CryptoKitties, the smart contract-based game that launched November 28, is a hybrid decentralized application (dapp) built on the Ethereum blockchain. Users can buy, sell, and breed digital kitties, which have different appearance and traits based on a genomic algorithm. The game quickly went viral--anecdotally, many users bought their first Ether just to play.
At the time of writing, CryptoKitties has sold more than 150,000 unique digital kittens for more than 34,000 ETH, about $16.5 million USD. On fees alone, the development team has earned just under $1 million. CryptoKitties smart contracts continue account for about 8 percent of Ethereum network traffic, down from a high of nearly 15 percent a few weeks ago.① Sustained high network traffic led to delayed transactions and higher fees, with at least one ICO postponed because the Ethereum network was "clogged" with CryptoKitties-related activity.②
The popularity of CryptoKitties is an important indicator of mainstream interest in cryptocurrency and coincides with recent widespread media exposure.③ It also highlights the limitations of the Ethereum network and adds urgency to the search for scaling solutions. In hindsight it makes sense that the first viral dapp would be about cats--they are, after all, an "essential building block of the Internet."④ Despite criticism that a digital cat game takes up bandwidth that could go to more 'serious' projects and ICOs, we find that CryptoKitties presents an important test that the network must overcome before digital assets become reality.
CryptoKitties is a hybrid dapp--while certain aspects of it are decentralized, such as kitty ownership and genes, others are centralized including the web app, release of new genes, and genetic algorithm. The web app is basically a GUI for the smart contract and makes interacting with the blockchain accessible to users with minimal technical knowledge. Users need to install the in-browser wallet app Metamask to login and begin using CryptoKitties.
User experience is an important and often overlooked ingredient for popularity. CryptoKitties allows users to participate in a blockchain-based open market where value is based on digital scarcity without actually understanding how any of it works. The developers at AxiomZen even claim that educating the masses about blockchain technology is their project's goal:
"When we created CryptoKitties, our vision was to make the blockchain a little more approachable for everyone. For blockchain technology to be widely adopted, people need to understand how it works. We wanted to build a product that was fundamentally decentralized, while keeping some things centralized where it would result in a better user experience." – CryptoKitties on Medium
Whether or not you take their words at face value, we believe that the real value of CryptoKitties lies in the successful demonstration of this business model.
In the innovation adoption lifecycle, the CryptoKitties user base belongs to the second group of people to use a new technology: the "early adopters," after the first group of "innovators." The next stage will be "early majority," followed by "late majority."
The relatively widespread adoption of CryptoKitties gives it popular legitimacy, a form of legitimacy that is qualitatively different from that of regulated Bitcoin futures. In the latter case, we use legitimacy to refer to the financial industry’s acceptance of Bitcoin as an emerging asset class and vehicle for speculation. Futures trading is still at an early stage and is only available to qualified investors, not the public in general. By contrast, CryptoKitties invites anyone to adopt blockchain technology in order to play their game--the average buy-in is less than $100 equivalent in ETH.
In addition to blockchain technology in general, the game gives much-needed legitimacy to the Ethereum platform, and demonstrates to the broader community the value of protocols other than Bitcoin. With respect to adoption and legitimacy, Ethereum has serious challenges to overcome: first, it is highly technical and even more difficult to explain to ordinary people than Bitcoin; second, it lacks functional applications at the current development stage; and third, legal and regulatory pressure, as well as risk of fraud, surrounding token sale crowdfunding, which is the major use case of Ethereum to date.
CryptoKitties makes another important contribution to blockchain technology by demonstrating the feasibility of its business model. Its design is simple: deliver a functional product without an ICO, and monetize with a fee-based revenue model.
The other functional dapp that takes up a similar amount of network traffic is EtherDelta, the decentralized trading platform for Ether and ERC20 tokens. EtherDelta also proved its no-ICO, fee-based model could be profitable (it charges 0.3% taker fee). But EtherDelta lacks a user-friendly interface, and transactions cannot be reversed once initiated. As a result, every day users make mistakes and lose money using the platform because of simple errors like confusing number of tokens with price. EtherDelta is not designed for mainstream users.
CryptoKitties earns money by selling "Gen 0" kitties, or tokens that are minted every 15 minutes, at dynamic prices based on the average price of the last block's transactions. It also takes a 3.75% fee on every transaction--nearly a half million USD in the first two weeks on transaction fees alone. With a lightweight development team of about 10 people, this is a highly profitable model. We predict that such projects will become more popular in the future, especially after ICO hype cools down and regulations hamper the ICO fundraising model.
Network Effect and Scaling
The success of CryptoKitties depends on the network effect, a phenomenon where the value of a good or service increases as more people use it or participate. The network effect can be seen in the adoption of the telephone, internet, email, social media, e-commerce, and so on. Mobile payment processors such as Alipay are more convenient when you can use them everywhere. The main challenge for CryptoKitties or any other dapp, therefore, is reaching a critical mass of users to achieve significant network effects. Once many users are onboard a platform, it provides utility simply because other people are using it.
The network effect, based on the number of users and participants, is independent from the price of a cryptocurrency or token traded on an exchange.
Once network effect is achieved, the main challenge is scaling of the network itself. The fact that CryptoKitties uses nearly 15% of Ethereum network bandwidth shows that Ethereum itself has a long way to go until it is ready for mass adoption. This is not necessarily bad: it provides a crucial stress test of the network and pressures the Ethereum developers to address the scaling issue with more urgency.
Several scaling solutions are currently under development for Ethereum: - Plasma, an on-chain scaling solution which uses a series of smart contracts to create hierarchical trees of sidechains. The sidechain is created through a smart contract, so each chain can have its own rules. It periodically broadcasts information to the main chain (Ethereum). - Raiden, an off-chain scaling solution similar to the Lightning network for Bitcoin. Raiden proposes to scale Ethereum using state channels technology. Off-chain transactions allow a collection of nodes to establish payment channels between themselves without directly transacting on Ethereum, forming a layer for small, fast, and inexpensive transactions while the main blockchain will be used for large settlements. - Sharding, from 'database sharding', in which the network is separated into different parts and the protocol moves away from requiring full nodes. This model requires substantial revision of cryptoeconomic incentives, since nodes will have to rely on other nodes.