Delphi Digital In-Depth Report: Axie Infinity Player Surge, Key Reason Behind This

This article is authorized to be reprinted from ChainNews, with the original title "Delphi Digital In-depth Report: Why has the fundamental of the popular blockchain game Axie significantly improved?"

Within two months, the daily active users of Axie Infinity surged from 38,000 to 252,000. Its community treasury grew from less than $1 million to over $14 million.

Author: Yan Liberman, Analyst at Delphi Digital, holds the Chartered Financial Analyst (CFA) and Chartered Alternative Investment Analyst (CAIA) qualifications. Delphi Digital authorized ChainNews to publish the Chinese version of the report.

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Compiled by: Perry Wang

Special Note: This report was published on June 30, 2021, and the data mentioned in the report is up to the end of June 2021.

Key Points:

• The launch of the Ethereum sidechain Ronin for the blockchain game Axie Infinity has been a key catalyst for the explosive growth of the game in the past two months. The daily active users (DAU) skyrocketed from 38,000 at the end of April to 252,000. Most new users are believed to come from the Philippines and Venezuela, a trend supported by the increased Google search interest from these regions.
• Through breeding and marketplace fees, Axie's community treasury has grown from under $1 million to over $14 million in about two months, resulting in a market cap for AXS of 7.59 (fully diluted valuation / 30-day annualized earnings).
• Due to Ronin's negligible gas fees compared to Ethereum, more users find it easier to engage in breeding, driving the growth in the number of Axies, breeding fees, and marketplace transaction volume.

Axie Infinity is a globally popular digital pet breeding and battling game. It has become a paradigm of playing games to earn money, helping millions of people around the world make a living. Even billionaires like Mark Cuban, owner of the NBA's Dallas Mavericks, are hooked on Axie's creatures, stating, "Anyone in the world can now play games and earn money."

With the recent launch of its dedicated Ethereum sidechain Ronin, the release of the "Play-To-Earn" documentary, and surpassing the milestone of 1 million Axies, the Axie project has achieved many exciting milestones for investors to look forward to.

In this report, we delve deep into everything Axie: providing the latest statistics reflecting the surging popularity of Axie, exploring the economic principles behind Axie breeding, reviewing the treasury revenue performance since the launch of Ronin, and observing the fascinating interactions between the price, supply, and burn of Small Love Potions (SLP).

For those looking to adopt their own digital battle pets, we offer an overview of the Axies market. Finally, we explore the exciting developments behind Axie and what dynamics to watch out for in the near future.

Since the launch of Axie Infinity's dedicated Ethereum sidechain Ronin, Axies have been experiencing exponential growth. The image above clearly shows the rapid capture of users' attention (data up to the end of June): significant growth in DAU, Axie holders, monthly marketplace volume, and Discord members since the end of April. The Axie community treasury has also seen significant growth.

Axie Infinity has garnered significant attention for its "Play-To-Earn" mechanism design, especially after releasing the Play-To-Earn video showcasing how it helps the Filipino people earn a living by playing Axie.

Last year, a Venezuelan player wrote an article claiming she earned more playing Axie in a few days than working for a month. We used Google search trends to assess the popularity of "Axie Infinity," where 100 represents the peak popularity of the term, and 50 means half of peak popularity. It is evident that interest in Axie has significantly increased over the past three months.

Since April 24th, DAU, Axie holders, and Discord members have shown significant increases. With the limit of Discord users being 100,000, the total number of Discord members remained stable at around 100,000 in the early weeks of June. After communicating with Discord, the Axie team removed the limit, allowing the member count to continue to rise.

Axie Infinity has integrated the fiat on-ramp platform Ramp.Network into the Ronin Chain, allowing players to easily purchase ETH with a credit card. Players who are not involved in the crypto space can now top up ETH into their Ronin wallet and easily buy Axies from the market.

As fiat on-ramp currently only supports purchasing ETH and not selling crypto assets, the data only shows fiat on-ramp buying activity. On June 22nd, the daily fiat on-ramp trading volume hit a historic high of around 130 ETH, a significant increase from under 20 ETH just a month ago. Since the only use of ETH on Ronin is to purchase from the market, this is expected to boost market transaction volume, albeit a minor increase.

The daily market transaction volume has increased alongside the amount, rising from around $100,000 per day at the end of April to over $4 million in June. The growth in user numbers is driving the increase in market transaction volume, as the barrier to entry for players is to own at least 3 Axies to participate in battles.

Since the launch of Ronin, Axie's treasury revenue has seen significant growth. As mentioned, the total treasury revenue has increased from under $1 million at the end of April to over $14 million today. One of the unique attractions of the entire game industry is its excellent resilience in the face of macro turbulence, as demonstrated by the 2008 financial crisis and the 2020 COVID-19 pandemic. The crypto gaming sector has also shown a similar trend: despite sharp sell-offs in the crypto token market, Axie Infinity has had its highest growth month ever.

Our research also breaks down the contributions of breeding revenue and marketplace fees to the treasury revenue.

Prior to the launch of Ronin, marketplace fees dominated treasury revenue. However, since the launch of Ronin two months ago, breeding fees have grown to account for over 50% of the total treasury revenue. Before Ronin, pet owners paid SLP and transaction costs in ETH, with gas fees often being too high for many users, which was not only disadvantageous for pet owners but also meant the treasury received no breeding fees.

The high transaction fees on Ethereum have deterred many players who wanted to breed Axies. With the introduction of Ronin, the fee structure has improved. Players now pay the same amount of SLP but no longer require ETH for gas costs, only needing to spend 2 AXS. This cost reduction is the reason for the recent surge in breeding activity. At the same time, by paying 2 AXS instead of ETH gas costs, the treasury now has a new source of revenue.

Axie released a statement on June 30th, stating, "We will be increasing the AXS cost of breeding fees to 4 AXS. This decision was made to ensure healthy growth in the number of Axies and to create additional utility for AXS." With this change, it is expected that the breeding rate will decrease, but in the current high-growth scenario, it may only be a slight pullback.

Axie's price-to-earnings ratio helps us understand how the game has become a cash flow-generating machine. To calculate the P/E ratio, we use the fully diluted valuation divided by the 30-day annualized average earnings. The P/E ratio has dropped from over 800 at the end of April to a recent low of 7.59.

Axie's development history can be divided into two different periods: the pre-Ronin period before April 28th and the post-Ronin period after. The treasury daily growth has increased from under $100,000 in April to a peak of over $600,000 in June. Ronin's low gas fees have made breeding Axies and trading on the market cheaper, leading to increased revenue for the community treasury.

Notably, these are the actual earnings passed directly to token holders. Projects often mix revenue and earnings, where participants like liquidity providers (LP) share revenue, and the remaining portion is passed on as earnings to token holders. All these revenues will flow into the community treasury, which will be distributed to token holders after the staking section goes live. These are the most genuine form of retained earnings.

Recent Predictions

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We infer the current trend predicts the growth trajectory of the Axie platform until the end of 2021. The current DAU growth rate on the platform is about 30% per week. DAU increased by approximately 55,000 and 172,000 in May and June, respectively, with growth rates of 167% and 197%.

We acknowledge that the high growth rate is due to the small user base, so we assume a 50% growth rate in July, then a decrease of 10 percentage points each month until October, where it will stabilize at 20%. This means an average of about 160,000 new DAU per month, a figure we consider conservative as there was an increase of 172,000 in June alone.

It is noteworthy that the composition of DAU in this game is different from most games, as it is mainly driven by individuals seeking entertainment. Axie has players motivated by fun, but it also attracts users aiming for speculation and those simply looking to make money by playing.

The presence of speculative elements among users is not binary but varies in degrees of drive for many users. The answer to whether it is solely for making money is relatively binary, but it creates an additional, consistent, profit-driven player stream. These users cultivate resources, which are then consumed by players driven by entertainment and speculation, helping to drive growth in the game economy. With the growth in the user base, the demand pool for rare items expands, increasing the profits of speculators further. This economic flywheel incentivizes all types of participants to join the ecosystem for their own motives. This is why we believe the user growth prediction is reasonable—perhaps even too conservative. Leveraging the demand from new users engaging in the game, we can predict profit indicators from this user growth.

We keep the market fee extraction percentage at 4.25% of the transaction volume and apply it to the estimate of the transaction volume. While the average monthly transaction volume per user has continued to rise over the past few months, we conservatively decrease the average monthly transaction volume per user from 12 ETH in June to 8 ETH in December. This indicator can and is likely to climb to higher heights in the short term, but we expect that in the long run, the user growth rate will surpass the transaction volume growth rate. The benefit of using conservative growth estimates is that it makes the year-end indicators look more impressive.

The forecast for AXS in the treasury is also in functional relation to the DAU growth. We assume that each new bred Axie will require 4 AXS, which are fixed variables. The current cost for breeding a new Axie is 2 AXS, but it will increase to 4 AXS by July 2021. Since each new user needs 3 Axies to participate in battles, user growth is closely related to breeding demand.

In May and June, the ratio of new bred Axies to new DAU was 5.2 and 4.7, respectively. Currently, the ratio of Axies to DAU is below 5, indicating a soft market.

At first glance, you might think that the supply of Axies currently meets user demand, as each user needs 3 Axies to play, but advanced users and various collectors own many Axies. This is why we believe the ratio (monthly Axies bred / monthly new DAU) is likely to remain above 3 but gradually decrease in the coming months. By combining this ratio with the DAU figures, we can calculate how many AXS will accumulate in the treasury.

By the end of the year, the community treasury is expected to hold 15.6 million AXS and 26,600 ETH, approximately equivalent to $149 million today, excluding more AXS to be stored after the Staking incentives take effect. Token holders are entitled to share the earnings from the treasury and will begin receiving income distributions after Staking goes live. They can also decide how to spend these assets through governance.

We estimate that by the end of this year, approximately 24% of the circulating AXS will be held by the treasury, assuming no funds flow out of the treasury. Treasury inflows come from breeding fees paid in AXS and because 35% of issuance-based Staking rewards will go directly into the treasury. The expansion of the circulating supply comes from 65% of issuance-based Staking rewards, which are fed back to Stakers, mainly from tokens gradually released by various holder groups in various forms.

Axie plans to release the Staking incentive mechanism in the third quarter.

Given the above information, treasury growth may outpace the expansion of the circulating supply, so looking at the results of increasing treasury funds should be interesting. Our research also does not consider the tokens to be invested in Staking or the token supply receiving income distributions from the treasury.

Potential Weaknesses in the Axie Economic Flywheel

One way this flywheel model may collapse is through overbreeding.

"Over" refers to the relative demand for these Axies by future players. This will be a process triggered by multiple steps. The front-end load brought by overbreeding places high demand on SLP, and when SLP is relatively small in scale, the entry of a group focused solely on making money exacerbates the problem. These money-making users start farming SLP and selling on the open market, but the market demand for SLP is weak.

This situation arises because behind the scenes, Axie prices start to decline due to insufficient new users to offset the increased supply. As Axie prices drop, breeding becomes less attractive. Since SLP is used for breeding, this means a decrease in demand for SLP, which is the reason for the disappearance of demand for SLP mentioned earlier. The decline in SLP prices significantly reduces the appeal of the "Play-To-Earn" model to new entrants, player growth decreases, and Axie oversupply persists. This scenario will lead to economic stagnation.

We believe this is a low-probability event, as it would require a considerable amount of uncontrolled breeding and all other natural rebalancing components to malfunction.

In most cases, although SLP prices are suppressed, we will still see a large influx of "purely for money" players because it is still worthwhile for them. This will gradually erode the oversupply of Axies and stimulate breeding demand once again.

SLP prices are evidently a key influencing factor here, with SLP speculators actually helping normalize price fluctuations. They act as a source of demand when natural demand slows down and as a supply source when prices rise. Opportunistic breeders also perform similar functions, helping reduce individual average breeding costs by accumulating when prices are low.

Another interesting part that the team can control during this period is the cost of breeding Axies, which has just been increased from 2 AXS to 4 AXS. In this sense, the team can act like the "Fed," raising breeding costs (interest rates) to suppress breeding when inflation is too high and lowering breeding costs to stimulate breeding when desired.

In the long run, continuing to add utility to Axies is the best defense against such situations. The project team is more aware of this than anyone, considering various measures in game design.

We believe one of the most notable points is that future upgrades to Axies and land will require crafting materials. These crafting materials are obtained by "releasing" Axies, creating an element of currency tightening for Axie supply.

The currency tightening element itself is not the main novelty; the novelty is that player progression in the game will depend on breeding and releasing Axies, meaning breeding will not purely be to create Axies for sale to new players. Decoupling breeding demand from new player demand is crucial. This will also increase the value of upgraded Axies, raising the profit margins for speculators and collectors. Most importantly, it will further solidify the economic flywheel as the core of the Axie economy.

Disclosure: Delphi Ventures has invested in AXS. Members of our team also hold AXS and Axie NFTs. This statement is intended to disclose any conflicts of interest and should not be misconstrued as advice to purchase any tokens. The content of this article is for reference only and should not be used as a basis for any financial decisions. This article does not constitute any investment advice.