Gaming's Gray Market

Gaming’s $1b Gray Market

One of the main problems consumers face with in-game items today is the lack of ownership and inability to buy, sell, or trade their assets. In-game assets become a sunk cost for the consumer, a price of entertainment without any true ownership (or control). This is in direct contrast to the way physical game copies were sold through the early 2000s, when there was an expansive used game market. The one-time expenditure on a game could be partially recouped through third-party markets. This was a lucrative business for companies like GameStop, which generated nearly $1b in profit on used games in 2009 (Game Developer).

Although re-selling has been part of gaming for quite some time, the move to digital downloads and Free-to-Play (F2P), a $73.8b global market (2020), has created a lack of consumer protection across third-party reselling sites. These secondary markets operate in a legal gray area, given that they are unaffiliated with publishers or developers (the owners of the IP) yet act as a transaction facilitator for gamers.

In-game marketplaces: While secondary markets for in-game assets have gained popularity with the rise of F2P, it has a longer history in gaming with first-party marketplaces. Blizzard launched an auction house for Diablo III in 2012 (shut down two years later) and Steam launched its Community Market in 2013 which supports 164 games today (Steam Community Marketplace). Another example of a publisher building the infrastructure to facilitate secondary market sales is Second Life. While Second Life leverages an in-game currency called Linden Dollars, they also have LindeX, which allows users to exchange Linden Dollars for US dollars. Offering an internal marketplace not only creates an open economy for gamers, but it also gives users a far safer trading experience over third-party sites.

However, there are three main reasons why developers and publishers resist building their own internal secondary marketplaces:

1. Game developers want their players to continue to buy in-game assets via primary sales because these have a higher margin (100% vs 2-30%)
2. Game developers are pushing their games to be motivated by the game’s built-in progression system, which often have monetization milestones along the way, and
3. The success of a secondary market could cannibalize or reduce their primary asset sales.

For game developers, they would have to be convinced that a residual fee on secondary markets would outweigh the benefits of their primary asset sale strategy. As of today, this is a high hurdle to overcome, which is why game developers have resisted or not bothered with the development of their own internal secondary marketplaces.

Legally gray: due to this resistance from game developers, we have seen the emergence of suspicious (gray) secondary markets on third-party sites. Though not technically illegal, selling accounts or items is generally against the End User License Agreement (EULA) or Terms of Service (ToS) of most games. In many cases, these third-party platforms are not actually selling anything, but rather facilitating transactions between individuals.

In third-party secondary markets, gamers assume the risk of fraud. Leveled-up accounts or accounts that have acquired the rarest cosmetics or in-game items can be highly valuable, fetching resale prices in the hundreds or thousands of dollars. According to Night Lion Studios, selling stolen video game accounts generates ~$1b annually (Business Insider). Despite the magnitude of this market, there is nothing a player can do if the publisher chooses to ban the account (game licenses are typically sold to individuals and prohibits resale). It is a free-for-all market that has real consequences for players.

Trading Digital Items: Given these risks, secondary markets for in-game assets is a use case where blockchain is seen as a uniquely advantageous solution. At its core, blockchain technology promotes digital ownership. The item or account owner is not bound by any restrictions around using or trading their asset. It is important to note that blockchain is a technical solution presented to the non-technical problem of incentives for game developers in this situation. While blockchain may be the more elegant technical solution, without the technology, game developers can still create open APIs to have their digital items purchased and sold on third-party sites (or support open markets natively in-game).

Furthermore, while blockchain may be part of the solution, it does not address the need for a safety net for gamers (and arguably may make it worse). If a user is hacked or scammed the publisher cannot do anything outside of blacklisting an account or item from being used in game. It is most likely not recoverable. In today’s environment, a publisher can reverse a transaction, refund players, and even recover stolen accounts. This is a key benefit of web2 that is not yet solved for in web3.

Takeaway: we believe that the secondary market of in-game assets is going to continue to grow, thrive, and expand as in-game assets become more ubiquitous. We think that the adoption of first-party secondary markets will only emerge as an industry standard once publishers and developers see the economic benefit of adding residual secondary fees to their primary sale strategies. Until then, third-party marketplaces will remain until better solutions (developer-supported open marketplaces) emerge to meet this consumer need with increasingly safe and reliable methods. In short, developers and publishers must also evaluate the costs and benefits of pursuing a strategy mix that comprises third-party marketplaces, internal marketplaces, and primary sales.