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Professor Marco Di Maggio and independent researcher Wenyao Sha prepared this case. It was reviewed and approved before publication by a company designate. Funding for the development of this case was provided by Harvard Business School and not by the company. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.

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M A R C O D I M A G G I O

W E N Y A O S H A

Axie Infinity: Video Game Meets Blockchain

A game needs players. By simply playing the game, community members are adding value to the network and should be rewarded. It’s simple, but revolutionary. We’re looking for missionaries to align incentives with as we change the gaming world forever.

— Axie Infinity Whitepaper1

The date was March 29, 2022. Jeffrey “Jiho” Zirlin, Co-founder of the Vietnam-based game studio Sky Mavis, was getting ready for the spotlight on the stage of the Los Angeles Convention Center, where the talk of the town was NFT LA, the biggest non-fungible token (NFT) gathering in Southern California.2 Four years ago, the studio released Axie Infinity,a a blockchain-based video game in which players could earn, collect and trade NFTs at the height of the crypto crash (Exhibit 1, 2).3, 4 Since then, the game had grown into a global crypto phenomenon and garnered a dedicated community following.5

The Axie Infinity business model was an example of game finance (GameFi), one of the latest instances of blockchain-based technology seeking new use cases in real life.6 Riding on the waves of decentralized finance (DeFi), which brought peer-to-peer stablecoins, lending and market making into the crypto world, as well as non-fungible tokens, which introduced on-chain collecting and trading of digital artworks, GameFi attempted to offer a unique experience that blended the two in the form of a video game.7,8,9,10 In particular, the “play-to-earn” genre, in which the game enabled players to earn rewards that could be sold for real-world money, was among the most noteworthy exemplifications of GameFi.11 Indeed, in developing economies such as the Philippines, Venezuela and Argentina, playing Axie Infinity had become a full-time job for many, providing a much-needed source of income, or even the only source of income for some, when COVID-19 hit the hardest and the world went into lockdown.12,13,14,15 “Fifty percent of our users have never used crypto or blockchain before,” Zirlin mentioned in an interview in early 2022.16

Despite critics questioning the sustainability of its in-game economy, casting doubts over the uninspired gameplay, or outright calling it a pyramid scheme, Axie Infinity delivered a stellar growth story.17,18 By December 2021, Sky Mavis had made $1 billion in total revenue, recorded $2.7 billion in trading volume of its NFTs across 8 million transactions, and had 2.3 million Axie owners.19 The most

a Axie Infinity was originally created by Tu Doan, co-founder at Sky Mavis.

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recent round of fundraising in October 2021 valued the company at nearly $3 billion.20 Across almost all metrics, it was the most popular NFT project ever.21 “For a long time, people talked about okay, games are gonna bring mass adoption to blockchain technology. But for so long, nothing was happening. But finally, just recently, gaming has come on the scene thanks to Axie Infinity where Axie has now shown that it can generate even more revenue than a protocol like Ethereum or Bitcoin through fees. So I think this is gonna kick off a lot of interest in creating these new types of games and it’s amazing,” Zirlin remarked during an online presentation in September 2021.22

The stage was set, the camera was rolling and the crowd was cheering. As Zirlin stepped onto the podium, it was as if everything he had wished for was coming true – everything except one. Earlier in the day, news broke out that the Ronin network, the blockchain foundation on which the game was built, was hacked.23

Blockchain Primer: DeFi, NFT and Web3 Even as organic demand repeatedly pushed the price to new highs since Bitcoin’s launch in 2009,

cryptocurrencies and blockchain as a whole was plagued by the lack of tangible applications for the masses. In 2015, Ethereum, a second-generation cryptocurrency and successor to Bitcoin, was created to address the problem.24,25 With its support for smart contracts, digital agreements executed autonomously on the blockchain, Ethereum gave rise to both DeFi and NFT and gained newfound popularity. Protocols like MakerDAO (2017), Compound (2018) and Uniswap (2018) made it a reality to carry out basic financial functions including currency pegging, lending/borrowing and asset trading on a blockchain, without the need for any central authority as was often a necessity in centralized finance (CeFi).26 Additionally, NFT, tokens that were uniquely identifiable, pioneered a novel way of owning and exchanging digital assets and was most widely adopted among the artist community.27 For example, creators of Bored Ape Yacht Club (2021), one of the most well-known NFT collections, were entitled to receive royalties from all subsequent secondary sales of their works, typically amounting to 2.5% of the sale price, on top of the proceeds collected at launch.28

Both DeFi and NFT fall under the umbrella term “Web3”, a concept that had yet to be properly defined but generally represented the collective vision of what the next generation of the internet would look like.29 Web3 was preceded by Web1, when the World Wide Web was in its infancy and offered limited functionalities beyond users consuming what was available online, and Web2, when social media rose to dominance and user-generated content (UGC) became a significant part of the experience.30,31 Web3 brought with it an assortment of innovations: a distributed network, decentralized ownership, native interoperability, etc., making it potentially capable of becoming an integral part of many other technological advancements such as the internet of things, artificial intelligence and the metaverse.32,33,34

The Evolution of Video Game Monetization Historically, the video game industry had been operating under the “pay-to-play” model, in which

players were used to paying for the experience ahead of time.35 For decades, it was the predominant practice across console, handheld and PC gaming: developers made a game; players bought (and hopefully enjoyed) it; both then moved on and the cycle repeated. Any further exchanges of the game’s ownership on the secondary market had no bearing on the developer’s top or bottom line. As a result, the one-time nature of such transactions meant that in order to have a steady stream of revenue, developers would have to keep making new games. However, game development was a slow and costly business, usually requiring years of investment with low to no assurance of the game’s eventual

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completion nor success.36,37 As a response to the challenge, developers turn to push for more downloadable content (DLC), prequels and sequels, hoping to amortize the development costs over multiple installments in the same franchise.38

With the rise of smartphones, App Store and mobile payment, the "free-to-play" mobile games emerged as a serious contender to the traditional model.39 Over time, many adopters of the paradigm became commercial hits, notable examples including Angry Birds (2009), Fruit Ninja (2010), Flappy Bird (2013), etc. These titles, featuring colorful art style, intuitive controls and simple yet short, addictive gameplay loop, typically demanded minimal or zero upfront price to get started. Instead, developers were compensated via in-app advertising and/or microtransactions when players chose to purchase additional in-game accessories or unlock the full experience. Owing to their massive installed base, short development cycle and high user engagement, free-to-play games even drew interests from a number of established video game developers like Nintendo, Electronic Arts and Activision Blizzard.40,41,42 The model was so popular that high-profile games without a recurring revenue source were becoming increasingly rare.43

The “play-to-earn” model, Zirlin believed, was the next iteration in the evolution of video game monetization.44 Unlike free-to-play or any of its predecessors, play-to-earn put a special emphasis on offering players rewards that had the potential of carrying real-world value, simply for playing the game. The rewards usually took the form of a fungible token, i.e., a cryptocurrency, or a non-fungible one (NFT) and as such, play-to-earn games had a close tie with blockchain technology, e.g., Axie Infinity (2018), Gods Unchained (2018) and Splinterlands (2021). Due to its unique capability of decentralized bookkeeping, a blockchain-based infrastructure empowered game makers to focus on what mattered the most, i.e., the graphics, user interface and gameplay, without having to reinvent the underlying monetary system. A few well-known game developers were quick to follow, while others remained skeptical.45,46 Steam, the popular PC game distribution platform, specifically banned publications of “applications built on blockchain technology that issue or allow exchange of cryptocurrencies or NFTs” in 2021, whereas Epic, Steam’s rival, said they were open to them shortly after.47,48

Axie Infinity and the Play-to-Earn Model Zirlin considered himself a lifelong gamer. Being introduced to the medium by his cousin at an

early age, he found himself drawn to games that offered both competitive gameplay and strategic depth.49 Among his favorites were Starcraft, Diablo, and Super Smash Bros.50 So when he took his passion as an inspiration and discussed the idea with the rest of the founding team whom he met online, Axie Infinity was born.51

At the center of the Axie Infinity experience were Axies, digital personifications of the in-game companion animals that players could collect, breed and battle with on the fantasy continent of Lunacia. On one hand, Axies bore a remarkable resemblance to Pokémon or Tamagotchi – cute, little creatures that served as a gameplay device. On the other, they were also distinct in that each of them was an NFT that could be programmed to have utilities outside the game. For example, an Axie could be traded for another NFT, exchanged into a cryptocurrency, or sold for USD. “This is a digital nation. It’s about making games, about more than just having fun, but also making a living, forming deep economic relationships with anyone anywhere in the world,” Zirlin added.52

Once a team of at least 3 Axies was assembled, the player could then embark on the play-to-earn journey (Figure 1). There were the Adventure Mode, where players battled computers (Player vs. Environment, or PvE), and the Arena Mode, where players battled each other (Player vs. Player, or

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PvP), both in the form of a turn-based card game.53,54,55 Victories in either mode, as well as completing daily requests, could reward players Smooth Love Potion (SLP) and Axie Infinity Shards (AXS), two cryptocurrencies that were actively traded on crypto exchanges.56,57,58 Specifically, SLP served as the in-game currency for performing basic gameplay functions, while AXS was the governance token that gave its holders voting rights and shared ownership of the Community Treasury, the crypto wallet that held the game’s revenue.59

Figure 1 An overview of the play-to-earn loop. Players typically start with Axie battles (playing), followed by multiple exit points to cash out their rewards (earning).

Source: Created by casewriters.

Nevertheless, there was a catch: the starter Axies cost real money to buy.b With every new player getting started, there had to be some seller(s) willing to give up 3 Axies. This was where breeding came into play, an in-game mechanism that allowed players to take any 2 Axies and “breed” their child Axie (Exhibit 3).60 Each breeding would consume 1 AXS and varying amounts of SLP (Exhibit 4). The resulting Axie was designed to inherit certain genetic characteristics from its parents, in addition to a small probability of mutation.61 Players were free to sell any Axie, the same way NFT was being sold.

At the time, an average Axie was trading at about $100, so getting three of them posed a significant barrier to entry, especially in developing countries where the game was most popular.62 To address the imbalance, the so-called “scholarship” system was created, a self-organized community where “managers” lent coveted resources (e.g., Axies, SLP and AXS) to “scholars” who used them to play the game, each taking a cut of the earnings at the end.63 The manager’s share typically ranged anywhere from 30% to 75% of the total reward.64 Yield Guild Games (YGG), a Philippines-based scholarship guild and one of the biggest in the world, made its own business by scaling the manager-scholar partnership, arguing that an Axie Infinity account was comparable or superior to an interest-bearing bank account.65

b Sky Mavis later released Axie Infinity: Origins, a new title in the Axie Infinity franchise, in which the players no longer had to purchase the initial Axie team.

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The company followed a 70/20/10 profit sharing model among scholars, managers and itself, and succeeded in raising three rounds of capital of $1.325 million, $4 million and $4.6 million respectively in 2021.66

Building a Sustainable Economy

Sky Mavis charged 4.25% as marketplace fees on all Axie NFT trades.67 “95% of the value went to the players,” Zirlin argued, in contrast to the usual practice of game developers taking 100% as was the case during the pay-to-play or free-to-play era.68 The marketplace fees and the AXS portion of the breeding fees went into a Community Treasury collectively owned by every AXS holder, of which Sky Mavis controlled 21% on a fully diluted basis (Exhibit 5). In other words, whether through trading Axies, breeding new ones or just playing the game, active engagement in the game created value for Sky Mavis and players alike.

The in-game economy was precisely the biggest appeal of the game, as a Twitter survey showed in December 2021, but it was a delicate balance to sustain (Figure 2, 3). First, the game was already suffering from an oversupply issue for both the Axies and the cryptos.69 The former could only increase in quantity (via breeding), putting a perpetual downward pressure on their market price. As for the latter, although breeding was meant to eliminate excess SLP/AXS from circulation and restore their scarcity, many players primarily viewed them as speculative assets and ended up failing to spend them as the game intended.70 Moreover, the influx of new players was already showing signs of slowing down, daily active users (DAU) plunging to 1.5 million by March end from a high of 2.7 million in late 2021.71 As a result, the positive feedback loop could very well work in reverse, creating a death spiral should players lose interest in the game and move on.72 After all, it was next to impossible for every player to expect and earn a positive return on their investments in the grand scheme of the crypto economy, or the economy in general.73

Figure 2 A Twitter survey conducted by the official Axie Infinity account asking the community what they like the most about the game. “Economy” was the majority choice.

Source: Axie Infinity, Twitter post, December 2021, 6:46a.m., https://twitter.com/AxieInfinity/status/1475478148330442761,

accessed September 2023

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Figure 3 Sustainability of the in-game economy hinges on the growth of Axie Infinity’s player base. If enough new entrants are drawn to the game (presumably driven by the appreciation of SLP/AXS), the newly created demand for Axies will in turn encourage breeding which consumes SLP/AXS, further leading to them becoming even scarcer and more valuable. However, the opposite is true if the game fails to expand or retain its users.

Source: Created by caserwriters

Sky Mavis was certainly aware of the challenges and had begun working on the fix. Since Season 18, which started in August 2021, the daily limit of SLP reward was reduced from 100 to 50.74 A new feature to “release” Axies in exchange for resources was also in the works to alleviate the overpopulation problem.75 Most importantly, Zirlin knew that the game itself needed to have long- term staying power beyond the financial gains, just like virtually every other successful video game before it did. This could be digital pets, land ownership, crafting, mini games, etc.76 “There is still a long way to go. Even though we have a million users, we still need to make the game more fun,” he opined when discussing Sky Mavis’ strategy to go mainstream.77

The Ronin Hack

At 2 a.m. that day, Zirlin became aware of the hack.78 His drowsiness was gone the moment he saw an unread message from Aleksander Larsen, COO of Sky Mavis.79 From an internal memo written by Andy Ho, CTO of the company, Zirlin learned that 6 days prior, through a phishing attack targeted at a former employee, hackers managed to acquire majority control of the Ronin network (Figure 4).80

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Figure 4 Illustration of the Ronin hack. At the time of the incident, the Ronin network was secured by merely 9 validators, whereas Ethereum, in contrast, had thousands. The Ronin Bridge sat in between and provided support for two-way asset transfers. On March 23, 2022, hackers were able to breach 5 out of the 9 Ronin validators and therefore, gained majority control of the network. Subsequently, invalid transactions to withdraw tokens on the Ronin chain were initiated and authorized by the compromised system, allowing the attackers to cash out on the Ethereum side.

Source: Created by casewriters

The Ronin network was a permissioned blockchain system built on top of Ethereum, i.e., only accredited entities were allowed to participate in its transaction validation, which at the time consisted of four nodes run by Sky Mavis and five others by the Axie community.81 This architecture differed significantly from traditional blockchains, such as Bitcoin or Ethereum, which were permissionless and allowed anyone to operate as a miner/validator. The benefits were multifold. Ronin was able to offer greater efficiency, lower transaction cost and faster settlement than its Ethereum infrastructure, which the game was initially built upon before moving to a bespoke side-chain solution, having suffered enough from network congestion that was deemed unacceptable for a video game that required frequent, real-time responses.82 The obvious downside of a permissioned blockchain was that it tended to be more centralized, with authority being concentrated in a few hands and thus more susceptible to a single point of failure, which ran counter to Web3’s grassroots ideology.

“A ronin is a samurai without a master,” Zirlin explained during a podcast.83 As its namesake implied, the Ronin network represented Sky Mavis’ dedication to “take the destiny of [their] product into [their] own hands” according to the Axie Infinity whitepaper.84

About an hour before Zirlin took the stage at NFT LA, Sky Mavis published a post on the Ronin blog, officially alerting the Axie community about the devastating incident.85,86 It was purported that hackers stole a total of $625 million in ETH and USDC, making it the biggest crypto heist to date.87,88

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As players, fans and enthusiasts anxiously awaited Zirlin’s appearance, a whisper loomed over the crowd. Where would Axie Infinity, Sky Mavis, and play-to-earn all go from here?

Zirlin and Sky Mavis might have an answer already. The company removed all references to the term “play-to-earn” in the Axie Infinity white paper at the end of 2021 and replaced it with a new proposition, "play-and-earn", downplaying the economic incentives from their prior prominence.89,90

The answer was by no means perfect, however, as the game’s struggle to return to its former glory persisted and DAU continued to decline. Furthermore, just as Sky Mavis was about to ascend into the mainstream stage came the untimely security breach, shattering player confidence and putting its resilience to the test in a “potentially existential-level” crisis.91 “It is one of the bigger hacks in history,” Zirlin looked fatigued yet undaunted as he addressed the audience at NFT LA, reassuring the community and reaffirming his stance.92 “We are fully committed to continue building. … We believe in a future of the internet that is open and that is owned by its users.”93

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Exhibit 1 The Axie Infinity logo

Source: Sky Mavis

Exhibit 2 Screenshot of the Axie Infinity gameplay. The game adopts a turn-based battle system where players choose the cards (moves) they want to play every turn. Each move can be about offense, defense or buffs, and can come with its own unique effects and costs.

Source: “Axie Classic,” https://app.axieinfinity.com/games/classic/, accessed December 2023.

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Exhibit 3 Each Axie features a number of attributes: a class and 6 body parts. Each part has 6 genes (D, R1 and R2). Each gene has different probabilities of being passed down to its descendants.

Source: “Breeding and $SLP,” https://whitepaper.axieinfinity.com/gameplay/breeding, accessed September 2023.

Exhibit 4 Breeding costs in Axie Infinity. 1 unit of AXS and varying amounts of SLP are consumed per breeding. Breed count refers to how many times the parent Axie has bred before and can only go up to 6 before it becomes ineligible for further breeding.

Breed Count SLP Cost Per Parent

0/7 900

1/7 1350

2/7 2250

3/7 3600

4/7 5850

5/7 9450

6/7 15300

Source: “Breeding and $SLP” https://whitepaper.axieinfinity.com/gameplay/breeding, accessed September 2023.

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Exhibit 5 Allocation of the AXS token

Token amount Total Supply % Unlock schedule

Play and Earn 54,000,000 20% Gradual unlock over 4.5 years

Staking Rewards 78,300,000 29% Gradual unlock over ~5.5 years

Ecosystem Fund 21,600,000 8% Gradual over 4 years

Sky Mavis 56,700,000 21% Gradual over 4.5 years

Advisors 18,900,000 7% Gradual over 4 years

Public Sale 29,700,000 11% Instant unlock

Private Sale 10,800,000 4% Quarterly over 2 years

Total amount 270,000,000 100%

Source: “Allocations and Unlock Schedule,” https://whitepaper.axieinfinity.com/axs/allocations-and-unlock, accessed September 2023.

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Exhibit 6 Axie Infinity partners.

Source: “Partners” https://whitepaper.axieinfinity.com/partners, accessed September 2023.

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Exhibit 7 Selected milestones of Sky Mavi

Date Event

December 2017 Concept and Idea – Development begins

February 2018 Origin Axie Presale begins – 900 ETH raised

March 2018 In-House Axie-NFT Marketplace released

May 2018 Breeding game released

October 2018 Idle battle game released

January 2019 Land Sale begins – 3200 ETH raised

May