Are Play-to-Earn (P2E) Games Pyramid Schemes?

Jan 26, 2022

The short answer is mostly yes, but sometimes not. It depends on the details of each game and its underlying game economy. If you’re interested in learning more, below I spell out the requirements for a P2E game to be economically sustainable. If these requirements aren’t met, then you are probably looking at a P2E pyramid scheme.

A Caricature of a P2E Game

Before we begin, it’s important to emphasize how hard it is to make P2E games fulfill their promise of creating real income for all or most players. To see this, imagine a trivially simple game, one that uses only U.S. dollars, inspired by the underlying structure of most current blockchain P2E games.

In this game, players buy NFTs for 100 dollars from an imaginary GameCo to “start playing.” Then, they can use the NFT in-game to earn a return of 1 dollar per day for a year, payable by GameCo to their debit account. For the buyer, the NFT purchase pays for itself in 100 days (if paid in full) and returns 265% over a year (again, if paid in full). It looks like a great deal!

As new players join the game, GameCo accumulates USD extremely fast from the NFT sales. However, eventually, the hype dies down and the market saturates. Fewer and fewer people buy new NFTs as everyone realizes the model isn’t sustainable. When this happens, GameCo’s bank balance begins to decline until it reaches zero thanks to the large number of recurring $1 pay-outs and near-zero inflows. Inevitably, GameCo goes bankrupt.

In the end, players that bought NFT’s early and accumulated rewards for 100 days or more are net winners, and the players that joined late are the net losers. The game is strictly “zero sum.” For every dollar gained, a dollar lost by someone else. Early-comers “made money” because late-comers incurred losses of up to 100%. This imagined videogame is a textbook ponzi scheme.

If we make things slightly more realistic, it gets worse, because GameCo has costs. It has to pay the game developers, software engineers, artists, marketing teams, etc. that actually created the product. When we factor in these (often large) outlays, the gaming model goes from zero sum to negative sum. For every dollar gained by P2E players, there is at least one dollar lost by other players.

What’s my point? A lot of the P2E gaming models out there have this same basic ponzi structure. The thing is, it’s not immediately obvious because the underlying economics are obscured by the complexity of the various currencies and assets involved (Ethereum, in-game tokens, game-related cryptocurrencies and NFTs) and by the large volatility in their prices.

In current P2E games, instead of getting U.S. dollars for your NFT’s, you get in-game tokens or crypto-currencies on some blockchain, which you can then sell for stablecoins (like Tether) to cash out. This complicates things (cognitively), but does not change the underlying economic model or requirements for sustainability too much.

(How) Can P2E be Sustainable?

The only way for the subset of P2E players to sustainably get money out of the game (measured in USD) is for an external income stream (unrelated to P2E) to feed money into the game. This income stream is required for GameCo to buy back the crypto-assets created in-game and thus create demand for them, so that they are ultimately redeemable for stablecoins at a reasonable price.

So where does this external income stream that fuels demand for the game’s crypto assets come from? It could come from several sources:

Paying subscribers/game-buyers (that are in it for the fun, not for the returns)
Microtransactions (in-game services and shortcuts that don’t promise returns)
Vanity items (like NFTs, that promise no economic returns)
External advertising revenue (e.g. digital billboards)

More questionably, it could also come from these non-traditional sources:

Returns on investments made by GameCo’s treasury
Crypto philanthropists that donate to GameCo
Sustained token and coin appreciation

It’s not complicated. For all of GameCo’s P2E players to make money, the money has to come from somewhere. Most straightforwardly, from items 1 to 4 in the list above. The external income could come from paying gamers that are in it for fun/entertainment and pay a subscription (like in MMORPGs) or fork up cash up front (like in console gaming). It could also come from micro-transactions in the game, where players in it for the fun pay to speed up certain mechanics or improve their position in a queue (or whatever else). It could also come from the sale of vanity items (skins, rare mounts, titles, etc), which confer social status to buyers. It could also come from in-game advertising of external products (like computer hardware or accessories).

My point is, GameCo has to somehow make money to be able to spend it generating demand for in-game tokens and cryptocurrencies and assets. It needs to do this so that P2E players can ultimately cash out at reasonable prices and earn income (in USD). And the money GameCo makes has to come from sustainable sources, like from non-P2E players that are happy to hand over cash to GameCo in exchange for fun, entertainment, community and all the other things we get from traditional video games.

What About Non-Traditional Funding Sources?

Then there are other less straightforward income sources that could – at least in theory – fund demand for the game’s crypto-assets (and therefore P2E pay-outs) sustainably. The caveat is that these are all (extremely) uncertain or risky or both.

One (potential) income source is treasury income. Suppose GameCo is running a straightforward Ponzi like in the one I described initially. But instead of just putting the mountain of money from initial $100 NFT sales in a bank, it invests the money in an unrelated but profitable business endeavor that generates returns. The returns from that investment could ostensibly fund pay-outs for P2E players (via demand from buy-backs of the game’s crypto-assets), provided the investment is good enough. I don’t know of any games that have this model or claim to. And I don’t think gaming companies should adopt it. I’m only discussing it to be exhaustive about the possibilities.

That said, the idea of funding P2E pay-outs with investment income is bizarre and dumb for many reasons. First, what advantage does a crypto-gaming company have in terms of spotting good investments over a VC fund or an ETF in the stock market? Sure, maybe they get lucky and hit a jackpot. But on average, they’re probably not as good as investment professionals, so why bother? Second, it would be a very inefficient way to invest, since the investment vehicle is dressed up as a gaming company, it has to pay for all those game developers and engineers and marketing people. Why spend money on that? Third, you probably don’t have all of the disclosures, transparency and protections that traditional investment vehicles afford. For these and other reasons, this model for funding P2E pay-outs is a very bad idea.

Another income stream that could fund P2E pay-outs is crypto philanthropy. The extraordinary increase in value of Bitcoin, Ethereum and other crypto assets has minted an entire generation of crypto millionaires and billionaires that now want to “give back,” especially in a way that supports or advances crypto and the crypto community. These people want P2E blockchain gaming to “work” and may willing to fork up money ex-ante to fund pay-outs for a particular game. More likely, crypto billionaires may come to the rescue of a collapsing ponzi game ex-post to try and contain the reputational damage it would likely cause and keep the idea of blockchain gaming and P2E alive. Stranger things have happened.

Can token/coin appreciation make P2E sustainable?

Mostly, no. Crypto assets from popular gaming companies like Axie Infinity and Gala Games have had spectacular price increases since the games were launched that have made lots of people very rich. But these generally high and rising prices are not sustainable in the long run unless key conditions are met.

Ultimately, for game-related crypto-assets to have sustained value growth in the long run, they must satisfy one of the following:

(a) The game’s crypto assets must meaningfully represent a claim on a growing income stream, or

(b) The intangible value-added provided to buyers and holders of the game’s crypto-assets (assuming there is one) must increase, rather than decrease, in the long-run.

Let’s discuss (b) first. In the last year or so, we have learned that all sorts of assets can achieve and (apparently) sustain extremely high valuations, despite having limited economic viability, basic business disclosures, or real-world use. Think about shares in Donald Trump’s SPAC, which doesn’t have a business model. Think about GameStop, which is still over $100. Think about the governance tokens for the constitution DAO, which sky-rocked in price after the DAO failed to buy a copy of the U.S. constitution and couldn’t return the money because transaction fees on Ethereum were too high.

Bloomberg columnist Matt Levine suggests that these wild valuations are not only the result of FOMO and people chasing returns in a speculative bubble. Buyers, he muses, are also getting cultural, social, ideological, or aesthetic value from buying risky assets and are willing to pay for it. They are willing to risk large losses to participate in a broader crypto/meme movement or revolution. It is unclear whether and for how long this phenomenon is sustainable, but for now, it is contextually important.

It is possible – at least in theory – for gaming crypto-assets to appreciate in the same way. Maybe game designers can succeed in creating intangible value-added not through the game itself, but from the very act of buying and holding the crypto assets associated with the game. If game designers achieve this, and the intangible value-added from holding coins and NFTs grows rather than shrinks over time, and the crypto assets are not diluted by issuance of new assets, then sustained appreciation is (probably) possible.

To be clear, I am extremely skeptical that this is doable at scale and that it’s a sustainable way of accruing income to P2E players. Sure, certain historic NFTs and cryptocurrencies may have unique cultural value that will only grow if and as crypto is ‘adopted.’ But it is not reasonable to expect that any old P2E gaming company can make assets with these (extraordinary) characteristics, especially if the games are mediocre, as they often are.

So what about (a)? Game-related crypto assets may also go up in value and generate “income” to P2E players if they represent a claim on an income stream that is growing. The claim can be direct (through dividends or airdrops) or indirect (through buybacks). But there can only be a growing external income stream if there are more game subscriptions, game sales, micro-transactions, vanity item sales and advertisement. In this sense, (a) is nothing new, just a restatement of the initial conditions for sustainability I articulated above.

What about Axie Infinity?

Axie is probably also a pyramid scheme. Why? Because by and large, no one is playing for the fun of it. Instead, people in developing countries just log on day after day and grind for hours because their outside option is even worse, for now.

Real players aren’t putting money in to buy vanity items to show off with their friends. People aren't paying monthly subscriptions to have a good time. Nobody is buying micro-transaction products from Axie to make the game more enjoyable. Axie isn't selling ad space to third parties.

As a result, there are no structural sources of demand for the so-called Smooth Love Potion (SLP), the cryptocurrency that Axie players grind endlessly for. And without that built-in demand, there is not much to support SLP’s sagging price. If nobody wants SLP for anything other than speculating on its price or for breeding new Axis to generate yet more SLP, the price will eventually fall, as it recently has.

More likely than not, Axie will end badly, as all pyramid schemes eventually do. Maybe a crypto billionaire can step in and buy SLP to keep the show running for a while longer. Maybe Axie’s parent company can fund SLP buybacks with income from its web3 excursions or the business that its Ethereum side-chain Ronin might generate. But I doubt it.

Instead, the most likely outcome is that the people that get wiped out if and when Axie Infinity collapses are the very same people in the Philippines, Venezuela and elsewhere it was supposed to help.

Common Sense