Is there more to the NFT-mania than absurd investor expectation?
Non-Fungible Tokens (NFTs) have captured the art world by storm. Collectibles, ticketing, and gaming are also jumping on the bandwagon. But whether NFTs will have a sustained effect, depends on whether you are an artist, an investor, or a technologist.
Ever since digital artist Beeple sold his collection for $69 million at Christie’s in February, everybody in the art world knows what NFTs are. If you are wondering what pictures can fetch that kind of price, you can check out the collection here (completely for free!).
Beeple might be the top earner but this sale is by far no isolated case. Florence’s Uffizi gallery sold an NFT-version of a 1505 painting by Michelangelo for 170,000 USD. But never mind the grandmasters of art. Michelangelo’s price is nothing compared to what a pixelated jpeg might earn you. CryptoPunk #7523 – the third rarest of the CryptoPunk collectibles series – was sold for 11.75 million USD.
So what exactly are NFTs? NFTs are tokens that constitute a digital original. They are immutable entries on a blockchain used to track ownership, not of money, but of a digital original. These unique digital assets can be anything from visual art and music, to virtual items in a computer game, as well as commercial rights.
Having proof of ownership of the token means you own a particular digital copy. Think of it as owning a limited print of a baseball card. You can trade it, sell it, negotiate for it, and so on.
So NFTs are a form of cryptocurrency? No. It is true that they are both based on blockchain technology to solve the double-spend problem, which means they both are digital assets that cannot be copied. But one bitcoin, for example, is directly interchangeable with another bitcoin, just as one dollar is the same as any other dollar. This is what we call fungible; they can easily be exchanged. NFTs are the opposite because the underlying assets are unique. There is no like for like swapping.
So are NFTs really that revolutionary? The market certainly seems to think so. Outliers such as Beeple and CryptoPunks are accompanied by a general wave of wealth flowing into the sector. The value of NFTs sold in Q3 2021 soared to 10.7bn USD, an eightfold increase as compared to the preceding quarter. And this is not even accounting for off-chain purchases, say at auction houses.
Deep-pocketed art-investors and crypto-enthusiasts smelled an industry ripe for disruption. Digital art had been hardly monetizable before, hence artists endorsed NFTs with open arms. So did auction houses that made record profits thanks to recent NFT-sales. Celebrities and companies like Visa saw a possibility to raise money solely with the power of their brands, while pocketing some free and favorable press coverage along the way.
Yet at the same time scams and fakes are proliferating. And voices are getting louder arguing (often convincingly) that we are seeing nothing else than a huge bubble being blown up right in front of our eyes. They claim that most NFTs sold aren’t worth the hard drive space they are stored on. And certainly not the carbon emitted while minting and transferring them.
So the question on everybody’s mind is obvious: Can this trend and market volume be sustained? The answer differs fundamentally on whether you are an artist, an investor, or a technologist.
Lessons for artists and the art industry
1. Digital art is finally paid. Creators of all stripes – from painters to musicians – have been struggling to monetize their digital products. Mostly, digital versions of their work were offered for free via social media to raise attention, build a brand, and eventually sell… physical paintings. With the rise of NFTs many artists suddenly started making more money with digital versions than with oil paintings. You can read up some inspiring stories here.
2. New business models become possible. Artists can now earn from the secondary markets as well. Thanks to blockchain’s smart contract capability, artists can receive a cut each time their NFT changes hands later on. So can the platforms which minted and first sold the tokens. This ensures you don’t end up with nothing, should you one day become the next Beeple.
3. Expectations around NFTs resemble those around self-publishing. 10-15 years ago, Amazon and other platforms harnessed the rising popularity of ebooks and offered self-publishing options for writers. The promise was to enable everybody to monetize their books and eliminate the big publishing gatekeepers. Cutting out the middleman was the motto of the day. Even for those authors lucky enough to score a publishing deal, most of the revenue ended up in the balance sheets of publishers and retailers. Self-publishing platforms reversed the revenue split and gave authors about 70% of their ebook sales.
Now read the enthusiastic reactions on NFTs. Replace Penguin and Pearson with Instagram and Twitter and you couldn’t tell a difference between NFTs and self-publishing.
But self-publishing didn’t eliminate the incumbents. In many cases it made their gatekeeper function more important on the long run. Besides obvious functions such as editing or cover design, publishers were marketing platforms. And so are Twitter and Facebook. Yes, you can offer your NFT on OpenSea, but that alone won’t bring you buyers. You need the marketing power of your social media platforms if you really want to create buzz.
So, the worst mistake artists can make, is to be blinded by the mind-boggling prices of some hyped art-NFTs or collectibles such as the Bored Ape Yacht Club. After all, almost 60% of all NFTs sell for less then 1,000 USD and almost a third of that even for less than 100 USD.
4. The paradox situation today is that demand is outstripping supply. This will inevitably turn around. Either naturally, as more artists will be minting NFTs to cash in on their (digital) art, or in the case of dwindling investor demand. The latter could happen quickly, for example when crypto-investment plunges in a so-called crypto-winter. In this case, the value of NFTs will most probably plummet faster than that of established coins such as bitcoin and ether.
Lessons for investors
1. The price rally is driven by external factors, not by the NFT art world itself. The number of crypto holders has risen quickly, which means that technically it is possible for more people to buy NFTs. On most platforms you can’t purchase – and certainly not mint – NFTs without cryptocurrency. Moreover, the handling is getting easier as more and more wallets are available to store the NFTs and more platforms compete. Finally, FOMO (fear of missing out) led many small and large investors to search for the next big thing.
Hence, a plunge in prices is also more likely to be triggered by external factors.
2. Despite the hype, NFTs are still a niche investment asset. In Q3 2021 there were a meager 265,927 active wallets trading NFTs on the Ethereum blockchain. Compare that to the general crypto ownership, which globally surpasses 300 million holders. Ergo, out of 1,000 people holding cryptos, less than one person actually holds NFTs. Does that mean you should invest?
Two interpretations are possible. Either you have found an untapped, promising market, or investors are shunning NFTs for good reasons. Which ones could those be? Read on.
3. Most NFTs are not an investment, they’re a lottery. Buying a random NFT at OpenSea and hoping it will one day command similar prices to the CryptoPunk series, is like buying a portrait by an art student and thinking it might become the next Mona Lisa.
There is no utility value behind NFTs. They are not like ecosystem-tokens that enable other applications on top of them. They are not like cryptocurrencies either, as they don’t have an exchange-rate and thus can’t be used as money. You can’t instantly sell NFTs and their value is determined solely by what others are willing to pay for it. It is a key characteristic of fungibility.
4. For NFTs to have hard, sustainable value, they need to represent exploitation rights (e.g. for distribution, licensing).
Just being an original digital copy of the product provides no utility value. You might own a picture digitally, but not even have the rights to post it on your twitter account. If, however, the NFT serves as proof that you have licensing or distribution rights, this signifies real value. It is an economic asset with which you can earn money without selling it, for example by licensing it to others for usage.
Without utility value, NFTs are like old post stamps: mostly worthless, with some unforeseeable exceptions here and there.
Lessons for technologists
1. Digital scarcity and uniqueness go beyond financial assets. In its centralized version, the blockchain has managed the leap from finance to other industries.n Sectors such as supply chain or energy also use distributed ledgers to record the movements resources, a record that is enabled by digital scarcity. But all those tokens are fungible. Thanks to NFTs you can leverage digital scarcity for unique assets such as art or gaming artefacts as well.
2. NFTs caused another boost to Ethereum. The vast majority of all NFTs are minted on the Ethereum blokchain. Yet today more and more NFT-capable blockchains rise and challenge Ethereum. Their major selling point: Slashing Ethereum’s high gas fees, which means that artists can drop their NFTs for a fraction of the costs.
And still Ethereum dominates the NFT-market, demonstrating the immense trust in the security and interoperability of its blockchain. Another effect of the rising NFT-trading activity is the increased pressure on Ethereum to accelerate its Eth2 upgrade, which is supposed to make the chain more scalable and sustainable.
3. Utility NFTs will be king. We have talked about things such as exploitation rights, but the concept of utility NFTs is extremely broad. Utility NFTs can be used in domain names that are resistant to censorship, in computer gaming artifacts that power up your character, or as loyalty tokens that reward customers. An extremely important use case are incorruptible land registries. According to the World Bank, only about 30% of the global population have a legally registered title to their land.
But the most important use case will be the metaverse. NFTs are the building bricks of this new digital world in which virtual possessions are built, traded, and used to generate income. For example, you can have an NFT entitling you to use a factory or a theme park in the metaverse and charge people for it. If Mark Zuckerberg is right with his predictions about the metaverse, the impact NFTs will have on the metaverse-economy could eclipse the value it has for art and other areas.