ELI5 by ChatGPT: Crypto Gaming Economy and the Circular Flow of Income
ChatGPT helps me explain GDP in a crypto economy
I write about web3 economics, mostly related to gaming. Follow me on Twitter @nghtshft_eth or subscribe here:
TL;DR
The circular flow of income model is developed to understand how money is exchanged between participants in an economy. Participants are classified into 5 sectors: Households, Firms, Government, Foreign, and Financial.
Households and Firms are the 2 main sectors. They send money to each other in exchange for resources (e.g. labor, goods & services).
We can extrapolate from the model to design a sustainable crypto economy:
Motivating players as Households and Firms
Balancing Household and Firm sources and sinks
Introducing “Factory NFT”
Controlling injections and leakages
Circular Flow of Income
The circular flow of income is a basic concept in economics that explains the exchange of goods, services, and money between different sectors of the economy.
In a simple economy, the circular flow of income involves two main participants: Households and Firms. Households provide labor and other resources to Firms in exchange for wages and other income. Firms use these inputs to produce goods and services that are sold to Households, who in turn use the money they earn to buy other goods and services, and so on.
In a more complex economy, the circular flow of income involves the Government, Financial and Foreign sectors as well.
The Government collects taxes from Households and Firms, and uses the money to provide goods and services and make transfers to Households. The Financial sector receives savings from Households and Firms, and reinvests the money as investments. The Foreign sector involves the import and export between the domestic economy and the rest of the world.
The circular flow of income is an important tool for understanding how the economy works. It helps us see how different parts of the economy are connected and how changes in one part can affect the others.
For example, if a Firm invests in new technology and increases its productivity, it can lead to higher wages for its workers and more income for Households, which in turn can lead to increased spending and demand for goods and services.
Crypto Gaming Economy
We can apply the circular flow model to design a more sustainable crypto gaming economy.
1. Motivating players as Households and Firms
To create a more circular economy in a crypto game, it's crucial to distinguish between two player motivations: Households and Firms.
Households represent players who prioritize consumption (various forms of fun, as defined by Bartle) and Firms represent players who aim for profit. Although a player can play both roles, it's easier to model the economy by separating these motivations.
For Firms to maximize profits (i.e. money surplus), Households need to be net spenders through consumption (i.e. money deficit). In free-to-play (F2P) games, the top 5% or even 0.5% of spending players typically generate most of the game's revenue.
This is expected to be the same in crypto games, where a small percentage of players are willing to spend enough to cover the entire Households sector. To achieve this, crypto games need to have engaging gameplay that leads to high spend depths in the tune of $100K+, similar to successful F2P games.
2. Balancing Households and Firms sources and sinks
Having distinguished between Households and Firms, the next step is to find a balance between them. From the earlier diagram, the flow of income between Households and Firms is determined by their interactions in the resource and product markets, posing two balancing challenges. We use Axie Infinity to demonstrate.
Resource Market: Household Income = Firm Cost
$SLP is used to reward gameplay (Household income for providing labor) and breed Axies (Firm cost to produce goods). Gameplay rewards scale linearly with number of games played whereas Axie production costs scale linearly with amount of Axie produced. The disconnect between the two factors caused the resource market (and thus Axie’s broader economy) to collapse.
A more effective design is to create a dynamic rewards mechanism, where the size of the $SLP reward pool scales with Axie production activities. For example, $SLP paid to breed Axies (Firm cost) can replenish the reward pool (Household income). The reward pool can then be distributed to players based on their engagement.
Axie Origin has already implemented this by introducing leaderboard rewards, where a fixed $AXS prize pool is set by the developer each season and dynamically shared by all players based on time (games played) and skill (win rate).
Product Market: Firm Revenue = Household Consumption
Axie Infinity failed to generate enough consumption. Most of the Firm revenue (Axie sale by profit-seeking breeders) came from new Firm costs (Axie purchase by new profit-seeking breeders) rather than from Households (fun-seeking players).
To overcome this, crypto game developers can look to the established playbooks of successful F2P games to enable high spend depth.
3. Factory NFT
To balance Households and Firms motivations even more explicitly, "factory NFTs" can be introduced.
Factory NFT is a concept where players must own specific NFTs to produce new game assets. Firms own factory NFTs, which act like PP&E in the real world, and produce new gameplay NFTs to sell to Households. Meanwhile, Households own and use gameplay NFTs solely for gameplay / consumption.
In this model, Firm revenue from producing and selling assets is directly linked to Household consumption (product market). Firm costs can be linked to Household income by making reward tokens a necessary resource for factory NFTs to produce new assets (resource market).
This design not only completes the circular flow of income but also gives game developers control over the game economy's productivity growth through managing the supply and pricing of factory NFTs in the market.
DigiDaigaku is one of the first blockchain games to experiment with Factory NFTs:
Digi NFTs are factory NFTs
Spirits NFTs are the resources generated from Digi NFTs to Digi NFT owners via airdrop
Spirits NFTs can then be burnt to mint “Digi Heroes,” which are gameplay NFTs
DigiDaigaku’s Factory NFTs follow a simple metagame: the quality of a Digi Hero is determined by the compatibility of the Digi NFT and Spirit NFT. Future projects can gamify the production loop further by introducing more complex metagames.
4. Controlling injections and leakages
The circular flow model quantifies economic growth, i.e. GDP increase. To achieve this, game developers should strive to encourage more injection than leakage in the Government, Financial, and Foreign sectors.
Government
Represented by the game developer or DAO, Government can easily achieve net positive value injection as long as the developer builds thoughtfully and is not overly extractive on fees.
Financial
Managing the Financial sector involves lowering savings and increasing investments. Savings can be reduced by enabling spend depth and maximizing consumptions. Firm investments can be enabled by introducing factory NFTs, especially with a thoughtful production metagame.
Foreign
Injection (e.g. players converting ETH into game tokens) can be achieved organically with the growth of the game, though should be done in a controlled manner to contain inflation. To deter leakages (e.g. players converting game tokens into ETH), some projects, such as ICE Poker, are experimenting with exit tax and redemption penalty.
Final Thoughts
Many of the design heuristics proposed in this article are hypotheses, based on first principles referenced from traditional economics and adjacent industry practices. They provide a path for crypto gaming to take educated risks and fail forward.
WAGMI.
Additional Reading
Circular Flow Model | Investopedia
The Circular Flow Model of a Market Economy | Jason Welker (YouTube)