Over the last decade, blockchain technology has been leveraged to redefine gaming experience for developers and players alike. With innovations such as smart contracts and non-fungible tokens (NFTs), developers now have new toolset for crafting novel games and designing their economics.

Two of the defining watershed moments in the web3 gaming history were the congestion crisis of CryptoKitties, launched in 2017, which led to a renewed focus on Ethereum scaling solutions and alternative Layer-1s, and the meteoric rise of Axie Infinity, launched in 2018, which introduced the play-to-earn (P2E) model to the masses and recorded 3 million daily active users (DAUs) and $1.3 billion of annual revenue within 3 years of time. However, the subsequent downfall of this model due to unsustainable economics served as a wake-up call, sending everyone back to the drawing board.

Since then, the blockchain infrastructure has been continuously improved, and fully on-chain games have started emerging in 2021, giving web3 game developers more options for their product roadmap. In recent times, numerous game labels have started to use the term ‘web3 game’ loosely even when they incorporate only one or two features of the blockchain. Therefore, we think it is important to clarify what exactly constitutes a web3 game.

We can categorize web3 games into two distinct segments. The first encompasses fully on-chain games while the second involves games that utilize aspects of blockchain but aren't entirely on-chain i.e. web2.5 games.

Fully on-chain games unlock new mechanics

On-chain gaming taps into the core features of blockchain such as programmable value and permissionless composability to create an engaging gaming experience. Some examples of such games include 0xMonaco and Dark Forest that are similar to developer games (games made by developers, for developers). In this model, the blockchain serves as a substitute for a centralized game server, allowing all players to index from and write to a shared state on-chain. Gubsheep, the co-founder of Dark Forest, outlined several additional features of fully on-chain games through this article:

• The source of truth for game data is the blockchain.

• The game logic and rules are implemented via smart contracts.

• The game is developed in accordance with open ecosystem principles.

• The game is client-agnostic.

• The game embraces real-world value digital assets.

These games seek to unlock mechanics that are fundamentally new rather than just make incremental improvements on existing games. While we find this approach innovative and are fully supportive of such games, we think such an approach may be limited to only a few particular types of games for the next few years such as strategy games, board and card games and real money games. However, these games will be instrumental in unlocking new experience for gamers and serve as sandboxes for experimentation and innovation.

The key value propositions of fully on-chain games are their extensibility and their ability to enforce rules and frameworks through smart contracts

On-chain Games are Extensible

One of the major advantages of on-chain gaming is extensibility or permissionless composability. Permissionless composability allows any user to build games, applications, user interfaces and more on top of existing blockchain protocols without requiring any sort of permission. This reflects in the modding world: players have been modifying games since the early days of PC gaming. They have added new maps to Doom and created entirely new games such as Counter-Strike from Half-Life and DoTA from Warcraft 3. This shows that modding has always been integral to gaming culture. However, there are two significant drawbacks with modding in the web2 world: i) The new clone has to bootstrap its own player liquidity and ii) The success of the clone game does not benefit the original game that put in the initial effort.

Now, with fully on-chain gaming, the power of user-generated content (UGC) is amplified. This is because the game is open source and has open data by default, allowing anyone to add new features or components to the game. This means that any game can be infinitely modded by anyone. As described in this article by AW Network, a well-considered design of the game's foundational layer on top of blockchain allows any player to introduce enhancements to an ongoing game. The community serves as the final judge as to whether the functionality advances or detracts from the game. This approach enables the deployment of code on top of a live game, granting existing players access to new features and also contributing to the overall success of the original game.

The best example of composability in fully on-chain games is Dark Forest. It is a persistent 4X “Space” game built on zero-knowledge proofs. The entire game’s state is on-chain, and the smart contracts controlling it are publicly known. This means that the game is front-end agnostic. You could re-skin the game to other themes so long as the moves generated by your user interface were in accordance with the protocol.

On-Chain Games Benefit from Smart Contract-Based Social Systems

The other major advantage of on-chain games is their ability to enforce rules and frameworks through smart contracts, which will likely help make games more social in the long term. It's a proven fact that blockchain can make games more financial. But through the use of smart contracts, one can also make them more social.

An example of this is Curio which introduces a feature known as 'treaties.' This feature allows gamers to form social contracts with other players within the game, creating a platform for players to record their agreements on-chain and build upon shared strategies.

Despite these advancements, games still struggle to fully embody the intricate social dynamics found in human societies. This issue largely stems from the difficulty of virtual environments to reflect the depth of real-life relationships that are often governed by legal and social frameworks.

For an instance, web2 games like 'Three Kingdoms: Strategy Edition', a popular Chinese wargame, have seen players draft extensive documents to set alliance structures. Yet, these agreements lack legal enforcement, rendering them vulnerable and typically dependent on trust alone.

In contrast, on-chain games offer concrete advantages, enriching gameplay with reliable mechanisms for interaction that go beyond what web2 can offer. Like real-world relationships that are enforced by law or societal norms, smart contracts in the digital space can facilitate similar binding social structures, transforming the way we engage with one another in games.

Onchain gaming is still in its early stages and needs to solve for multiple problems

Most fully on-chain games have started their journey within the last 2 years but have not yet achieved significant success due to obstacles that include:

• Technical Constraints: Current technical infrastructure isn’t ready and often leads to subpar user experience, simplistic gameplay, and limited engagement. Players should not have to constantly interact with their wallets, and the onboarding process should be as simple as buying a game on Steam.

• Limited Tooling: Existing developer tools, such as the EVM and Solidity data models, are not optimized for complex game development. Games require high throughput, low latency, and minimal or no transaction costs.

• AI Bots - Games can be populated with AI-powered bots that have full knowledge of the state since the game logic is on-chain and the data is transparent. It would be difficult to deal with bots that cannot be distinguished from real players and ensure that players are unique.

• Ticking - Blockchains use a transaction system and an event-driven runtime. However, most games operate on tick-based loops that do not rely on player input. For example, games like Minecraft have a persistent world where fires burn, water flows, and time passes in a loop-driven runtime, even without player input. This continuous change in games is distinct from the event-driven nature of blockchains and apps.

• Hiding Information - Hiding information on-chain is difficult since blockchain, in essence, is an open and decentralized database. Games that require hiding some information from other players have a harder time being played on-chain because of this.

Builders in the on-chain gaming space are working on resolving these challenges

There are several companies working to address these problems. Some of the prominent names include Mud, Dojo, Argus and Curio, and they have been actively working to resolve the above mentioned issues.

• MUD is the most popular game engine for on-chain games on the EVM. MUD is an open-source, free-to-use “Engine for Autonomous Worlds.” It is essentially built around the Entity-Component System framework, focusing on three critical issues in the development of fully on-chain games: synchronizing contract and client states, enabling on-chain content updates and facilitating interoperability with other contracts.

• Dojo Engine is a public good game engine built by Starknet builders. Dojo is aimed at simplifying the development process through the use of an Entity-Component System. It’s the only provable game engine in the market. Provability in this context means that the same game loop can be proved on a rollup’s sequencer or locally on the client side like your browser.

• Argus Labs is a customized L2 with a base shard and a World Engine, game developers can create unique execution environments with custom parameters like higher tick rates, native AA with gas customizations, ECS database and compatibility with clients like Unity, Unreal, JS, etc.

• Curio is using custom L2s and working with Caldera for their custom OP Stack implementations. They have an embedded ECS structure in their ticking chain and will provide comparable features like automatic indexing, client support for Unity, etc.

The projects mentioned above are just a few examples of the small but growing group of builders in this space. While these projects are still in their early stages of development, they are making significant contributions to the advancement of on-chain gaming and are unlocking mechanics that are fundamentally new and cutting-edge. 

Should games be fully on-chain?

While fully on-chain games are the future, and the space is witnessing a lot of developments, not every game is suitable to be fully created on-chain. If a developer is considering entering this new genre, some of the questions to think about are which types of games are best suited to run entirely on-chain? To which genres will permissionless composability and permanence best cater to? How to tackle the problems around bots when the game logic is on-chain and free to interact with? Is it truly essential to have your entire game logic on-chain, and to what extent does transitioning the game entirely on-chain result in the generation of new value?

If the answers to some of these questions aren't favorable to one's preferences, then one should consider the alternative model we call web2.5 gaming.

Web2.5 gaming companies need to build sustainable models to drive adoption

This idea explores the existing landscape of gaming and determines where blockchain is most likely to fit in and add value. Most of these games want to keep crypto and blockchain utility ‘under the hood’. For those aiming to develop popular genres such as MMORPGs or MOBAs, which typically involve numerous simultaneous elements, opting for a web2.5 approach is the most suitable choice.

The underlying assumption we have been making in the above assertion is that web2.5 games need to address the broader traditional gaming user base and not just crypto-natives. Our view is that web2.5 games will not succeed without web2 gamers, and ultimately the former will compete with web2 games for end users' time and money.

The first question to answer before entering into the arena of web2.5 games is: Why do gamers care about blockchain? While the ultimate answer is probably that players don't actually care – in the same way that players don't care about a developer's choice of game engine or cloud provider – the responsibility nevertheless falls on developers to create a fun experience and only integrate those parts of blockchain technology that can retain the magic circle of the gamers.

This comprehensive framework on "What value does web3 bring to games?" can assist developers in structuring their thoughts on topics such as social coordination systems, user-generated content and ownership permanence. It is crucial for game developers to avoid force-fitting blockchains just for the sake of it. Let's explore some thoughtful design approaches for web2.5 games.

Web2.5 Design Approaches

• User assets live on-chain while game loops live off-chain. This model is employed by the majority of web2.5 gaming companies, wherein the asset layer is fueled by NFTs and can be traded on the marketplace with royalties. This creates an opportunity for these companies to add an additional layer of monetization while giving full ownership of the in-game assets to players.

• Adding tokenization to incorporate open economy design in a web2.5 game. The primary objective of introducing tokens into a game is to align incentives. All active stakeholders, such as developers, gamers and creators, should receive rewards for their active participation and contributions towards the growth of the underlying game. It is essential to determine the extent of authority granted to various types of stakeholders. An important question to ask is how much power should be given to different stakeholders and on what basis. 

• Open up certain mod SDKs to the community to enhance the game experience. Traditionally, game developers collaborate with various third-party entities to bring their creative visions to life. These entities assist with content production, QA testing and more. In certain gaming ecosystems like Roblox or Fortnite, this concept of third parties can be expanded to include the player base through the incorporation of user-generated content (UGC) tools. While the idea of permission composability does not apply to web2.5 gaming, an important question arises: How can these companies leverage blockchain technology to enhance the current model and improve incentive alignment? This could be an interesting area for developers to explore.

• Putting the data on-chain after each player session. The most significant advantage is in governance. Assets owned or actions taken on-chain can determine a player's eligibility and influence in-game governance votes. Generally, all of this can be replicated via in-game credentials around what assets players own or what they’ve achieved in the game.

What web2.5 games should focus on?

Player Acquisition and Retention Strategies

User acquisition and building a dedicated community are top priorities for any game to survive. Web3 games currently face challenges in acquiring users. Establishing an initial community through mints and airdrops has proven effective, but it has long-term implications for player culture and expectations.

The fundamental problem that needs to be solved remains the same: maximizing player lifetime value (LTV) while minimizing customer acquisition costs (CAC). The key is to create sustainable economies and prioritize low-cost blockchain solutions for acquiring users without setting unrealistic expectations, which many web2.5 games have failed to do in the past.

The most promising area for acquiring users in blockchain gaming lies in leveraging web3-native features to drive growth. This can be achieved by establishing a token-based economy with sustainable economics and ensuring a meaningful token distribution strategy post the development of a robust community.

However, a thriving ecosystem is not only about numbers but also about the engagement and retention of those users, transitioning seamlessly from initial excitement to long-term loyalty. Game developers can scrutinize the contents of any given wallet, monitoring both individual and total asset values. Transactions within wallets can be dissected to reveal insights into total volumes, transaction frequencies and the average value of transactions. Furthermore, wallets can be examined to determine current purchasing power and the proportion of transactions executed in a specific period of time, thus helping identify the power users of the game. Incentivizing your power users is key to building a high-retention product. 

Distribution Strategies

Web3 games currently only have limited access to game distribution platforms. They are allowed in the Epic Store but blocked from Steam. This may change over time but given a platform like Steam accounts for 50-60% of all PC game downloads globally, this is definitely a significant disadvantage for web3 games.

Mobile is one of the biggest distribution categories for a web2.5 game. The most recent estimates state that by the end of 2023, there will be a total of 3.3 billion mobile gamers, and this number will grow 12% YOY to reach 3.79 billion by 2026. However, most web3 mobile games face challenges as any sale of NFTs on IOS or Android devices is subject to Apple's and Google's 30% revenue cut. 

Recent innovations in Progressive Web Applications (PWAs) have shown promise for generic games, offering a potential pathway around traditional app distribution platforms. However, they fall short for high tick-rate games, which require more intensive and real-time processing power. While consumer applications like friend.tech have explored it to circumvent platform constraints, these methods are nascent and remain largely untested for gaming applications. Nevertheless, there is a lot of potential for innovation around PWAs and how gaming companies can utilize this technology, particularly in the distribution of assets to users.

Even though gamers are devising increasingly sophisticated methods to circumvent these rules, such tactics are not sustainable for every game. Therefore, we anticipate that, in the short term, most web2.5 games will continue to be developed for browsers and will gradually shift towards mobile platforms as these issues are resolved.

Game Economics and Monetization

The current challenges faced by web3 gaming companies are evident, particularly in managing an inflationary economy and attracting genuine players over mere value extractors. 

For most games that want to drive sustainable adoption, these games need to carefully consider their token strategy. This could involve directly selling tokens on the open market, allocating them as rewards for gamers' contributions to the protocol, or implementing a hybrid approach. The challenges in this area are numerous, involving the determination of issuance schedules, the establishment of token utility, and the bootstrapping of liquidity, among others. Careful planning in this domain is crucial, as the initial launch of a token is a one-time opportunity that can make or break the game's ecosystem if not executed properly.

When it comes to monetization, web 2.5 games can benefit from the industry's extensive history by adopting a hybrid approach tailored to their specific needs. On one hand, they can implement models such as subscriptions and advertising, while on the other, they can incorporate royalties or taxes on NFTs.

Game Architecture and Design

Web2.5 gaming isn't just about launching a token or leveraging blockchain for the sake of it. Instead, it's about harnessing the unique capabilities of blockchain technology to introduce groundbreaking features that genuinely enhance the gaming experience.

A recent illustration of this is "Parallel Colony," which represents an entirely new genre of gaming. In this AI simulation game, avatars are placed within a mining colony and collaborate with players to explore the world. Each avatar possesses an ERC 6551 wallet (Token-Bound Account), signifying that your avatar has its own digital assets, including ERC 1155s and Prime token. These assets can be bought, sold, created, and traded with other AI avatars. An example scenario might be an avatar coding to plant mint, subsequently cultivating and harvesting it, and finally brewing tea.

With the emergence of newer technology like token-bound accounts and AI mechanics, web2.5 gaming companies can leverage these systems to achieve incremental improvements in their games. By doing so, they can methodically address issues related to user experience, interoperability and tradability, leading to a gradual but steady enhancement of their product.

Fully on-chain games and web2.5 games are both poised to maintain their relevance and thrive in the long-term gaming landscape

The excitement around the development of on-chain gaming is exciting, but it's important to recognize that the field is still in its infancy. Progress in web3 often unfolds at a slower pace than anticipated, and the journey is usually longer than projected. And there is no problem in that since they seek to unlock mechanics that are fundamentally new, rather than just making incremental improvements on existing games. Nonetheless, a cautious approach to timelines is necessary to align expectations with reality.

At this formative stage, the critical focus for this emergent genre should be to cultivate strong communities and address pivotal challenges. Enhancing user experience, managing bots effectively, concealing sensitive information on-chain, optimizing high ticking rate, countering sybil attacks, and developing robust tooling are essential milestones that, once achieved, will solidify the foundation for on-chain gaming's future growth.

On the other hand, web2.5 games have their own issues since most operate on an unlevel playing field with their web2 counterparts that do not face the same challenges with user onboarding, Play Store restrictions, and Steam blockade. Additionally, unlike established web2 entities that have amassed years of historical data for accurate forecasting, web2.5 games often lack this depth of data, putting them at a further disadvantage in planning and strategy development. 

However, as web2.5 games get closer to the quality standards of web2 games and gamers gain a deeper understanding of the real worth of ownership and interoperability, leading to widespread adoption of web2.5 games, we are confident that the remaining challenges related to distribution can be resolved. As gamers become acquainted with top-tier web2.5 games and the demand for such games rises, distribution platforms will need to take this growing gamer demand into account and consider this game category. We are currently witnessing several experienced gaming professionals creating high-quality games using the web2.5 approach.

As a web3 fund that focuses on emerging markets, where gamers predominantly use mobile devices and are gradually embracing newer game types and getting exposed to newer revenue models, a practical investment approach involves concentrating on high-quality web2.5 games. These games should possess strong intellectual properties, offer a user-friendly experience, relate to the cultural themes and genres of the target markets, and have an optimized go-to-market strategy tailored to the specific audience.

We express our gratitude to David from Playmint, Yijia from Curio, Ishan and Parth from Glip and Hyunmyung from Derby Stars for generously sharing their valuable insights, which have been integrated into this article.

References

• Unblocking On-Chain Games: Part One — Throughput

• Infinite Modding

• A Guide to Authentic Virtual Society

• The Inevitability of the Format

• How Blockchain Gaming Founders Should Think About User Acquisition

• Our Questions About Web 2.5 Gaming

• Autonomous Worlds (Part 1)

• The Strongest Crypto Gaming Thesis