Axie Infinity....

Axie Infinity- Is Play-To-Earn a New Paradigm or just another Pyramid scheme?

Axie Infinity and blockchain play to earn NFT games have been talk of the metaverse lately. There is tons of excitement around these new blockchain games and the 3rd world phenomena of Axie scholarships. If you are not familiar with the topic, check out this great writeup by Packy McCormick. But Axie and play-to-earn is not without controversy…..

Axie critics have been quick to label the game a pyramid scheme or in more mild criticism an mlm with some structural flaws. Anyway, I figured this is worth a more detailed examination. Let’s start with the basics…

What Is A Pyramid Scheme?

The NY Attorney General defines it this way:

 

So, how does one make money in Axie?

Well, as far as play-to-earn goes, you earn SLP (Smooth Love Potion) tokens for playing the game. These tokens can be sold on crypto exchanges for cash. You can also use these tokens to fund part of the breeding cost for Axies, which then can be sold to other players seeking to join the game.

But where does the money come from that allows scholars grinding SLP to convert these tokens into cash? The answer is new players. You cannot play Axie without having at least 3 Axies in your account, and you cannot create new Axies to onboard new players into the game without SLP. So, from a fund flows standpoint the “earning” in the game is ENTIRELY DEPENDENT on fresh $ flowing in to pay the existing players. This dynamic is exacerbated by the fact that the money flowing into the game is based on implied yields or payback period for the initial Axie investment/team formation. Throughout most of recent Axie mania this has been in the 1-month range which has works out to several thousand % annual IRR. This has caused the minimum buy-in price to join the game to surge from around a $100 as of two months ago to as high $1300 a few weeks ago (it’s a little over $600 today). In that time period, the games DAU’s have gone from just under 100k to over 1ml. Naturally yields have plummeted in the process and Axie has responded by cutting SLP rewards as breeding yields have come under pressure. But assuming Axie had kept growing at the +100% month/month rate it was at for most of June/July, you would onboard the population of the planet with internet connection within the next year to deliver these yields.

Now is there anything fraudulent about any of this?

The answer here appears to be no because the token and Axie prices fluctuate to reflect these flows. So, unlike someone promising a high yield and asking you to recruit others or in fact concealing what he is doing, the freely trading tokens and their relationships are providing pyramid transparency. There is of course one caveat to this, and that is that everyone getting involved understands this perfectly well.

For example, if you joined the game roughly 2 weeks ago, the axie floor price was $350. And at that time your assumptions for one month of breeding based on SLP/AXS prices would have netted you a breeding yield of 45% a month. Add in SLP you’d expect to collect for 30 days and you would been expecting to clear about $2k or roughly 200% return in a month. Today, a month of cost-efficient breeding is essentially breakeven, and the SLP rewards for adventure have been cut in half. Meanwhile the price of SLP is down 40%.

 

 

So, your economics have taken a huge hit and this is just with the game’s growth slowing to mid-teens weekly growth from the 30-40% clip it had been averaging. This is where the games feel good marketing and ‘disruptive’ 3rd world job creation narrative run into trouble.

The Axie game is structured in a way that SLP earned can’t be claimed for two weeks, and in most scholarships isn’t distributed for another two weeks. So, you essentially have 1 month of inflows from onboarding to payout existing scholars/investors. The birthing in the game is also designed in such a way that an influx of players larger than the existing universe would immediately drive up token demand and Axie price as breeding takes five days. The game devs are also pretty vigilant on making sure that you can’t multi-account which it turns out is quite critical to make this whole ecosystem work. So, you’ve basically built a system that is a total pyramid structure with respect to earning and now that it took off are trying to figure out ways to keep it from tipping over. The recent move to cut SLP daily rewards is a good example of this.

Note the word choice here with respect to why they cut the reward: “long-term health of the ecosystem”

The no-bs way of explaining this is that they cut the reward because outflows are outstripping inflows due to the fact that the rate of new player growth has slowed enough that implied SLP outflows for those ‘earning’ is now around $30-$40ml a day. Remember, if you are not adding at least as many new players as presently exist in the game, returns start to rapidly diminish. They had to get out in front of that and make this move to try and improve breeding returns otherwise investors will turn to redeeming their scholarships and selling their Axies to try and recoup their principal. The problem here is that in doing this they have made recruiting scholars more challenging which makes the passive investment scheme far more difficult. (If you can afford to spend $1k on a game, odds are you don’t have 3-4hrs a day to dedicate to earning $15-20.) Basically, once an ecosystem starts in this type of play-to-earn fashion there is no way out, and every move the devs will make will be with the goal of trying to retain users until the game goes through a bust that’s severe enough to attract fresh new dollars seeking to repeat this cycle.

The only way to break this cycle is to have people that play the game for fun and part with their dollars without expecting an investment return. It’s at that point that a small army of human players in the game who are “earning” might be possible if there is consumption at a very high ARPU from casual players seeking entertainment. Axie has hinted at all kinds of potential options to make this happen, but with a universe that is effectively 99% investors/yield seekers that pivot is basically mission impossible. You would need to earn more a day from recreational players than the minimum wage of the earners which with 1ml earners at $20 a day would imply a casual player universe that is doing $600ml a month in revenue just to cover grinder wages. No game has cracked that number yet, and of course you’d need to do far better than that to make a profit. But back to the narrative questions here….

I’ve seen people say Axie shouldn’t be labeled a pyramid scheme because there are no victims here. In a typical scheme, the bottom of the pyramid is effectively left holding the bag by some promoter or failing mlm that’s exploiting 90%+ of members for the benefit of the small group that gets rich.

In the case of an Axie scholar, the assumption is that no money is put up and thus the prospective earning opportunity is far better than whatever is available to them. Anything is essentially better than nothing if you are unemployed in the 3rd world. The risk of financial loss is entirely born by the scholarship sponsor whose putting up the axies/investment $. Of course the sponsors aren’t doing this for free, so whose to say exactly what happens in the event of a total collapse. And having reviewed some of the terms of these scholarships, they don’t exactly advertise that you could in theory get nothing. Yes, it’s highly unlikely you’d see overnight zero, but what if the exchanges stopped providing SLP liquidity or the game was banned in key countries. I also have a hard time imaging that were a regulatory body like the FTC to take a look at something like this that they wouldn’t view the term “axie scholarship” as deceptive marketing. Also, there is already plenty of evidence of people seeking out short-term loans to play the game as the implied yields suggest a swift payback period. What happens to those folks in the event of a collapse? Yes, they should all know better, but you are marketing to a population that in fact for the most part doesn’t.

Also, the element of the promoter/operator here is kind of cloudy. It’s supposedly a decentralized game with a governance token, but so far the decisions being made with respect to governance are quite centralized. The breeding/earning relationships and payout periods are managed to keep the pyramid growing and maximize transaction revenue which benefits the insiders who were granted AXS. The exchanges who have listed these tokens also earn trading fees. This makes these tokens unregulated financial products essentially whose source of value/utility is entirely dependent/connected to a floating pyramid structure.

For example, everything going on with the AXS token is in my opinion quite problematic. The token has 20xd in a short time period, and a major driver of that is the fact that the Axie treasury is accumulating it in the form of breeding fees.

In the past two months, the Axie treasury has accumulated roughly 20k eth and 13ml AXS tokens in fees. Those AXS tokens have been headline grabbing as a “revenue” measure for the game as they are presently worth close to $1bl while the eth from marketplace fees is close to $60ml. The latter is most definitely revenue (though more like a cash-out tax on investors who have found a new recruits), but the former is in fact not.

Up until recently the notable crypto exchange you could trade AXS on was Binance, and to this day it still accounts for well over 70% of AXS daily volume. If you track the Binance wallet you can see that it had a 20ml AXS balance that has been roughly cut in half over the past few months. Where has this AXS gone? Well for the most part it has been consumed by breeding and moved to Axie’s ronin sidechain where it ends up in the Axie treasury wallet.

The drainage looks like this….

And the current holders look like this…

Anyway, as the price of AXS is largely derived from the trading on the Binance exchange, you can clearly see that you have halved the supply on that exchange. This makes AXS more like an IPO with a tiny initial float that has immediately halved that float. But as you are not extinguishing these shares this is not a buyback. You could argue that a more accurate description of what has transpired here is that AXS has essentially gone through a temporary reverse stock split. Now the problem with this is that in the land of crypto everyone is infatuated with draining supply as a driver of price, but we all know that ultimately price is unreliable if there is huge swath of supply that is just sitting there waiting to be released. This is also further complicated by the fact that AXS price relationship to the three Axies needed to play the game is managed by the developer. What’s interesting about all this is that the firm that designed the AXS token for Axie also seems to think this a good thing. They recently put out a report on AXS that has modeled supply in treasury as a % of total circulating supply hitting 50% by year end.

The idea of draining supply making a token an appealing investment while nice in crypto theory won’t work in practice. AXS will get prohibitively expensive and eventually very illiquid which will then drive up breeding costs to the point AXS for breeding will need to be reduced to virtually nothing. At which point, there is no longer an AXS sink and you flip to just having this shadow supply overhang which will lead to demand for AXS collapsing and a sharp crash in the price. It’s for this reason that the treasury should be net sellers of AXS on a daily basis much like SLP earners should probably have daily liquidity. Of course, if you allow both these things to happen you make attracting speculators trading the token and investors seeking yield more difficult.

It’s also unclear whether charts like this from the token creator or the one below from the devs accurately reflect how these parties are analyzing Axie ecosystem.

If everyone is entering the game is seeking yield, then the Axies per holder will quickly trend to the three Axie minimum needed to participate. As a huge swath of these are on loan to scholars, Axie’s per holder will only spike when the pyramid collapses and scholars start exiting the game or sponsors try to dump their Axies to recoup principal. This chart basically demonstrates that Axies are overwhelmingly not being collected, but in fact simply being utilized to chase yield. I’m sure at that point they will need to consider raising the axie’s required to earn. Anyway, this could theoretically go on forever which is why you can’t really ever have a game like this that’s decentralized. Because really it’s not a game, it’s a financial investment scheme.

Burning Axies for land or battle parts or allowing SLP to be used to buy axies or just about any other tossed around change is simply a means of trying to manipulate the financial relationships in a manner to attract fresh $. None of it works unless the game has actual revenue from consumption.  Even A free play mode doesn’t address these issues as the game is about breeding and battling. Free players being able to make any money from battling would screw up the game economics, and them being able to breed with no upfront cost would also do the same. Allowing them to essentially rent an axie to play adventure mode or battle each other would serve no purpose other than boosting recruiting for the investment scheme by creating a new scholar/investor funnel. Even some form of freemium would be problematic cause of all the floor axies essentially bred to simply enter the game instantly become worthless. You’d literally need to reset the universe.

That being said, if you really believe the game is unbelievably engaging and that a marketplace for trading Axie’s would be vibrant without yield chasers then the template already exists for how to make this work. Sell currency in the game that is needed to breed, buy land, etc and provide your own marketplace to trade Axies and let the metaverse do the rest.

We are clearly in an era were the willingness to scrutinize stuff like this is limited. Who wants to be the Debbie downer asking the simple questions when the numbers are painting a picture that’s at the other end of the spectrum. And in Axies case there is a ton of evangelical level marketing to contend with. Like do you want to criticize a game that is essentially sending money to unemployed folks in the third world during covid?

Obviously not! And crypto enthusiasts love this because it’s almost doing missionary work in crypto every time a scholar sets up a wallet and opens a trading exchange account. But it is what it is and there is no getting around that which means these issues will surface soon enough. If you thought China’s crackdown on tutoring or elements of live streaming recently were bad, wait till governments in the 3rd world actually need to pay attention to these games. Anyone remember Albania in 1996? Nothing good ever comes out of a whole country getting swept up in a financial scheme.

With that in mind I do believe that a minimum there needs to be some regulation with respect to the exchanges that are playing the role of liquidity provider for these things. There are now several NFT games cut and pasting the Axie playbook. Announce you sold few rare game NFT’s for huge sums despite minimal to non-existent DAU’s (anyone wonder about the related party transactions here?) and hope this triggers token interest which then in turn creates earning yield in the game and attracts farmers/earners. We also have seen a Yield Gaming Guild formed to essentially capitalize on the play to earn trend which has listed their own token. This is basically raising money to fund yield farming of NFT play to earn game. Which essentially means you are creating a pyramid for hire that will hop around from one game to the next. What’s next mercenary downline tokens? The Oliver Twist Gaming Guild? NFT’s are definitely a fun creation and a potentially super valuable tool for genuine artists to make money and for collectors to enjoy, but the minute you turn them into high yield certificates of deposit they are no longer cute kittens, penguins, axies or whatever; they are financial instruments and should be treated as such