Pay-to-play, Free-to-play, and now, play-to-earn. The third evolution in the gaming industry, ‘GameFi,' is here, and it's powered by the blockchain. These games represent a paradigm shift, making games profitable for both players and studios:
- Some players are making enough money to quit their full-time jobs
- GameFi titles generated $2.32 billion in the third quarter of 2021, which represented almost a quarter of total NFT trading volume
These are only two reasons why nearly 60% of US and UK-based developers are exploring blockchain technology to open up new business models and increase the appeal of their games.
While exciting, these emerging opportunities are creating new challenges for accounting and finance teams struggling with government bodies' lack of regulation and ambiguity. Here, we’ll walk you through how digital assets impact the gaming industry and give strategies to maintain healthy accounting and financial practices with GameFi and secondary marketplaces.
What is GameFi or Web3 Gaming?
GameFi (also called Web3 Gaming) refers to decentralized gaminbleg applications that reward players with economic, play-to-earn (P2E) incentives for performing tasks like winning battles, mining for resources, etc.
These incentives can include tokens, licensing revenue, or items within a game that can be sold on secondary marketplaces. These mechanisms create an in-game economy that creates value for the game’s players, ecosystem, and developers.
Here are a few examples of games challenging the traditional gaming model:
- Decentraland famously sells virtual land, which brands are swapping up left and right.
- Axie Infinity allows gamers to transform their skills and time into earnings and distribution rights for tokenized in-game items on secondary markets.
- Gods unchained’s is a virtual version of Magic The Gathering where players can collect and trade cards with real-world value based on their native GODS token (more on that later).
In a previous article, we discussed how intangible digital assets are revolutionizing the world, and gaming is no different. Today, developers use tokens to reward players and provide new revenue sources for video game makers and their customers alike. This is one of the many reasons why the space is attracting investment from prominent VC firms and other financial institutions.
- Sky Mavis, the studio behind Axie Infinity, recently received a $152 million Series B round led by Andreessen Horowitz for a valuation of $3 billion.
- An online marketplace OpenSea says it is now worth $13.3 billion following a new investment of $300 million.
- Investment firm Grayscale recently launched a Decentraland Trust.
Gaming is big business: The gaming industry as a whole is estimated to be worth $268 Billion by 2025. The question is, why should profits be one-sided?
Monetization is the name of the game
And secondary markets are an essential part of it.
The most profound advancement of the GameFi ecosystem is that gamers retain full control over the assets they earn while playing. This allows them to trade their assets freely with other players and sell them on primary or secondary marketplaces for real-world money.
Savvy developers are encoding NFT-like mechanisms into the smart contracts that power these assets, which allows them to obtain royalty fees with each subsequent sale of the asset. And the results speak for themselves.
A rare card in Gods Unchained was purchased for 137 ETH on a secondary market. As part of that transaction, the game studio received 13 ETH. Even more impressively, Axie infinity’s NFT reached $4 billion in sales back in February – almost double the worth of the CryptoPunks portfolio.
This is a stark departure from traditional gaming models, where the only way players could purchase in-game items where through dark markets or over-the-counter markets. For example, Blizzard, the studio behind World of Warcraft, directly refuted play-to-earn models in their games, banning practices like gold farming due to fraudulent practices.
But GameFi can bring legitimacy to this type of work, transforming communities worldwide and replacing traditional forms of employment.
Why didn’t companies do this before?
One reason gamers are skeptical of new revenue models from gaming studios is the loot box controversies of the past few years.
In the past, studios have sold loot boxes as random collections of virtual goods but often give players a small chance of winning a rare item. The strategy brings in piles of money for studios but has come under criticism for being linked to gambling. Countries like Germany are now banning minors from playing video games that contain loot boxes.
But for all the – sometimes warranted – pushback, GameFi can provide ethical means of monetization that could benefit both gamers and studios.
4 unique challenges of digital asset accounting for blockchain gaming companies – and how to overcome them.
Challenge 1: Transaction volumes make recordkeeping a challenge
Scale: The promise and challenge of blockchain technology where thousands of transactions happen every minute. It’s not uncommon for businesses to record 100s of billions of individual transactions in their ledger. Because of this volume, any inaccuracies or missing transaction that isn’t recorded will not be spotted until it’s too late.
Accurate and efficient reconciliation is crucial because, in this worst-case scenario, it would be next to impossible to identify and remediate the source of the variance.
How to overcome it: Track everything. Crypto holds the opportunity to unite accounting, taxes, and compliance units within larger organizations (for example, cost basis must be tracked for both tax and accounting purposes). Take advantage of this and maintain good records for every single transaction.
Another tip is to treat GameFi assets like inventory –– but this has two important considerations to note:
- Each token is a unique asset. As such, remember to track the cost basis of the token when you got it and again when you sent it out.
- If the NFT is a collectible, you’ll have unique tax considerations compared to calculating capital gains and losses on a stock.
Challenge 2: Regulations for pay-to-earn players
Creating a new class of workers has its problems: Are the NFTs or digital assets players are rewarded with securities?; Do you have to grant players 1099s?; How do you report earnings from games or secondary marketplaces?
While regulators are now beginning to give general guidance in these areas, many unresolved questions remain.
How to overcome it: Maintain proper wallet hygiene.
Good wallet hygiene is essential as organizations scale because it helps accountants understand transactions from a workflow perspective as they process them. We recommend maintaining transaction-specific wallets (e.g., investments, DeFi transactions, revenue, etc.)
We also recommend setting up treasury controls around wallets. Some of our customers have had single wallets with hundreds of millions of dollars, which introduces obvious complications.
Challenge 3: Tracking profitability
Studios can monetize through GameFi mechanisms is to sell rewards as NFTs. But in doing so compliantly, they must determine profit margins and costs of goods.
Imagine determining the value of a physical piece of art: calculating the cost basis would be akin to the costs associated with its creation, like the canvas, paint, etc. Similarly, all the costs associated with creating an NFT would be included in the cost of goods sold, including salaries, contract labor, gas fees, electricity, utilities, and other overhead costs.
How to overcome it: Diligent recordkeeping. Track the costs of all the inputs associated to creating the NFT, including creative costs like software or infrastructure costs like gas fees, creating the smart contract, etc.
But tracking all the relevant transactions on the blockchain is easier said than done. Solutions like Bitwave make it easy for enterprise organizations to maintain these records.
Challenge 4: Exchange management
Adding exchanges impacts tax and accounting because pricing strategies differ on what decentralized exchange (DEX) you’re trading on.
How to overcome it: The IRS has issued advice stating that you should use pricing from the principal market you primarily trade on. Tools like Bitwave help you monitor assets sold on DEXs and have tools to mitigate different pricing on exchanges automatically.
The golden rule: Take a bookkeeper-first approach
Create a single wallet for every new revenue stream your business is making. Then your accountants (or easy-to-use software solutions like Bitwave) can write rules that allow your business to recognize revenue easily –– and even book it into direct revenue events in your ERP.
All fun and games
Non-fungible tokens (NFTs) were the dominant crypto trend of 2021 and are shaping to impact the video game industry in a big way. Have a question about GameFi or crypto accounting in general?
High volume NFT and digital asset revenue recognition, accounting, and tax tracking is what Bitwave specializes in. Reach out today to schedule a demo.