be actively discovered by themselves. If you need to rely on third-party advisors to find projects, it indicates a problem because they will discover opportunities before you do. We are primarily focused on early-stage investments. Then, through cold outreach, phone calls, or encouraging the team to visit companies in person, we aim to understand all aspects of the company's products, team, market, and financing, compiling everything into an A4 memo. This memo is discussed in weekly meetings, allowing investors to provide feedback. This system is very systematic, and investment managers will continuously refine their skills through this repetitive process.

This process is the best way to judge the timing of a sector. For example, why did we invest in Weiling during its angel round so quickly? It was because we had done our homework beforehand. In July 2019, when we looked at cloud gaming, I felt this sector was particularly promising. We scoured the entire country for projects, visiting over 20 cloud gaming companies in a month, but none seemed good enough. We also analyzed how cloud gaming would impact companies in the supply chain, believing it would affect cloud service providers. So, we visited Alibaba Cloud, Baidu Cloud, Kingsoft Cloud, etc. A friend from Alibaba Cloud recommended a company called Weiling, which seemed interesting. We met the team in the morning and transferred the funds in the afternoon because we had done our homework.

Meeting enough projects gives you a sense of what constitutes a good sector, what good companies exist within that sector, and what the best timing is. I have been in investment for 12 years and have certainly met two to three thousand companies face-to-face. As mentioned earlier, full-chain may require us to find it ourselves since the full-chain ecosystem is still relatively sparse. According to the strategy I just outlined, I will look for emulator teams and independent game teams for projects that do not have high graphical performance requirements, while we still welcome recommendations for Web2.5 projects.

Wanwu Island: Do you think we are at the low point of a capital winter?

First, I believe we are at a low point, but I think it will soon improve. It’s roughly a one-year cycle. You need to endure the bear market for this year. Our fund's fundraising thesis clearly states that I believe a bull market will start in 2024. I find the Bitcoin halving cycle very interesting. First, the selling pressure in the market has indeed decreased, so its price will rise. Second, the Bitcoin halving cycle coincides with the U.S. election cycle, which will likely bring many economic stimulus policies. From this perspective, I think a bull market in 2024 is to be expected. Not to mention that even with high interest rates, Bitcoin is still at 30,000. If interest rates start to drop, that would be quite terrifying.

I tell teams around me, whether they are doing investments or projects, to hold on because if you can endure, you will see the dawn. This is the hardest time to endure; money is scarce, and all production materials are cheap. The more people cannot hold on, the more cheap and low-cost production materials will be available, whether in terms of talent or traffic. If you can survive the winter, you will definitely reap the rewards later.

I also believe in the importance of networking. My experience in Singapore last year showed me that there are many things we do not know here, and there are also many things Singaporeans do not know about us. Therefore, in the second half of this year, I plan to visit Tokyo, the United States, and Dubai. Through these interactions, you will realize what the value of a businessman is: bringing various new information to another place to create comparative advantages. People should not think that building networks is difficult because foreigners see any news about Chinese people as new information. They might wonder why their media coverage differs so much, prompting them to want to come and see for themselves. So, it’s essential to communicate more with friends outside; only then will everyone realize what their advantages are. If you keep turning around in mainland China, you might feel there are no opportunities, but I believe there are many opportunities abroad.

Wanwu Island: What traits and behaviors of entrepreneurs would impress you?

My biggest reflection in the first half of this year is that great things take ten years to achieve. This insight comes from my observation of miHoYo. I met their team back in 2013 when there were only five people at the Jiaotong University Entrepreneurship Center. The most important factor in their transformation from a small company to a large one is persistence. 2013 saw a significant wave of mobile game investments, but it was perhaps the most challenging time for miHoYo. Many investors in China had approached them, but no one chose to fund them. Such adversity tests a team's original intent.

For example, Suji from Mask Network, whom I met in 2019, also showed great persistence. At that time, why did the metaverse capital choose to continue funding him? Because Suji had sold his house; it was incredibly tough. He believed in this venture so much that he sold his home, while others thought, "Well, we are just investors, not obligated to give all our money." His commitment was significant. So, original intent is crucial.

People have heard many stories, whether mythological or real events. Everyone faces numerous choices in life, and the core difference between the protagonists and antagonists in these stories lies in whether they abandon their original intent when faced with life's decisions. Did you choose to do the right thing or take the easy way out? I believe it is rare to maintain one's original intent, not give up in the middle, and continue to strive.

MiHoYo's ultimate goal is to create a virtual world where a billion people live. I don't think they are boasting; they genuinely aspire to achieve this. They want to accomplish something greater and do not consider merely surpassing NetEase to become China's second-largest gaming company as fulfilling their original goal. Their ambitions were set during their youth, and despite facing numerous challenges along the way, they have remained steadfast. If I encounter such a team, I would certainly be willing to support them. If you have risked your entire life on this, what’s a little money from me?

Wanwu Island: How do the outstanding founders you meet unite their teams?

Most of the teams I meet are familiar faces; they have previously collaborated, whether as classmates or colleagues. If you do not have such relationships, it is challenging to entrust a part of your business to someone you are not familiar with.

So, I believe the first point is that colleagues and classmates are indeed more suitable. The second point is that everyone shares a common long-term vision and has gone through hardships together; they have also experienced success and shared profits. However, some may choose to relax or have other ideas after sharing the profits, at which point the company may need to undergo some restructuring. Some friends may need to leave, and sometimes the boss may find it hard to let go of old buddies after many years. But everyone’s life is not solely about their career; they may leave for various reasons and need to do so.

The third point is that there should be honesty among team members; there should be no tricks, and trust is essential. I used to believe that ability ranked above trust, but now I feel that for companies that need to last over ten years, trust must come before ability.

Wanwu Island: How do venture capitalists choose directions in a rapidly changing market? How do they set goals and rhythms?

From my observations, most entrepreneurial failures fall into two major categories:

The first is being ungrounded, having a great vision but failing to produce tangible results;

The second is lacking goals, working hard without knowing what they aim to achieve.

I suggest being cautious when communicating with investors. Investors do form impressions of founders, and there are personas involved. Your persona should be favorable to investors, just as our venture capital fund also has a persona with our LPs. I believe that following trends is unwise. Most people fail to ground their ideas or lack goals because they do not know what they want and are not persistent, swaying back and forth with market fluctuations, ultimately achieving nothing.

An investor may stay in an industry for 8 to 10 years and might consistently appear in your entrepreneurial timeline. Therefore, if you keep changing directions, investors will be aware of what you have done. They will wonder why you have abandoned previous efforts; why should they believe you will succeed this time? The structure of investors and entrepreneurs is very different. Entrepreneurs can only focus on their own matters, while investors must chase trends and make strategic allocations, as they are distributing funds across the industry. Investment is about diversification, which is a completely different logic from entrepreneurship. It is very likely that something deemed reasonable six months ago may not be seen as viable six months later, leading to immediate withdrawal. People should not trust everything venture capital media says because changes happen too quickly; this is determined by the nature of an investor's work, which requires them to have a broad perspective rather than a deep one.

Wanwu Island: Thank you, Yuetian, for sharing insights into the gaming venture capital field. We will launch the second season of Wanwu Creation Camp in September, focusing on Web3 games, and we welcome you back for continued discussions with projects in S2!