The rise of NFTs

Created

Jan 19, 2023 8:01 PM

What are NFTs?

NFT stands for non-fungible token. What is that?

Something is considered fungible if it is interchangeable with something else which is similar. A dollar bill for example is fungible in that you can exchange it for another dollar bill (and you don’t care about what serial number of the dollar bill you have). Similarly, Bitcoin is a fungible token in that two different bitcoin are completely alike.

Things that are non-fungible then, are those which are unique and not interchangeable with other things. And non-fungible tokens are essentially unique tokens that are tracked on the blockchain.

Non-fungible tokens have a few characteristics:

They are unique: Each non-fungible token represents some object in the digital or real-world and is unique, even if there are similar such objects. For example, even if someone “creates” 100 pieces of the same digital art as NFTs, each one will be tracked separately on the blockchain.
They are verifiable: The history ownership of these NFTs is recorded on a public ledger and is visible to everyone. This makes it difficult to “copy” and relatively simple to prove authenticity.
They are tradable: Just like other crypto assets, they are also tradable, although typically on special exchanges.

Today, most NFTs are built on top of the Ethereum blockchain.

Core Use Cases

Two of the core use cases for NFTs today are digital art and collectibles.

Digital Art

It can be difficult for digital artists, in particular, to monetize their talents to make ends meet. Anything digital can easily be screenshotted or copied and pasted. H

However, by allowing for proof of ownership and authenticity, NFTs provide a means for digital artists to sell authentic copies of their work to their fans. In some ways, NFTs allow for adding scarcity to an otherwise infinitely reproducible object, which then makes it valuable.

One of the cool things about NFTs is that artists can specify beforehand if they would like a cut of secondary transactions (for example, specifying a 10% cut of secondary transactions when “minting” the NFT), and so continue to earn a stream of revenue as their work exchanges hands in the future.

Today, numerous NFT marketplaces have popped up focusing on digital art with the leaders in them being NiftyGateway (owned by the Winklevoss Twins) and SuperRare, and there has been ~$90M worth of sales in February alone.

Data via CryptoArt

Even major auction houses such as Christie’s have gotten involved. They are currently running an auction for a unique NFT of a collage by digital artist Beeple chronicling his pursuit of creating digital art for every day for 13.5 years straight. A previous piece of his, Crossroads, is currently the most expensive digital art NFT, fetching $6.6M.

Beeple: The First 5000 Days is currently being auctioned by Christie’s

Collectibles

Collectibles as a hobby or even asset class aren’t new - people have been collecting coins, stamps, sports cards, and other memorabilia for centuries, with the annual spend on collectibles estimated to be ~$200B.

NFTs allow for porting some of these collectibles to the digital world and for creating completely new kinds of collectibles.

As an example of collectibles that exist in the analog world, Sorare has brought sports cards, specifically soccer to the digital world via NFTs, and has created a fantasy football game around it. One can imagine something similar happening for other sports and similar trading card games (Pokemon).

In terms of new collectibles, consider CryptoKitties which is a combination of collectibles and games, which is based on new IP. As another example, NBA Top shot has created a new kind of “collectible” - that of highlights of iconic moments, which can only exist digitally.

CryptoKitties

In the last 30 days, NFT collectibles have seen over $350M worth of transactions, dominated by NBA Top Shot.

February 22nd 2021

One of the interesting aspects here is that many of these collectibles have a gaming element to them, which provides for another source of recreation and another source of value to them.

For example, On Sorare, users can make weekly teams with their cards and earn points based on player performance in that week, making users eligible for prizes in the form of Ethereum or other rare cards (which have monetary value).

Emerging Use Cases

Gaming

Many popular games have certain items which are scarce such as rare skins or weapons (Fortnite) or player packs (FIFA). NFTs allow for a way to create an economy around these items and allow for the game publishers to make them transferable while making money on secondary sales of them. They also allow users to ensure that the items are really as scarce as publishers claim.

While I touched on some NFT-based games above, I put this under emerging because so far popular gaming title hasn’t moved their digital goods to NFTs yet.

Merchandising

You could argue this falls in the collectibles category, but I wanted to call it out specifically.

Fans have always purchased merchandise from celebrities and influencers they care about, ranging from things like hats and t-shirts to limited editions or rare copies of CDs or books.

NFTs allow for creators and influencers to better capture value from merchandising in two ways.

The creation of new forms of digital merchandise such as limited edition tracks or song NFTs, digital avatars, or attire.
Directly capturing value (in both primary and secondary sales) of these items through proof of authenticity and being able to auction them off without the use of layers of intermediaries.

Shawn Mendes’ digital avatar, available for sale through OpenSea

One could say this use case has already become common, with a few examples below, but I think there’s a lot more that will happen in this space.

3LAU auctioning off NFTs of his Ultraviolet album for a total of $11.7M. The winner even gets to collaborate with 3LAU on a custom single, which is tokenized as an NFT.
Mesut Ozil, an iconic German footballer, sold a limited quantity of digital items including hats and hoodies, selling out in under 10 minutes, netting $500K. Similarly, Shawn Mendes NFT merchandise is currently on sale.

What the winner of the 3LAU NFT auction received

Taylor swift remarked in 2014 that the selfie was the new autograph. Perhaps NFTs are the new limited-edition merchandise.

Real-world Assets

While tying NFTs to virtual assets is pretty common as in the use cases above (other examples include domain names), another use case could be to tokenize physical or real-world assets as NFTs.

The benefit of doing this is to be able to track ownership and authenticity going forward, as well as potentially enable. This is still somewhat in its infancy, but some initial examples include:

A FEWO x RTFKT sneakers drop which did $3.1M in sales, where the owners of the NFTs 6 weeks after the drop will be shipped the physical pair of sneakers as well.
Christie’s auctioned off Robert Alice’s Block 21 with an embedded NFT in Oct 2020, where the NFT serves as a mechanism primarily for proof of ownership and authenticity (the value comes from the physical piece of art).

In the future, however, maybe we’ll see elements of tokenizing songs or contracts or property where the owners of the NFTs are entitled to the economics associated with the item.

What Drives Value of NFTs

“But can’t you just infinitely reproduce that digital collectible or piece of art? What is the point of buying it?” is a common reason given for why NFTs shouldn’t have much value.

But as we’ve seen, based on these selling prices, people certainly seem to believe they have some value. So what is driving the value of these NFTs?

Intrinsic Value or Utilitarian value: As mentioned earlier, some NFTs (but not all) are tied to physical assets or have some utility such as in a game (e.g., Sorare’s fantasy cards). This provides the owner some utility - either monetary or otherwise, which provides some of the value. However, broadly, most NFTs have very little to no utilitarian value.
Scarcity: Scarcity is a key driver of the value of NFTs. NFTs enable scarcity of in many cases otherwise infinitely reproducible objects, such as digital art. Creators have the ability to choose how many pieces of similar artwork they “mint”, and the fewer they mint, the more individual value each one will have.
Creator / IP: Unsurprisingly, like in the art world, the reputation or fame of the creator or artist often determines the value of NFTs. NFTs which are “created” or backed by famous influencers or artists are more likely to have more value. Similarly, on the collectibles side, owning or having officially licensed the IP is critical to success. Me creating a Pokemon card isn’t going to make it valuable, but if Niantic creates an official version, that is a different story.
Signaling value / Story around NFT: At the end of the day, similar to collecting art, people also own it as a status symbol, and like to show them off. NFTs which in some way signal taste, knowledge, or are tied to memorable moments will have more value than those that don’t.
Speculation: Today, arguably a lot of the prices we’ve seen sales happen at are speculative in that buyers believe that they can turn it around and sell it at a higher price later on, rather than an interest in the creator of the artwork. Over time, I expect this speculation to reduce and the mania to subside a bit.

Closing Thoughts

NFTs have really taken off in the last few months, and while some of it is driven by speculation and I expect a cooling-off period.

However, they are the best way to create scarcity and track authenticity for virtual objects, and represent a good use case for “crypto” without needing to market it as such. For this reason, I believe they are here to stay. Interestingly, projects such as NBA Top Shot and Sorare have avoided too many uses of crypto and blockchain in their marketing and branding.

There has been a lot of activity in the space across the value chain, including:

Infrastructure to mint NFTs and transact: This includes infrastructure such as 0xcert to create and manage NFTs and Metamask which is a commonly used wallet.
Marketplaces to buy and sell NFTs: These include OpenSea which is one of the largest marketplaces for collectibles and NiftyGateway which is one of the largest for
Full-stack NFTs experiences/games: Companies here have either created new IP (Cryptokitties) or licensed out existing IP (NBA Top Shot and Sorare)

But it’s still early, and I expect to see a lot more in the above, as well as in:

Showcasing NFTs: A part of the value of NFTs is driven by signaling, showcasing, and sharing NFTs is very important. While there have been some companies here, I expect to see both physical displays optimized to showcase digital art and virtual social networks or showrooms which allow users to showcase their NFTs (and also sell them) pop up.
More licensed IP and merchandising: Some sports teams and celebrities have gotten involved, but I expect a lot more to do so. Companies that own IP such as Disney, Nintendo will likely want to get in on the action as well as more musicians and other kinds of artists, and so I expect startups to build more infrastructure to support these vertical-specific use cases or try to snag those official licenses which are critical to NFT success.

Today, minting costs and transacting costs are still quite high and so I expect innovation on that front as well.