Delphi Digital: The fundamentals of popular chain game Axie have improved dramatically. What's behind it?

Delphi Digital's in-depth report: What's behind the dramatic improvement in the fundamentals of popular chain game Axie?

Yan Pberman is an analyst with Delphi Digital and holds Chartered Financial Analyst (CFA) and Alternative Financial Analyst (CAIA) qualifications. Delphi Digital publishes the Chinese version of this report under license.

Original text: Perry Wang, Link to Wen

Special note: This report was issued on June 30, 2021, and the data mentioned in the report are as of the end of June 2021.

Key points:

The launch of blockchain game Axie Infinity's proprietary ethereum-side chain Ronin was a key catalyst for the game's explosive growth over the past two months, with daily active users (DAU) skyrocketed to 252,000 from 38,000 at the end of April. Most new users are thought to be coming from the Philippines and Venezuela, which complements the growth in Google search trends from these regions.

Through breeding and marketing fees, Axie's community coffers have grown from less than $1 million to more than $14 million in about two months, meaning that AXS's P/E (fully diluted valuation / 30-day annualized earnings) is now 7.59.

Since Ronin's Gas costs are negligible compared to Ethereum's, it is easier for more users to reproduce, driving the growth in Axie numbers, costs and market transactions.

Axie Infinity is a digital pet development and combat game that is popular around the world. The game is the poster child for the money-making movement that has helped thousands of people around the world earn a living as we speak. Even Mark Cuban, the billionaire owner of the NBA's Dallas Mavericks, is addicted to Axies Pokemon -- in his words: "Now anyone anywhere in the world can play games and make money at the same time."

Add To that the recent launch of Axie Infinity's proprietary ethereum side chain Ronin, the release of Play-to-Earn documentary, and the breaking of the 1 million Axies mark, and the Axie project has a lot To be excited about.

In this report, we delve into everything about AXIE: We provide the latest statistics reflecting Axie's soaring popularity, explore the economics of Axies reproduction, examine Axie's Treasury performance since Ronin's launch, and look at the fascinating interplay between the price, supply, and burn of a little love potion (SLP).

For those who want to adopt a digital combat pet of their own, we provide an overview of the Axies marketplace. Finally, we take a look at some of the exciting developments going on behind the scenes with Axie, and what you need to watch out for in the near future.

Axies has been growing exponentially since the launch of Axie Infinity's proprietary ethereum side chain Ronin. The chart above clearly shows the rapid capture of users (data as of the end of June) : Since the end of April, DAU, Axies holders, monthly market turnover, and Discord members have all seen significant growth. The Axie community coffers have also grown significantly.

Axie Infinity has been getting a lot of attention recently for its "Play the game and make money" mechanic design, especially after releasing a Play-to-Earn video showing how it helps Filipinos make a living playing Axie.

Last year, a Venezuelan player published an article claiming she could earn more playing Axie in a few days than working in a month. We used Google search trends to assess the popularity of "Axie Infinity", with 100 being the upper limit of the term's popularity and 50 being half the upper limit of its popularity. As you can see, Google search interest in Axie has increased dramatically over the past three months.

Since April 24, the number of DAU, Axie coin holders, and Discord members have all increased significantly. Since Discord's user cap is 100,000, the total number of Discord members has stabilized at around 100,000 for the first few weeks of June. After talking to Discord, the Axie team lifted the cap and allowed the number of members to continue to rise.

AXIE Infinity has integrated fiat currency platform RAMP.NET work into Ronin Chain, allowing players to use credit cards to buy easy ETH. Players who are not involved in crypto can therefore also top up ETH into their Ronin wallet and purchase Axies from the marketplace in an easy way.

Since fiat money currently only supports the purchase of ETH and not the sale of crypto assets, the data only shows the on-ramp buying activity. On June 22, fiat on-ramp daily trading volume hit a record high of around 130 ETH, which means very strong growth considering that it was less than 20 ETH a month ago. As the only use of ETH on Ronin is to purchase from the market, it is expected to increase the volume of transactions on the market, albeit only slightly.

The volume of daily market transactions has grown along with the value, from about $100,000 a day at the end of April to more than $4 million at one point in June. The increase in the number of users is driving the increase in market volume, as the threshold for players to want to play the game is to purchase at least 3 Axies to participate in the battle.

Since Ronin's launch, Axie's vault revenue has grown significantly. As noted above, the total revenue from the vault has increased from less than $1 million at the end of April to more than $14 million today. One of the unique attractions of the industry as a whole is its remarkable resilience in the face of macro turbulence, as demonstrated by the financial tsunami of 2008 and the COVID-19 of 2020. A similar trend has been seen in crypto games, with Axie Infinity recording its highest ever growth month despite a sharp sell-off in the crypto market.

Our research also focuses on the breakdown of the Treasury revenue in the reproductive income or marketing costs of each contribution.

Prior to Ronin's launch, marketing fees accounted for the lion's share of revenue in the coffers. However, since Ronin was launched two months ago, the cost of reproduction has grown to more than 50 per cent of the vault's total revenue. Prior to Ronin's launch, pet owners paid SLP and transaction fees in ETH, and gas fees were often too high for many users, which not only was not good for pet owners, but the vault was also unable to receive any reproduction fees.

Ethereum's high transaction costs have been a dissuade for many who want to breed Axies players. With the introduction of Ronin, the fee structure became better. Players now pay the same number of SLPs, but not the Gas cost of ETH, which costs only 2 AXS. This cost reduction is responsible for the recent surge in breeding activity. At the same time, the Vault now has a new source of revenue by paying 2 AXs to replace the ETH's Gas cost.

AXIE issued a statement on June 30 saying, "We will increase the AXS fee for the breeding fee to 4 AXS. This decision is made to ensure that the Axies population continues to grow healthfully and to create additional utility for AXS." Reproduction rates are expected to decline as a result of this change, but are likely to dip only slightly at the current high growth rates.

Axie's P/E ratio helps us understand the level of cash flow generation that games have become. To calculate the P/E, we use the fully diluted valuation divided by the 30-day annualized average earnings. The P/E ratio has fallen from above 800 in late April to a recent low of 7.59.

The history of Axie can be divided into two distinct periods: the pre-Ronin period before April 28, and the post-Ronin period after that. Axiie's vault grew from less than $100,000 a day in April to a peak of more than $600,000 in June. Ronin's low Gas rates make it cheaper to reproduce Axies and to trade in the market, thus increasing the revenue of the community coffers.

It's worth noting that these are actual gains passed directly to token holders. Projects typically mix income with income, with participants such as liquidity providers (LP) sharing the income and passing the rest on to token holders as income. All of that revenue would go into a community-owned Treasury, which would be distributed to the token holder once the portion of the stake is Staking. These are retained earnings in their truest form.

Recent projections

We extrapolate that current trends predict the growth of the Axie platform through the end of 2021. The platform's daily active users are growing by about 30% per week. In May and June, DAU increased by approximately 55,000 and 172,000, representing 167% and 197% growth, respectively.

We realize that the growth rate is so high because the user base is still very small, so let's assume 50% growth in July, and then it drops 10 percentage points every month until October, after which it stays at 20%. This implies an average of around 160,000 new DAU per month, which we consider to be a conservative estimate given the 172,000 increase in June alone.

It's important to note that this game has a different DAU mix than most games, which are made up of individuals looking for fun. Axiie has some fun-driven players, but it has also introduced an audience that is focused on speculation, and an audience that simply makes money by playing the game.

Whether users have a speculative element is not only a "yes" or "no" answer, but it is driven to different degrees for many users. The answer to whether to simply make money is relatively dualistic, but it creates an additional, consistent, profit-driven stream of players. These users cultivate resources that are then consumed by entertainment-motivated and opportunistic players, helping to drive the growth of the game economy. As the user base grows, the pool of demand for rare items grows, further boosting speculators' profits. This economic flywheel motivates all types of participants to join the ecosystem for their own reasons. That's why we think our user growth forecasts are reasonable -- perhaps too conservative. Using the demand for new users to participate in the game, we were able to predict revenue metrics from this user growth.

We kept the percentage of marketing fees at 4.25% of the volume and applied it to the volume estimates. While the monthly transaction volume per user has continued to rise over the past few months, we conservatively reduced the monthly transaction volume per user from 12 ETH in June to 8 ETH in December. This metric can and likely will climb higher in the short term, but we expect user growth to outpace transaction growth in the long term. The second benefit of using conservative growth estimates is that it makes year-end indicators look better.

The prediction of AXS in the vault is also a function of DAU growth. Let's assume that each newly bred Axie costs 4 AXS, and these are fixed variables. The current AXS cost per new Axie is 2 AXs, but this will increase to 4 AXs by July 2021. Since each new user needs 3 Axies to participate in combat, there is a close relationship between user growth and the need for reproduction.

In May and June, the ratio of newly bred Axies to new DAU was 5.2 and 4.7, respectively. The current ratio of Axies to DAU is below 5, which means the market is weak.

On the surface, you might think that the Axies offering is currently in line with user demand, as each user needs three bars to play, but power users and collectors of all kinds have a lot of bars. That's why we think the ratio (Axies monthly reproduction/monthly new DAU) is likely to remain above 3, but gradually decline in the coming months. Combining this ratio with the DAU number allows us to calculate how many AXs will accumulate in the vault.

By the end of the year, community coffers are expected to have 15.6 million AXs and 26,600 ETH, equivalent to about $149 million at today's prices, not including any more AXs that would be stowed once the Staking incentive takes effect. The token holder is entitled to take a share of the proceeds from the vault, and then start receiving income distribution once Staking is built. They can also decide how to spend those assets through governance.

We estimate that by the end of this year, approximately 24% of the outstanding AXS will be held in the vaults, assuming no money is flowing out of the vaults. The money in the coffers comes from the cost of reproduction paid through AXS, and because the 35% of the bonus for Staking based on issuance goes straight into the coffers. Part of the expansion of supply in circulation comes from the 65% issuance-based incentives that are rewarded to the Staker, mostly from tokens that are gradually released in one form or another by different groups of holders.

Axie plans to release Staking incentives in the third quarter.

Given the above information, the growth in the vaults is likely to be higher than the expansion in circulating supply, so it should be interesting to see what happens with the increase in the vaults. Nor does our study take into account the token supply that would be invested in Staking, or received from the Treasury for income distribution.

Possible weakness of the Axie economic flywheel

One way this flywheel model could break down is by overbreeding.

"Excessive" is relative to the expected future demand for these Axies's. It will be a multi-step process that sets off a cascade of effects. The front-end load caused by excessive reproduction has a high demand for SLP. When the SLP size is relatively small, the problem begins to expand when the group size purely for the purpose of making money enters the field. These money-making users began farming SLPs and selling them on the open market, but the market demand for SLPs was weak.

This happened because, in the background, the price of Axies began to fall because there were not enough new users to offset the increased supply. Breeding has become less attractive as the price of Axie has fallen. Since SLPs are used for reproduction, this means that there is less demand for SLPs, which is why the previously mentioned demand for SLPs disappears. The drop in SLP prices made the "play and make money" model much less attractive to new entrants and player growth slowed, while the Axie oversupply persisted. In this case, there will be economic stagnation.

We think this is a low probability event, because it would require a significant amount of runaway reproduction, and in an environment where all other components of natural rebalancing fail.

In most cases, despite the suppressed SLP prices, you will still see an influx of players who are "just for the money" because it is still worth it to them. This will gradually erode the oversupply of Axies and stimulate demand for reproduction again.

SLP prices are clearly an important factor here, and SLP speculators actually help to normalize price fluctuations. They act as a source of demand when natural demand slows and a source of supply when prices rise. Opportunistic breeders perform a similar function, helping to reduce the average cost of reproduction for individuals by accumulating when prices are cheap.

Another interesting part the team can control during this period is the cost of reproduction Axies, which has actually just been raised from 2 AXS to 4 AXS. In this sense, the team can act like a "Fed", raising the cost of reproduction (interest rates) to discourage reproduction when inflation is too high, and lowering the cost of reproduction when it is desirable to stimulate reproduction.

In the long run, continuing to add utility to Axies is the best mitigation for such situations. The team on the project knew this better than anyone, and they took a variety of measures into account when designing the game.

In our view, the most important thing to note is that future upgrades to Axies and the land will require materials to be made. These ingredients are obtained by "releasing" Axies, creating a deflationary element for the Axie supply.

The deflationary element itself is not the main novelty, but the novelty is that the player's progress in the game will depend on spawning and releasing Axies, which means that spawning won't be purely about creating pieces that need to be sold to new players. It is critical to decouple the needs of reproduction from the needs of new players. This will also boost the value of the upgraded Axies and increase profit margins for speculators and collectors. Most importantly, it will further consolidate the economic flywheel at the heart of Axie's economy.

Disclosure: Delphi Ventures has invested in AXS. Members of our team also hold AXS and AXIE NFT. This statement is intended to disclose any conflict of interest and should not be construed as a recommendation to purchase any tokens. This information is for reference only and should not be used as a basis for any financial decision. This article does not constitute any investment advice.

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