Dialogue with Chen Yuetian of Huofeng Capital: Why hasn't there been a successful chain game yet?

Editor**|**Wu Says Blockchain

Chen Yuetian was responsible for entertainment investment at Innovation Works, and later participated in investments in projects such as IOST, Mask Network, StepN, and Jay Bear. Fire Phoenix Capital is also a relatively small number of VCs focusing on the Crypto Game industry. The podcast interview was conducted on November 20, 2023, and some of the discussion on the market and data has changed. Listen to the podcast for the full version

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What about investing in 2023?

In 2023, our investment activity is very active, with new investment actions almost every month. Especially in the primary market, although there are relatively few investors due to the downturn in the secondary market, we still insist on investing in the primary market. It is widely believed that it is wise to dip at market lows, so we are actively looking for suitable investment opportunities.

Our main focus is on the crypto game sector, and we have clarified the scope of our investments. After a series of screening and research, we have invested in some projects that are worth paying attention to in the domestic market. While there weren't a lot of high-quality projects overall, we still found some opportunities with potential.

For example, a foreign gunplay game project I recently mentioned, "Shrapnel", is valued at about $500 million after the introduction of the Tokenomics model. The other project is "Big Time", which is currently valued at about $900 million. These projects demonstrate the great potential and market interest in the crypto gaming space.

In addition, we also looked at some projects that were launched during the last Bull Market, especially those that have recently started to focus on Tokenomics. We found that by introducing these specific cases to people in the traditional gaming industry, their understanding and attitudes towards crypto games and Token economic models began to change.

Is the investment area mainly gaming, or will it be dispersed to others?

Our investment strategy is firm and focused, with a focus on investing in the crypto game space. We don't diversify too much because our funders have a clear expectation of our investment focus – they invest in us to focus on the crypto gaming market.

Of course, we will also explore some areas of innovation to some extent, such as artificial intelligence, but these investments are only a small part of our portfolio. Our main task and goal remains to find and invest in promising projects in the crypto gaming space.

We understand the expectations and requirements of our funders, so we will not easily change our core investment track. Even with the ups and downs of the crypto gaming market, we stick to our area of expertise. Ultimately, our goal is to succeed in our chosen field, rather than switching between tracks frequently.

Is it currently mainly invested in the Chinese team?

In 2023, our fund focuses on investments in the crypto game space. Based on my personal resource background and network advantages, we occupy a certain advantage in the Chinese team. Our investment logic is not only based on optimism in this area, but more importantly, to meet the needs of investors and recognize our investment philosophy.

Although we invest in our global team, we are mainly focused on the Chinese gaming industry, as this is the market we know and are most familiar with. Our investment strategy takes into account the wishes of our funders and market trends. For example, while we've also explored investments in AI and funded MyShell.ai, our main focus is still on crypto games.

We believe that Crypto can help Chinese gaming companies capitalize through non-traditional equity and equity markets. The liquidity and valuation premium in this market give the team better opportunities for capital reserves and development. For example, we have observed that some game projects have been valued in the hundreds of millions of dollars after Tokenomics, which is far more than the possible capitalization valuation of Chinese games in traditional markets.

We see that Crypto, as a Capital Market, is very suitable for facilitating the circulation and return of capital. At the same time, we also realized that the game team's unfamiliarity with the Capital Market required an educational process. Through the more relaxed regulatory environment abroad and the demonstration of successful cases, we will gradually educate and attract more teams to recognize this. We believe that the Crypto market provides a valuable capitalization platform for the gaming industry. Although there is a certain risk of a bubble, as long as the future business model is viable, this market will eventually grow from immature to mature.

Has there been any change in the industry's current valuation logic for games?

In the world of crypto funds, investment preferences are closely tied to the background of the funder and positioning in the broader Capital Market. In particular, funds that focus on native crypto such as public chains and Decentralized Finance tend to support innovative and cutting-edge projects in the Blockchain space, such as preferring project types such as Magic.

However, our fund's funder base is slightly different. Most of them joined through my personal connections, many of them long-time friends, interested in the gaming industry or the owners of the gaming industry themselves, looking to explore the Crypto Game space. These funders are funding sources outside the industry, and they prefer more mature products and teams that can be understood, have a clear business model, and are more mature. This type of team is more likely to attract the support of our fund and its funders.

In fact, this reflects two different types of teams and investment orientations. The markets that our funds and their funders are willing to participate in have more advantages than traditional finance. Everyone is open to this capitalized market. Whether it's in the form of equity stock backed by Web2 in the past, or the team backed by Crypto now, their qualities at the game product and R&D level are essentially similar. In addition to the need for innovation in the business model, the team of modern new game products also needs to have a deeper understanding and familiarity with the crypto field.

Will the invested project also face difficulties in a Bear Market?

2023 has been a year of continued active investment in the crypto gaming space for us. Although there aren't many funds that sell as frequently as we do, one of the advantages of the crypto market is the willingness to co-invest. In the projects we support, these teams have been able to raise between $5 million and $10 million even in a bear market environment, which is quite rare in the current market environment, and even compared to the Chinese equity market in 2023, a single investment is very large.

Our funders are mainly personal friends or gaming industry bosses who are interested in the gaming space and want to explore the crypto gaming space. Since they prefer understandable business models and mature products, we tend to invest in teams that they can understand and recognize.

In terms of Capital Market, Crypto's primary market remains active and well-funded. It's just that the financing cycle may be extended, and the investment conditions may be more favorable to investors, which means that the conditions may be average for the founding team. But overall, the cost of game development is relatively predictable, as it mainly depends on the size of the team, the cost of manpower, and the cost of outsourcing. Once a team has enough funding upfront, they usually don't suddenly face a situation where they run out of funds.

On the other hand, we've also met some teams that don't end up choosing to invest. These teams often struggle to finalize lead investments, resulting in a long-term inability to raise funds, which is also a common phenomenon in the current market. As a primary market fund, we remain active in bear markets. We have made adjustments in terms of investment conditions, for example, in a Bull Market we may accept a three-year Token unlocking period, but in a Bear Market, we may require a shorter unlocking period.

Will the Chinese side be in a more advantageous position than the project side in the Bear Market?

Indeed, there are relatively few funds in the crypto market that are willing to continue investing and still have funds on their books. Since many funds operate in a mix of primary and secondary markets, their funds are often set aside to buy assets such as Bitcoin (BTC) and Ethereum (ETH) at the right time in anticipation of bottom-buying opportunities. In contrast, our funds focus entirely on investing in projects in the primary market, which is relatively rare in the market.

In terms of project valuation, we have seen investment opportunities in different tranches, including projects valued at $10 million, $20 million, $40 million and even $90 million. However, we tend not to invest in projects that are overvalued, such as the $90 million project that has only one in our portfolio. We prefer to invest in projects with valuations between $10 million and $20 million, which is more appropriate for us.

Is there a phenomenon where some VCs exclude Crypto Game?

One of the capitalization features of the crypto market is the very high emphasis on narrative. In this market, if a project has a compelling narrative, it can be successful even if it doesn't have a substantial product or outcome. This phenomenon reflects a core feature of the crypto Capital Market: narrative has a higher weight between fundamental analysis and narrative.

Compare different types of projects, for example, a team of 40 or even 70 to 80 people takes two years to develop a decent game, compared to a team of about 10 people who can complete a project and tokenize it in half a year to a year. In this case, many venture capitalists (VCs) who are more active in the Capital Market may be more inclined to choose the latter. Because the latter not only has a short development cycle and lower risk, but also can realize capitalization and benefits faster.

This tendency reflects a common phenomenon in the crypto market: investors and capital are more inclined to projects that are quick and can bring a quick return on capital, rather than those with long development cycles and large capital investments.

Is the development of GameFi also largely limited by regulation?

When talking about regulatory standards, we usually consider whether a matter is appropriate to operate. First of all, I think teams involved in this kind of thing shouldn't just think about operating domestically. Once you decide to get involved in gaming, the company should be seen as a global business in a way. It is important that these companies clearly understand their global positioning and not just be technically based on Blockchain. If a team and its main market are concentrated in China, this undoubtedly increases the risk.

Take, for example, large-scale projects with Chinese backgrounds, such as STEPN's GMT, which are not at significant risk and are still launching a new game, Gas Hero. If a company is involved in gaming and Blockchain, its company structure, team composition, employee status, and products should have a global perspective from the start. This includes actions to consider, such as access restrictions for Chinese users, Chinese IPs.

When it comes to business, I think the fundamental principle is innovation. Law and regulation often lag behind innovation. This is the basic principle of business innovation. If something is evaluated using existing laws and regulations, there are usually two outcomes: either it is incomprehensible or it is illegal. Obviously, breaking the law is easy to judge and easy to conclude, just don't do it, and being difficult to understand means that there is a gray space. On the fast edge of innovation, regulation always lags.

Compliance solutions need to be created to avoid obvious violations. For example, there are still many Chinese teams involved in the development of the exchange, but they have positioned themselves as global companies from the beginning. They may have a development team or personnel in the country, but the contract is not a labor contract in the traditional sense, but is project-based. They also don't operate in the Chinese market. If someone asks, the teams ask how these people were able to access these services without blocking Chinese IP Address.

What do you think about the criticism of some GameFi projects, such as low playability, imperfect economic models, etc.?

I think first we need to have an accurate understanding of finance and the Ponzi theory. A project should not be lightly labeled, as an overly abstract understanding can lead to misunderstandings and biases. For example, consider China's real estate market, which many people think is not a Ponzi model, but a normal financial activity; another example is China's stock market, especially some chip companies on ChiNext that have lost money for many years but still have high Market Cap. Is the value of these companies a bubble, and is their own development, even if they go public, still in the Ponzi model?

In my opinion, if a company is to avoid being considered a Ponzi model, it should have positive cash flow and net profit per year, while having a reasonable Market Cap in the Capital Market. Otherwise, the price and value of many assets are actually determined through transactions. In financial markets, controlling Circulating Supply is a common strategy, which can increase the Market Cap. For example, if Shanghai's real estate market implements purchase restrictions and circulation restrictions, the circulation becomes smaller, and housing prices will be more likely to rise. Banks will also recognize these properties as assets and lend money, so that the total amount of borrowed funds for the whole market opportunity property can be substantially increased.

We've previously discussed whether a particular game falls under the Ponzi model, but if you look at the Crypto Assets market as a whole, the biggest problem may be the lack of positive cash flow for the underlying asset. Therefore, it can be considered that there is a certain risk in this market to some extent. That said, I think the gaming space is already one of the areas in the space that is close to quality assets and has the potential to generate positive cash flow.

Is there a contradiction between the financial attributes and playability of the game?

Indeed, there may be a certain contradiction between the financial nature of the game and its playability, which is the core problem that the game development team needs to solve. Games are designed to provide an exciting experience, but overemphasizing the financial attributes within the game, such as buying, selling, or speculation, can compromise the experience of the game itself. When players play this type of game, they often have two different feelings: one is the entertainment experience brought by the game, and the other is the excitement brought by the fluctuation of the value of game assets. These two feelings are often difficult to distinguish clearly, leading to problems with the game loop that players feel.

For example, when the value of a game's assets keeps rising, it can attract a large number of players to participate. But when these players lose interest because of the drop in the value of their assets, they may forget about the fun of the game itself. This situation places extremely high demands on the design capabilities of the game product team. They have to find the right balance between the gaming experience and in-game value transactions, or create a system that blends the two.

In the case of Fantasy Journey to the West, this game balances the two aspects well. It does not have extreme asset value fluctuations while maintaining a good gaming experience. Items in the game have some value, and at the same time, they build a system of cooperation between players, such as some players focus on producing items and materials, while others focus on other aspects. Such a design creates a small social system that effectively combines the gaming experience with financial attributes.

Why are viable crypto gaming projects still not emerging?

There are two main reasons why there are no viable crypto game projects yet. First of all, the market itself doesn't need complex gaming products to be profitable. In the crypto market, simple financial products and speculation are enough to attract capital, dropping the incentive to develop complex, deep games. This is the first reason.

The second reason is that industry experts who really know how to integrate the gaming experience with the economic system are not inclined to participate in the development of crypto games. These experts are usually veterans of the gaming industry who have a wealth of experience and in-depth understanding. For example, most of the planners and producers in the current game industry grew up in the context of free to play, and they may not be familiar with the economic system of early MMORPGs (such as Legend, Fantasy Westward Journey, Westward Journey, etc.). Different business models and game designs, such as the character fee system created by miHoYo and the design of the economic system, are completely different professional knowledge and skills, so when it comes to MMORPG-like economic systems such as Tokenomics, the existing mainstream talents do not match.

To solve this problem, a process is required. Professionals in the gaming industry first need to realize that the crypto market is an excellent capital opportunity. If this awareness is not in place, then the best game producers may not join the field. Without the involvement of these top talents, all of the issues we discussed may still remain unsolvable. The challenges of game product development and operation, as well as the challenges of business model design, need to be solved by these masters. But the key question is, why would these top talents choose to join this field?

What do you think of the testing of Web3 projects by major domestic manufacturers?

For large domestic companies to try Web3 projects, this reflects the typical internal innovation process of large companies. In this process, there is no one-size-fits-all approach to judging success or failure, and each project needs to be evaluated individually on a case-by-case basis, with a lot of detail involved.

In-house innovation in large companies requires several key elements: First, the company's top management, especially bosses, must pay enough attention to this area. Second, the executive team needs to have accurate understanding and support. Finally, the work of the executive layer must be accurate. If these elements are met, the innovation attempt is likely to succeed.

However, there are some common problems. For example, if a company spreads resources that should be invested in one important area into ten different innovation directions, this dispersion can lead to unpredictable end results. In addition, some companies may only pay lip service to innovation, but in fact do not agree with it in their hearts, and they may be motivated more by financial interests than by real intent to innovate. Such disagreements often do not lead to substantive results.