Fake it till you break it

In this week’s Nexus, we examine the concept of artificial scarcity in digital worlds and the limitations of current token supply systems

One aspect of Bitcoin that remains sticky with crypto enthusiasts is the idea that an important aspect of the value of an asset is limited supply. By limiting the total supply of Bitcoins, the goal is to establish trust in its value and prevent dilution. Ironically, current inflationary problems can be traced back to policies around money printing through "quantitative easing," which started around the same time as Bitcoin emerged.

Limiting digital asset supply

The control of digital supply is crucial as information can easily be copied, making it challenging to be protected. However, controlling authorization to own it is possible. Centralized servers have been used to control the supply of digital assets, but this method has its drawbacks, such as the need to trust the centralized entity. Blockchain technology offers transparency and proof of the designed limitations of digital assets, which can be enforced through a blockchain algorithm or smart contract code, limiting tokens and NFTs. While there is no requirement to limit the supply of digital assets, leaving it open potentially invites inflationary issues. This was seen in the case of Axie Infinity, which did not impose any maximum limits on SLP earned through gameplay or the number of Axies that could be bred. The idea behind this was to allow the token and Axie supply to scale with the player base and give players control over the economy. However, this led to overproduction and greed which resulted in a death spiral that Axie Infinity: Origins is still trying to recover from.

Token supply systems in web3 games

Although it is now widely accepted to set limitations around the economic aspects of web3 games, there is still a need to carefully consider the implementation of these restrictions. Following the collapse of Axie Infinity, the approach has often involved transitioning to a two-token economy where one token is used as a utility token that can be earned and is allowed to be inflationary, while the second token is a governance token with a fixed total supply. This strategy makes sense as it allows the game's economy to expand with the players, ensuring there is always something for players to earn and spend. Additionally, the fixed supply of the governance tokens is comparable to shares in an organization and ensures that the value of these tokens is not diluted over time. Other variations on this approach include single token capped economies, as well as governance tokens with such high utility that they effectively serve as a secondary utility token. Various token distribution schemes have also been developed, outlining precisely how and when tokens will enter circulation for different parties. As a result, it is possible to anticipate how changes in token supply and potential selling pressure will affect the token's value.

Drawbacks of a fixed token supply

Despite its widespread adoption, there are certain flaws with a fixed token supply system that tend to be overlooked. First, a limited supply only becomes relevant once it has been reached. Prior to that, the cap is simply determined by the circulating supply, which is a constantly fluctuating value, and thus the impact on the token's value is more determined by typical supply and demand pressures. Since most tokenomics plans are designed to last for several years, it is rare to find examples of tokens that have already reached their cap, which makes it difficult to predict their impact. Typically, the expectation is that demand will grow faster than the circulating supply, resulting in a gradual increase in the token's value over time, primarily benefiting investors. However, since it is unlikely that demand will always keep up with supply growth, token prices tend to fluctuate considerably in the early stages, influenced by both high and low prices. Second, these fixed caps are essentially educated guesses regarding the maximum amount of tokens required. While it is relatively easy to announce token buy-backs and burning if the supply ends up being too high, there is rarely a plan in place for dealing with a shortage of tokens. Attempting to forecast and regulate a token's supply for a game that is still in development or is yet to be released is akin to putting the cart before the horse.

Fixed supply NFTs

Although our attention has been on tokens so far, fixed supply NFTs can also present issues. While it makes sense to control the exact supply of collectibles, as is customary in the physical world, it is often impractical for other types of assets. The biggest issues often lie with NFTs that are necessary to access a game or are a critical aspect of gameplay. Limiting the availability of these gatekeeping NFTs has resulted in significant inflation and speculative or FOMO behavior, but it is rarely sustainable. This is partly because it contradicts the desire for growth in the economy. Restricting growth can hurt long-term revenue in favor of short-term fundraising. Pre-sales and land sales are notorious for this. There are ways to do pre-sales that provide early access or a special recognition status, which may not generate large sums of money but will be more sustainable. Land sales will also ultimately prove problematic, particularly if they become a bottleneck for user-generated content that is crucial to the economy's design. Although the available land may appear to be sufficient initially, if the game becomes successful enough to run out of land at reasonable prices, content creation could stagnate. Platforms like Second Life tried to increase their land supply when prices became exorbitant, which resulted in a drastic crash in land prices and an exodus of businesses and players that damaged the entire economy.

Real and artificial scarcity

The main topic of this discussion is the concept of "artificial scarcity," which refers to the irrevocable decision to limit the supply or create scarcity. The term "artificial" is used as scarcity is either determined arbitrarily by a person or group (”artificial”), or by real-world constraints such as physics, economics, and time (”real”). Gold is an example of real scarcity since its finite nature is not decided by anyone, but rather by real-world constraints. Bitcoin is a combination of both artificial and real scarcity, with its maximum supply being artificial, while the current circulating supply is real, as it is dependent on factors like mining power. Unfortunately, most tokens and NFTs are purely artificial in design with tokenomics plans specifying the exact amount of supply available at any given time, or the exact number of NFTs that will be minted simultaneously. Axie Infinity was originally designed with more real scarcity as SLP was minted based on play constraints and NFTs were minted based on breeding system constraints, which related directly to the SLP constraints.

Innovation emerging from artificial constraints

Although many consider Axie Infinity to be a failure, it is worth looking at the interesting ways in which real-world constraints affected the game, in contrast to purely artificial ones. The real-world constraint on the supply of SLP was determined by both the total Axie supply and the total number of players. The total Axie supply was also limited by the total SLP supply, which was needed to cover breeding costs. One of the interesting aspects of real constraints is that they can potentially inspire innovative solutions, rather than being insurmountable barriers. Because the high prices and investment potential were in Axies, early adopters and investors sought ways to overcome the breeding constraints. The main breeding constraint was that it required SLP, which could only be obtained through daily play. This led to the first innovation of having other people play with one's NFTs to generate the necessary SLP to continue breeding and create a positive feedback loop. Another constraint to consider was the amount of SLP earned each day, which depended on skill level. This led to the second innovation around the formation of guilds to help facilitate more skilled play and business models around SLP profit sharing to reward skill and dedication. Today, the problems with the system are obvious, but these simple real-world constraints led to innovations that would not have been possible with purely artificial constraints.

Constraining supply via demand

Rather than replicating the problems of Axie Infinity, we should focus on how constraints can shape a system. In real life, gold mining might be a tough industry, but the constraints of geology and technological scouting lead to new innovations both in tech and business. With play-to-earn models, play is often the constraint on supply or earnings, but simply using bots or cheap labor is not a sustainable solution. Instead, we need to get creative and consider how supply can be constrained by demand. Shifting the constraint to highly competitive play was a simple adaptation Axie Infinity has implemented with its AXS token, but unfortunately this also tends to burn and churn players over time. One interesting example is the soft-peg system used by Splinterlands, which adjusts the daily reward supply of its uncapped DEC token based on the price of the token as a proxy for demand. While this system is not perfect, it does show promise in keeping the token price close to or above the desired soft-peg price. However, using price as a proxy for demand is not entirely accurate as it does not take into account how demand is expressed, and it only throttles daily output without controlling the real circulating supply.

Creating authentic game economies

We are only beginning to explore the potential of real scarcity in web3 games, as the possibilities in a dynamic digital world that can draw from multiple sources of information are vast. It is crucial to view supply as a result of the various forces and regulations we put in place when constructing a web3 game economy. Traditional web2 game economies, for instance, depend on game and economic design to shape the uncapped supply of soft currencies, rather than simply establishing arbitrary caps to confer value. While Source and Sink design may be more challenging than capped circulating supply design, it is an essential approach to embracing the freedom of the digital world and advancing economic design. Capped circulating supply design and tokenomics supply curves are a simplistic and unsophisticated approach that only applies in specific scenarios, such as collectibles. Instead, we should aim to make our game economies more authentic by creating them with regulations and frameworks, rather than artificial limitations.

Thanks for reading this piece of our weekly series “Nami’s Nexus”, where we look to decode web3 gaming and dive into the various areas and nuances of the industry and beyond. Don't forget to subscribe to our blog and follow us on Twitter to receive more web3 gaming content.