Introducing $METV - The Metaverse ETF
Regardless of what your favorite video game is, what platform it’s on, or what time period it’s from, a game engine was at the core of its development. Game engines are the software framework that developers use to create and build video games. They contain numerous components integral to the development of games from simple indie titles to the most complex AAA games. While this list is not exhaustive, most of the top engines share the following essential features:
Graphics: Certain engines cater to simple 2D rendering, while others are capable of intensive 3D rendering, with much overlap. The premier 3D engines are able to import files from software like Blender and Autodesk Maya, so externally designed assets may be used within the game. The development of models via third party applications allows developers to be more flexible with the graphics their game employs.
Physics: Most game engines utilize external physics software to simulate the movement and interaction of objects with each other. Of paramount importance is accurate collision detection, where each object is defined with its own bounded space. Since speed is more important than accuracy for games, physics engines aim to approximate rather than replicate interactions. The most popular integrated physics for 3D simulation are Nvidia’s PhysX and Bullet, both of which are open-source.
Figure 1: Screenshot of Open 3D Engine Interface
Source: AWS GAME Tech Blog, July 2021.1
Sound: Immersive environments rely not just on graphical capability, but also on robust in-game audio. Sounds include spoken dialogue, musical cues, sounds from objects like weapons and vehicles, and ambient music playing in the background. A recent opportunity for growth has been in spatial audio, which offers 360-degree sound experience that simulates a real environment. This is key for the metaverse, which relies on closing the gap between the physical and virtual worlds.
Input: Engines utilize native input managers to convert input from players into actionable movement within the game. Hardware input involves mouse clicks, mouse movements, key presses, controller inputs, and increasingly, support for virtual reality controllers. Virtual axes are mapped to these various controls, and allow properties such as sensitivity and dead zones to be customized.
Artificial Intelligence: In video games, artificial intelligence (AI) algorithms are used in order for game environments to adapt to players’ reactions. One of the most common applications of AI is in the creation of non-playable characters, whose actions, dialogue, and overall behaviors depend on the actions of the player character. As virtual worlds expand in size and scope, AI has provided for procedural-content generation, where elements like the weather, the terrain, and even the music can change dynamically.
Networking: While AI is key to the single-player experience, the most popular games today are connected to the internet for online play. This can take the form of cooperative gameplay (co-op), where players work together as teammates, or competitive multiplayer, such as player-versus-player (PvP) combat. Modern engines provide complete networking frameworks for online play, with the goal of reducing latency between clients spread across the globe.3
Years of development for the top engines have culminated in the creation of full-service multimedia tools with applications beyond gaming, as interactivity and immersion have become hallmarks of the digital age. Game engines are now being used for everything from previsualization for film production to automotive modeling, providing unparalleled levels of detail for creators. These engines also support nearly every platform, facilitating collaboration between mobile, desktop, console, virtual reality, and alternate reality devices. This level of fidelity is pivotal for the metaverse, which will rely on broad interconnectivity between millions of concurrent users.
The ingredients involved in sophisticated game engines are complex, and are the work of years of iterative development. As a result, progressive generations of existing engines alone may take close to a decade, as evidenced by the development history of Epic Games’ Unreal Engine (UE), the second most popular engine for developers globally. There was a four year gap from UE1 to UE2, and four years elapsed between UE2 to UE3. However, as game development has ballooned in complexity, and the resources required to create AAA games has greatly expanded, the gap to release UE4 doubled to eight years, with UE5 maintaining that same cadence. While Epic is privately held, financial documents made public during the Epic v. Apple bench trial revealed that the company had 564 employees working on the engine in 2019, showcasing the resources needed for engine development of the highest caliber.4
Figure 2: Disclosed Employee Breakdown by Function at Epic Games
Source: The Verge, May 2021.
There are various factors developers have to consider when deciding to use a third-party engine versus an in-house model. The two biggest advantages to outsourcing are cost and time savings. Developing an engine is a higher order task than developing a game itself, and for complex 3D engines, requires significant manpower to create before actual video game development can begin. New studios may chew up a large portion of their budget making the engine that will underlie their games, and if their first title is unsuccessful, may need to raise more money or close up shop. Existing commercial engines allow for developers to use a full development kit out-of-the-box, abstracting the difficult tasks involved with game creation. This allows developers to focus on storytelling and asset creation, expediting the time it takes to bring design ideas to reality.
On the other hand, the clear advantage to making an engine is in the flexibility it affords. Resources permitting, every feature of the engine can be customized in a programming language of choice that feels comfortable to the team. Many developers also enjoy it as a learning experience which encompasses all aspects of game development. Furthermore, it can carry over to multiple projects, making successive games faster to develop, and in some circumstances actually save time versus the alternatives. Lastly, the engine itself could eventually be run as a business, becoming a profit center for the company.
For a majority of developers, however, the benefits of utilizing an existing engine outweighs in-house creation. To showcase the breakdown in engine use, we can turn to data from Steam, the largest games distribution platform globally. As of March 31, 2022, there were 56,636 released games on the service.5 Just 26%, or about a quarter of all these releases, use a custom or in-house engine. Many of these are published by large video game holding companies which include numerous development subsidiaries, such as Sony, Electronic Arts, and Capcom, to name a few. Of the 74% of games that use an external engine, 92% use one of the top five: Unity, Unreal, GameMaker, RPGMaker, or RenPy. A breakdown of the most frequently used game engines on Steam is provided below, with those under 1,000 uses bucketed under “other.”
Figure 3: Game Engine Frequency for Steam Releases
Source: Game Data Crunch, as of 3/31/2022.
On Steam alone, there are 63 trackable game engines that developers have used to create their games. These can be divided into two categories: open-source and proprietary. Like open-source software in general, this category of engines are completely free to use, as they are maintained by a community of developers rather than a for-profit corporation. In this model, the source code and documentation are available to everyone. An “open-source license” allows both commercial enterprises and end users to use, share, and modify the code as they see fit, giving them leeway to tweak parts of it for their own unique needs. One of the most popular open-source engines is Godot, which supports deployment to multiple platforms, and has stable support for over a dozen programming languages.6 Every release of Godot relies on hundreds of uncompensated developers who iterate on the code to push the project further. Game developers seeking a middle-ground between developing their own engine and paying for proprietary tech often go the open-source route.
Proprietary engines are those owned directly by the company publishing them. These types of engines are usually distributed via licensing models, taking either a split of game revenue or a recurring subscription fee in exchange for their use. Some specialty engines are sold for a fixed price, such as RPG Maker, a dedicated engine used to make roleplaying games.7 While users can purchase the latest version of the engine for $79.99, there are over 300 add-on resource packs that range from $2.99 to $44.99. Furthermore, upgrades are not free for future versions, which are typically released every three to five years.
As a result, the subscription and royalty models have emerged as the most popular monetization frameworks, as they ensure that the engine is always up-to-date and inclusive of all the tools the engine developer has to offer. Ongoing maintenance of the engine becomes fully outsourced, eliminating the need to purchase a newer version at an additional cost. While there may be service tiers, users know exactly what they are getting for their subscription price or revenue sharing agreement. Meanwhile, the company behind the engine receives a predictable revenue stream, enhancing their financial forecasting and potentially lowering retention spend. The two most popular engines in the world, Unity and Unreal, are monetized in this way.
The history of the Unreal Engine is synonymous with the history of Epic Games and its founder Tim Sweeney. In 1991, Sweeney, who was studying mechanical engineering in college, wanted to create a text editor that was more flexible than the commercial ones at the time.8 After he started to write his own, he began to add game-like elements to the program, such as making the cursor a controllable element, adding collision physics to walls, and turning text symbols into enemies. After nine months of development, Sweeney had not only created a 2D adventure game, but also his own scripting language and game editor. He called the game ZZT, so that it would be the last game alphabetically to show up on messaging boards. Players could not only play one of the four game worlds included in the release, but could also create their own worlds, editing everything from the map to the sounds played from the speakers.
ZZT was published under “Potomac Computer Systems”, the first entity that Tim Sweeney incorporated under. This was later renamed to “Epic MegaGames,” a name he thought sounded like a large company, despite only having one employee. With the modest proceeds of the game, Sweeney sought to expand, hiring business partner Mark Rein in 1992, who previously worked for Wolfenstein creator id Software. By 1993, the studio already had 30 employees in numerous functions, all working on new personal computer titles. Epic MegaGames’ big breakthrough was in 1998, when it developed 3D first-person shooter “Unreal.”
Unreal was built using a proprietary engine loosely based on the editing tools of ZZT. This engine, which was named after its inaugural title, was developed for three years between 1995 and 1998, with numerous advancements that made it capable of 3D game design. While Unreal Engine (UE) was being developed to utilize the CPU for graphical calculations, the advent of dedicated graphics cards in the late ‘90s allowed Sweeney and the team to take advantage of the new technology. Other innovations included detail texturing, where environmental textures are layered on top of each other to appear higher resolution, and sophisticated collision detection, paving the way for modern hitboxes.
Figure 4: Screenshot of Game Environment from Unreal (1998)
Source: Old PC Gaming, October 20139
Epic MegaGames was renamed to Epic Games in 1999, and became the first developer to license its engine technology on a large scale. UE is now on its fifth iteration, and has become the tool of choice for AAA developers looking to make high-detailed, immersive games. Thousands of games have been developed using the software, with notable third-party franchises including Borderlands, Batman: Arkham, Mass Effect, and Tom Clancy’s Splinter Cell. UE supports development over numerous platforms, including modern consoles, computer operating systems, and major VR devices. Epic follows a simple revenue model under one primary license for games professionals. Under its standard license, royalties of 5% are due on gross game revenue exceeding $1 million. This model, which premiered alongside UE4 in 2014, allows Epic’s revenues to scale along with titles developed using its engine. Given that many of these are big-budget games grossing millions of dollars, UE has provided a meaningful tailwind to the company’s overall growth.
Figure 5: Licensing Options for Unreal Engine 5
Source: Epic Games, as of 4/5/2022.
In addition to UE, Epic Games also has a digital distribution service. The Epic Games Store launched in December 2018, as an open storefront for games. The store takes a 12% cut for game sales, markedly lower than the standard 30% rate common to digital distribution. In addition, games built on UE that are published through the store have the 5% royalty waived. The storefront is also host to Epic’s own games, including Fortnite, a third-person shooter known for its 100-person battle royale mode. Fortnite is Epic’s flagship foray into the metaverse, and has transcended its core gameplay to become a virtual multimedia experience. Fortnite has hosted some of the most popular concerts of all time, including a Travis Scott live event in April 2020 which had 12.3 million peak players (limited to 100 per instance). The digital merchandise revenue from these live events, which typically are about ten minutes long, can be greater than multiple legs of an actual tour. The game also has a dedicated mode called Fortnite Creative, where users can create their own structures and share them with up to 16 players.
Epic Games is currently private, and had a valuation of $31.5 billion as of April 11, 2022.10 During this funding round, Sony and Lego Group both invested $1 billion, to partner with Epic in building the metaverse. Epic’s goal from its origins has been to connect players with each other, and provide them with the creative tools to have them make unique experiences. This partnership will focus on the digital experience across “gaming, music, and creative collaboration,” and will continue to leverage popular culture to stay at the forefront of media.11
Unity was founded in 2004 by a group of three developers in Denmark — Nicholas Francis, Joachim Ante, and David Helgason. The trio initially met on the Mac OpenGL forums a couple years prior, discussing a shader system that Francis was trying to implement into his game engine. Converging in Copenhagen, the developers tried their hand at creating a traditional studio, with games supported by their own technology. They spent two years programming the very first version of Unity, and incorporated under the name Over the Edge Entertainment (OTEE). Deciding that the best way to sell the engine was with a full commercial game, OTEE developed their first title GooBall, which was released for the Mac OS X operating system in March 2005. In terms of gameplay, GooBall was similar to Super Monkey Ball, in that the player controlled a roller ball through a physics-based environment.
The experience and proceeds from the game allowed OTEE to refine Unity further, before a June 2005 full release at Apple’s Worldwide Developers Conference. While the initial version of Unity was exclusive to OS X, the team immediately started working on a version that could be exported to web browsers and Microsoft Windows. At the time, many independent developers utilized either the Torque game engine or their own software, and AAA studios used either their own or Unreal, so the Unity team faced an uphill battle in commercializing their engine. From early on however, the team had a goal to democratize access to game creation, and listened closely to indie developers as they developed their product. In 2007, OTEE was renamed to Unity Technologies, reflecting their full commitment to engine development. A year later, they released a version of the engine for publishing on the iPhone, which became wildly popular and propelled the company to new heights.
Today, Unity is available on more than two dozen different platforms, and remains the premier engine for indie and mid-sized game studios. Following the same ethos Unity was founded with, the engine is free for personal use or for small companies generating less than $100,000 annually. The tiers for more sophisticated individual use and for organizations come at varying price points, per the chart below. Given that over 50% of indie games on Steam have never made more than $4,000 in lifetime earnings, most developers never pay for their engine use. However, at the highest end, the top 1% of games have each made over $7 million, which means they are utilizing either the Pro or Enterprise plans, depending on the number of seats their team needs. Unlike Unreal Engine, Unity is royalty-free even for the highest-grossing titles. For example, if a Unity developer with 40 employees is bringing in $10 million annually, they would only pay a fixed subscription fee of $96,000 per year for the Enterprise plan, versus $450,000 for Unreal (5% of gross revenue above $1 million).
Figure 6: Difference Pricing Plans for Unity
Source: Unity Store, as of 4/5/2022.
CEO John Ricitello, who has led Unity since after leaving EA in 2014, has prioritized the company’s mobile strategy. The engine has about half of the global market share among mobile games across iOS and Google Play stores. Unity’s financial benefit from spreading wide across the app ecosystem is not only in its subscription fees, but in its monetization via Unity Ads. This service allows developers to monetize their games via advertisements, via cost-per-impression and cost-per-install frameworks. These rates are set by the advertisers, who compete against each other for developers’ ad inventory. This process is managed via Unity’s real-time bidding exchange called Unified Auction. As such, Unity is a demand-side platform that competes with other platforms such as Trade Desk and Magnite. For every impression or install, Unity receives a portion of the revenue, and while this exact share is undisclosed, ads made up more than 60% of the company’s 2021 revenue of $1.1 billion.15
Unity is the first pure-play game engine company to go public, with the stock making its debut on the New York Stock Exchange on September 18th, 2020, under the ticker “U.” The IPO was one of the hottest of the year, with the stock rising from $52 to $68 per share (31%) on its first day alone. Shares did not end their rise there however, and amid a buoyant market for tech stocks, more than doubled to end 2020 at around $153. However, rising interest rates and inflation have since dented growth stocks broadly, and Unity has since retreated to $99 per share, as of March 31st, 2022. While the company has operated at a net loss for every quarter since going public, top-line revenue growth has been strong, at 43% year-over-year for 2020, and 44% for 2021.
Investors seeking exposure to the growth in engines may be well served by owning Unity. For one, the mobile games market is both the largest and fastest growing segment of the industry, in part due to its penetration in emerging markets that consoles have not been capable of. Developers value Unity as a dependable, easy-to-use, and versatile engine capable of creation across dozens of platforms. These platforms also include alternative reality and virtual reality, which may benefit from the metaverse tailwind this decade. Lastly, Unity’s end-to-end solutions have been growing, giving customers an extensive suite of tools to grow their game into a business.17
Figure 7: Unity Stock Performance Since September 2020 IPO
Source: Unity Store, as of 4/5/2022.
The last few years have seen engines expand well beyond their core capabilities as game development tools. While most of the revenue that Unity and Unreal each derive still comes from gaming, starting in the 2010s, they have seen their uses expand to areas like filmmaking and engineering. Both offer enterprise licenses specifically for non-gaming uses. These engines’ graphical capabilities have started to blur the line between reality and virtual, with advancements like ray-tracing contributing to the photorealism shown in recent demos. The ability to work in real-time within a 3D platform is expected to revolutionize many industries, and displace traditional tools and some legacy software applications. The following are some industries that have already benefited from engine use:
Perhaps the widest non-gaming use case thus far for engines has been in filmmaking. Modern blockbuster films with large budgets require planning before sequences are shot, so as to not reshoot continuously. This is especially important for shots that feature stunts, or those that have a long set-up time and must be executed correctly on the first try. The traditional pre-planning process is known as previsualization (“previs”), and since the advent of 3D computer graphics, has been handled by specialized software. Engines like Unreal and Unity allow for lean previs teams to create complex scenes, bolstered by the lighting, physics, and asset libraries available in the package. Recently, Unreal has emerged as the industry-standard engine for previs, and has been used in productions like Ford v Ferrari and The Mandalorian.18
A similar use case is for animation, and AAA game makers have been using engines to animate in-game cutscenes for some time now. Creating and rendering realistic films is a graphically intensive ordeal, but increases in computing power have now made this possible. In 2018, Disney used Unity to create three short films called “Baymax Dreams,” which were based on Big Hero 6, its 2014 computer-animated superhero film. Disney stated that Unity was like “having every department at [their] fingertips,” and the software’s powerful workflow and real-time rendering capabilities allowed them to make the shorts in half the time. More recently, Unreal Engine was used to make the music video for Australian dance group Rüfüs Du Sol’s single “Alive,” which won Best Dance Recording at the 2022 Grammy Awards. The nearly six minute video was directed by James Frost, who wanted a way to showcase remote landscapes without actually needing to travel the world. Unreal provided the director with the digital solution he needed that was photorealistic enough to immerse viewers.
Figure 8: Screenshot of Landscape from Alive Music Video
Source: Bloomberg, as of 3/31/2022.
The adaptability of Unity and Unreal Engine has provided a number of solutions for automakers, from the planning process to showroom sales. Automakers have used both platforms to design new vehicles in a real-time collaborative environment. For example, BMW runs Unreal Engine on mixed reality devices to test drive pre-production vehicles, which allow designers to iterate and push out improvements rapidly. General Motors has used Unreal as the software toolset for its new GMC Hummer EV, making it the first vehicle to do so. The software is capable of producing full high-resolution renders of the vehicle on the display, and has improved the touchscreen workflow process.
In May 2018, Unity created its automotive division, hiring away experts from manufacturers like Volkswagen, Renault, and GM. The company already counted 8 of the top 10 OEMs as customers, but wanted to deliver more enterprise-level services to support custom use cases from vehicle manufacturers. As more and more production becomes autonomous, infotainment systems in vehicles have grown in importance. In March 2021, Unity and navigation specialist HERE teamed up to create next-gen infotainment platforms. Drivers will be able to view advanced 3D renderings of their city, combined with custom UI elements from the automaker. As full self-driving is realized, they will also be able to play Unity games on the dashboard as well.
The medical industry has been upended by the 3D virtual interaction and visualization that Unity provides. Medical professionals utilize VR and AR systems built using Unity to model patient images.22 Specialized visualization libraries exist that integrate with the engine for the specific needs of the industry. Another growing use case is for surgical medical VR training, that simulates the operating room in a realistic environment. This training software has been used by hospitals, medical schools, and classrooms, and has received funding from its virtual reality partner HTC Vive. Apart from these tools, Unity has also been used to create experiences to help patients with mental health issues.
Game engines have grown beyond their roots as development kits for video games, and now have applications in numerous complex fields. The two most popular engines, Unity and Unreal, have nearly five decades of development experience between them, and have become broad multimedia tools, capable of immersive 3D graphical renderings. Similar to their original use cases, engines can shore up a development teams’ resources, so they may spend more time on designing ideas and creative assets, rather than first creating the development tools to do so. This decade will likely see engines emerge as a key infrastructure layer in building the metaverse, offering creators a way to bring their ideas to life within a vibrant digital economy.
15Unity 2021 Annual Report