Network Effects in Web3 Games: How Do Game Platforms Enhance Network Effects Through Token Incentives?

Written by: HIRAYAMA SHO

Compiled by: Lu, SeeDAO

Introduction

We collaborated with the research team at Animoca Brands to study the network effects in Web3 gaming. The aim is to propose more specific hypotheses regarding the network effects of Web3 products, starting from the close relationship between products and token economics discovered in our previous articles.

Overall, one issue faced by Web3 products is structural challenges that limit the realization of network effects. Additionally, it is particularly noteworthy that DeFi and Web3 games have different rules regarding network effects and token economics to support their development.

The Evolution of Blockchain Games Away from Network Effects

Blockchain-based games (hereinafter referred to as GameFi) have only emerged for about five years, yet they have achieved various innovations, including the use of NFTs, creating speculative demand through reward redistribution mechanisms, and more sustainable development mechanisms.

Due to their user-friendly interfaces and experiences, along with financial incentives, the user base of Axie Infinity and STEPN has seen explosive growth. However, the sustainability of products that rely solely on speculative demand is problematic, and their subsequent products attempt to eliminate speculative dependence as much as possible to achieve healthier token economics.

We will not discuss the pros and cons of this change here, but completely eliminating its speculative nature has weakened one of GameFi's greatest advantages: its connection to a global network through public chains. Speculation does not generate network effects and lacks sustainability, but it has long been a global phenomenon. Moreover, unlike DeFi, most existing games lack composability, and interactions among people primarily occur through game content. Therefore, GameFi can easily become a downgraded version of Web2 games.

How can a product be created that distributes tokens without affecting user experience, achieves a customer acquisition cost (CAC) lower than user lifetime value (LTV), and grows autonomously after exceeding a threshold? The answer is network effects.

Network effects (Nfx) refer to the phenomenon where the value of a product or service increases as the number of its users grows. The more users a product has, the greater its value.

When discussing network effects, it is worth noting that there are various types of network effects, such as physical effects, protocol effects, platform effects, performance effects, etc. For more information, please refer to this article. Different network effects have different characteristics in terms of type, category, and stage. For example, the old-fashioned telephone is an example of benefiting from physical network effects, where users can only call others using the same network. If one person can contact everyone they want to reach through a single network, then two telephone networks are useless, as the increased use of a single telephone network directly increases its value to users. Because its utility is direct, people need physical terminals and lines when using it in daily life, resulting in high switching costs, and competitors must provide the same or better utility with ten times or more efficiency to replace it.

Taking games as an example, as the number of users increases, the time required for matching decreases, the common topics for communication increase, and virtual societies are created in digital spaces, enhancing the enjoyment for each user.

What Factors Promote Network Effects (Nfx) in Web2 Games?

In traditional gaming and technology sectors during the Web2 era, the main factors influencing network effects (Nfx) include ease of use, quality, brand recognition, critical mass, complementary goods, and switching costs:

• The ease of use and high quality of a product or service naturally attract and retain more users, as these advantages can spread more quickly through word of mouth.
• Brand recognition contributes to network effects in that users are more inclined to use and discuss products or services from brands they are familiar with and trust. Coca-Cola's strong brand has contributed to its success, as consumers naturally have better recognition and memory of its products, aiding in faster product dissemination.
• Critical mass — a network needs to reach a certain number of active users to become attractive to other potential users, creating a positive feedback loop. Once critical mass is achieved, the network may grow rapidly and be widely adopted as more users join. For example, social media platforms like Facebook and Twitter become more valuable and interesting to users if enough friends and family are already using them.
• Complementary goods — these are products or services that are used in conjunction with a specific network or platform, making the network more attractive and encouraging user acquisition or retention, similar to how software developers create applications designed for specific operating systems, adding more value to the system.
• Switching costs — these refer to the financial or non-financial costs incurred by users when switching from one network to another, making them less likely to switch to competing networks, thus helping to lock users into that network as they become increasingly reluctant to give up their tangible and intangible investments in a specific network.

How Should Web3 Games Leverage the Advantages of Network Effects?

Web3 games typically have limited budgets and lack refined interfaces and user experiences, so they must fully utilize the unique features of public chains to attract users. Therefore, despite belonging to the same category, the business models of Web2 games and Web3 games differ.

To explore this direction further, let’s consider a rollup that is application/field-specific for gaming, supporting on-chain games with discrete mechanisms (all digital games are technically discrete, but here we focus on "actually discrete games, such as card games and board games, rather than shooting games and real-time strategy games).

Fully on-chain games store all game logic on the blockchain. Processing game logic on-chain not only increases information transparency and platform fairness but also makes the logic composable and interoperable by storing core components on-chain. We focus on games with discrete mechanisms here because the number of on-chain transactions required to represent game actions is limited and controllable. Additionally, thanks to zk technology, we can now support games like poker that require hiding certain information.

This roll-up solution has built-in features that can assist game creators, including random number generation, information hiding, user performance-based ratings, and visibility of on-chain activities. Once a game gains a sufficient number of users in a certain region, network effects can form in that region, allowing for user growth by expanding to other regions. It is important to note that in synchronous games, only users in the same time zone will affect network effects, but there are no geographical restrictions for game creators who gain greater benefits by increasing user numbers.

Game producers, streamers, and tournament organizers earn roll-up native tokens based on their performance. They should be incentivized for their contributions to network effects, not just for playing the game.

The Importance of Integrating Multiple Types of Network Effects into Products

The main reason Web3 projects, especially non-DeFi applications, cannot achieve scalability or self-sustainability (or both) lies in the product aspect. Many focus on sustainable token economic models, but what truly matters is the product itself. While Web3 games can achieve most of the functionalities of Web2 games, they have largely been "nerfed" due to significant budget differences, limitations in user interface and experience, and unreasonable designs for token integration.

nerf = to weaken (commonly used for balancing games)

Many Web3 games do not possess network effects, or only have the converging network effects indicated by the green line in the above image. This effect initially produces a noticeable utility increase but quickly diminishes to a certain value. For example, increasing the number of users in a region can reduce the time required for matching. The utility increase from reducing the time from 10 seconds to 1 second is significant, but reducing it from 1 second to 0.1 seconds does not lead to a substantial increase in utility. The value of a product depends on the ceiling of its utility.

On the other hand, the blue line represents network effects formed by geographically scalable products, token standards, and the transaction formats needed to create a comprehensive ecosystem containing multiple games, as well as tools for building on-chain game logic and a new type of wallet that provides a seamless user experience. These measures may not bring explosive growth in the short term but will function in a compounded manner.

By integrating multiple network effects into a single product, initial launches and long-term growth can be achieved. For example, the industry-specific rollup operator for the aforementioned games must initially create its own games and organize tournaments. However, as the number of users grows, a community will form, reducing game waiting times and encouraging more users to create games and organize tournaments in place of the operator.

Case Study of Network Effects in Web3 Games

The Magical Power of $MAGIC in the TreasureDAO Ecosystem

Current Web3 games find it difficult to leverage network effects through their platforms, and popular games like Axie Infinity and STEPN have very limited exposure in terms of network effects. However, as crypto gaming platforms shift towards creating multiple portals and targeting multiple player groups with a single token, the situation is beginning to change.

TreasureDAO is a great example, as their $MAGIC token allows users to participate in some metaverse projects within a decentralized ecosystem on Arbitrum. Since different projects on the platform utilize and are economically connected to $MAGIC, each game acts as a complementary product, adding value to the TreasureDAO ecosystem, allowing network effects to begin to emerge.

TreasureDAO adopts a bottom-up approach to creating a metaverse by providing users with free game assets to help build a community, attracting more players, ultimately reaching the desired critical mass. Developers pay great attention to cultural development while developing games.

Artists and developers can fully utilize community resources, while players enjoy an enhanced gaming experience. The design of $MAGIC also connects players from different games to the same community, allowing players to exchange assets between different games using $MAGIC, which also plays a powerful role in network effects. Additionally, the enhanced metaverse experience attracts more users, leading to more developers, which in turn provides better experiences, and so on. Over time, this cycle contributes to the overall development of the ecosystem.

The $MAGIC ecosystem protocol includes: Bridgeworld, Smolverse, Tales of Elleria, The Beacon, Battlefly, The Lost Donkey, Toadstool, Knights of the Ether, LifeVerse, Lost Samurise, and Realm.

As shown in the image above, TreasureDAO's ecosystem demonstrates good potential in the "one token multiple games structure," but the DAU (daily active users) influx brought by new games is only sufficient to offset the decline of old game users, failing to ensure self-growth, indicating that the ecosystem has not yet fully achieved self-sustainability.

Animoca Brands leverages its network effects by connecting many projects in its portfolio through shared liquidity pools and cross-project token rewards. Among them, the first NFT series supported by Animoca Brands, "Mocaverse," showcases this synergy by integrating multiple communities from other projects and subsidiaries within the Animoca ecosystem, enhancing its value.

In addition to the examples mentioned above, network effects can also be seen in the EVM economic model area and tools, such as programming languages, development toolkits, node services, token standards, token issuance, and tools. Creating a new EVM chain will form a decentralized, interconnected, and interoperable ecosystem, generating a series of positive effects, such as multi-chain deployment of products, utilizing infrastructure on other chains, and increasing potential customers for developers across different chains.

Unlike horizontally scalable EVM-compatible Layer 1 implementations, roll-up based EVM-compatible Layer 2 is vertically scalable. Although the economic models at the protocol level differ, both are equally effective for application layers like games. Furthermore, since each chain and roll-up has strong influence in specific regions and among different user perceptions, the same strategy used by Uber to expand its services to other regions can be employed to enhance network effects.

Vision for Future Token Economic Models

Token Incentives Targeting Specific Stages or Goals

As DeFi and GameFi products flood the market, management teams need to find opportunities to build user bases to benefit from gradually growing network effects. A common approach is to adopt phased token incentives to attract participation from the initial user base.

In these incentive schemes, maintaining an appropriate balance is crucial to fully stimulate early users' enthusiasm until the product matures to attract a broader audience. During this period, token incentives should be managed carefully to avoid issues related to unsustainable economic models.

While many may hold differing views, certain product categories do not require excessive decentralization, and token designs should not be immutable. For example, a fixed token issuance plan means that management teams cannot adjust their strategies based on changing environments. In contrast to some emerging DeFi products that attract users by allocating a fixed budget as token incentives during the initial phase, requiring payment of fees or purchase of items as a condition for acquiring tokens, and then funneling the proceeds into the treasury.

For gaming platforms, compared to DeFi, which offers a wider variety of utility tools, token incentive mechanisms need to be adjusted according to the platform's development. Initially, liquidity token rewards can be used to incentivize gameplay and community collaboration. As the platform grows, it becomes crucial to adjust these rewards to maintain a stable ecosystem.

By seeking alternative strategies in the later stages of the game lifecycle, managers can encourage participation in competitions, innovative game development, and intense leaderboard competition through token rewards of varying scales (or by completely avoiding token-based rewards).

The Evolution of Network Effects from Small Scale to Large Scale

As the title suggests, leveraging more small-scale network effects requires a strategy. For example, once Uber has a certain number of drivers in a city, the benefits of adding more drivers become minimal. Therefore, it is necessary to understand how to first expand the network to achieve small-scale network effects, and then leverage several small-scale network effects to facilitate larger-scale network effects, ensuring the project's sustainability.

We have seen this trend emerge in the horizontal scaling model of multiple small networks (such as Uber, Tinder) and the vertical scaling model of a single large network (such as telephones, identity verification).

These trends are also evident in the GameFi sector, as seen in how Axie Infinity and STEPN attempted to drive incremental network effects through token incentives tailored to individual games. In contrast, TreasureDAO utilizes the small networks of individual games within the platform to promote the expansion of the platform-wide token ($MAGIC) ecosystem.

For the cryptocurrency industry, another alternative method to stimulate initial network effects lies within its community. When companies expand the primary player base of a game through token incentives, a blueprint emerges for GameFi enterprises to leverage existing communities, gradually scaling from small to large. This provides GameFi companies with a new avenue to quickly accumulate network effect advantages and ultimately expand their products.

This is well illustrated in Yuga Labs' upcoming Legends of Mara game, which utilizes Otherside series NFTs. Previously, Yuga Labs received strong community support through Bored Ape Yacht Club and subsequent series, leveraging this to establish a user base for Legends of Mara in its early stages and ultimately expand its influence through network effects.

Therefore, to create a successful product, we must consider what scale of network effects we aim to achieve. For the sustainable development of the product, governance and token issuance must be flexible and differ from the old model of immutable token design.

Conclusion

Undoubtedly, Web3 games have immense potential. However, managers must fully leverage network effects for efficient growth while not overlooking the importance of sustainable token economics for long-term success. The success stories of existing Web2 projects and how they cleverly utilize network effects to scale operations provide valuable insights and lessons. As GameFi continues to evolve, if executed correctly, it will offer substantial benefits to users.

Thus, for product owners, designing games based on strong communities and appropriate incentives is crucial to achieving exceptional scalability through network effects.