"In 2020, the entire NFT market was worth a little more than $200 million. This year? More than $12 billion in digital assets traded hands by the end of August."
Source: https://www.coinbase.com/learn/crypto-basics/art-collectors-guide-to-nfts
In 2021 Beeple sold for $69 million at Christie's; Jay-Z, Odell Beckham Jr, and Visa collected a CryptoPunk each; Jimmy Fallon, Post Malone, and Steph Curry joined the Bored Ape Yacht Club; Adidas Originals launched their metaverse strategy in partnership with GMoney, Punks Comic, and the Bored Ape Yacht Club; and other titanic brands like Budweiser, The Matrix, and Marvel launched NFT collections. 'NFT' is the word of the year. NFTs are a big deal.
'NFT': The Collins Word of the Year 2021
But why are NFTs so valuable? From where does their value derive? And how high can their valuations go?
In this first paper of the NFT Curriculum, I explore:
(i) how NFTs and their underlying technology create value; and
(ii) why NFTs can be so valuable to collectors.
In summary: NFTs can be valuable because they create meaningful ownership of digital goods - whose proof of ownership and proof of creation can be guaranteed - which can be traded without friction on "perfect" information.
1. How do NFTs create value?
NFTs facilitate digital ownership
NFTs provide for the first time ever the ability to meaningfully own digital goods.
NFTs are simply tokens which represent ownership of something: from digital art, to digital clothing, to digital land. (They can also represent ownership of real life assets, but let's leave that to the side for a moment.)
In the Tim Ferriss podcast episode, The Wonders of Web 3.0, Naval alludes to NFTs as owning "a piece of the internet".
"Digital private keys enable digital private property. We don't need a centralised company to decide who owns what and hold it within their database. We can each do it ourselves. We can each own a piece of the internet."
Source: https://tim.blog/2021/10/28/chris-dixon-naval-ravikant/
(The development of "digital private keys" and their underlying cryptographic technology was foundational to the creation of digital ownership and precedes NFTs - more on that in a later Paper.)
Why is it so significant that digital goods can have owners?
(i) Ownership is a precursor to value: ownership creates a market
In a Web 2.0 world, it was difficult to verify ownership of a "piece of the internet". The internet facilitates the production and reproduction of content more quickly than any other technology in history, which means that content such as memes, digital art, and other digitally created content were difficult to verifiably "own".
What does "ownership" even mean in a Web 2.0 world? Do you own a digital good if you created it? Do you own it if you have the original on your computer? Do you own it if you have a copy of the original on your computer after you have right-clicked and saved?
right-click sleep: sartoshi regularly satirises the 'right-click save' attitude of those who are sceptical about NFTs (a must follow on Twitter who cracks me up)
Blockchain technology provides the answer in an open and trustless manner. The blockchain acts as a ledger of record which guarantees (amongst other things) who is in possession of an NFT at any given time.
This means that digital goods are now a provably "ownable" asset. This creates a new asset class around which a market can be built.
(ii) Ownership is a precursor to value: you cannot sell what you do not own
If you cannot sell the digital goods which you own then you do not own them.
Over the last few years many gamers have used real-life money to purchase digital goods. They "own" the digital goods, but if they don't like the game anymore and want to stop playing, or if a rival edition of the game proves to be better, there is no way for gamers to move their digital goods out of the game to either use elsewhere or sell for monetary value. In this respect, it is impossible to say that these gamers "own" their digital goods if their rights with respect to them are so restricted.
This is the equivalent of buying a basketball jersey at a basketball stadium and one of the conditions of sale being that you cannot wear (or sell) the jersey outside of the stadium - a clearly nonsensical term of sale.
Web 3.0 and NFTs fundamentally changes this paradigm.
"They flip the model from closed application, closed code, corporation owned platforms where the users are the data, to open code, contributors own the platform, users own their data."
Source: https://tim.blog/2021/10/28/chris-dixon-naval-ravikant/
If users own their data, and contributors own their platform, a reasonable logical extension is that digital goods will no longer be locked behind closed walls.
How do NFTs guarantee provenance?
Provenance is everything. The difference in valuation between a "real" or a "fake" is extraordinary in any asset class (art/fashion/wine/collectibles/cars).
Leonardo da Vinci's painting Salvator Mundi was sold for $450 million in 2017 after one of the most rigorous and intense studies of authenticity the world has seen. There were many similar paintings produced in the 16th century, but one by the hand of the master himself is naturally considered of incomparable value. The price achieved at auction was an absolute consequence of it being verified that Salvatore Mundi was by Leonardo Da Vinci himself.
Leonardo Da Vinci's Salvator Mundi: sold at Christie's in 2017 for $450m.
Ben Lewis wrote about this piece in his book, "The Last Leonardo", which is described as "an adventure story about the search for a lost treasure and a quest for the truth."
A quest for the truth.
The truth of the painting's origins and creation was more important than the painting itself.
This is where the blockchain comes in.
If blockchain technology and NFTs help guarantee "proof of ownership", then it must also guarantee "proof of creation".
How?
The blockchain reliably records "proof of ownership" by recording who bought what from whom and for how much (amongst other things). If an NFT changes hands 100 times, the blockchain will record the details of every transaction. This means that no matter how many times an NFT changes hands it will always be traceable back to the original creator account. As a consequence, transactions can take place more readily because buyers can be more certain about the provenance of goods.
Why is “perfect” public information so important?
Buyers are of course interested in more than just provenance before taking a position in an asset.
Some relevant data points for NFTs might be:
the supply of NFTs in a collection;
previous market performance/transaction history;
last sold price;
current floor price;
current bid price;
notable holders; and
percentage of NFTs on sale from a collection.
All of this information is available in public when trading digital goods.
In addition, it is even possible to see all the prices at which an NFT did not manage to sell, and all of the bid history for an NFT.
Armed with this information, buyers can make relatively well informed choices.
2. Why are certain NFTs so valuable to collectors?
Once property is established, it is up to the market to decide which NFTs are most valuable.
The following is a non-definitive set of contributing factors for NFT valuation, none of which in isolation are responsible for the entirety of an NFT's valuation.
(i) Beauty/Aesthetic
People have always desired the most beautiful things in society: fine art, luxurious homes, beautiful scenery.
In the NFT world, just one example of a widely considered "masterpiece collection" is the Art Blocks Curated Fidenza collection by Tyler Hobbs.
This is an example of generative art, where code is created and crafted to produce a variety of pieces in a similar style.
Fidenza #131 "Ensamble" by Tyler Hobbs - owned by @0xBEW. 999 Items in Collection - 80 ETH floor price
(ii) Historical / Cultural Significance
People have always desired old, historical objects which were significant in their own time and for their influence on proceeding generations.
The CryptoPunks project by LAVAlabs was one of the first NFT projects minted on Ethereum and almost every other 'Avatar' project has followed its blueprint: 10,000 characters with a variety of traits of differing rarities. As such, this is the OG "Identity" NFT.
Recurring traits: CryptoPunk traits like the 3D glasses (above example owned by @richerd) have been replicated in numerous 'Avatar' collections
(iii) Scarcity
Things which are most scarce tend to be most coveted: diamonds, pearls, 1/1 fine art.
In the NFT world, artists and projects define their own scarcity.
For art, this could mean deciding between an edition size of 1, 10, 25, or any defined or undefined number higher. (Open Editions create scarcity by limiting the number of pieces to those bought within a defined window of time.)
The Bitcoin Angel: Trevor Jones, one of the most respected and successful artists in the NFT space, sold 4,158 editions of The Bitcoin Angel in a 7-minute window earlier this year.
For collectibles, projects seem to control scarcity by producing no more than 10,000 NFTs in a collection.
Within those collections, there are additional rarities which create scarcity of certain traits. The Canary Collection (run by @osf_nft and @greatmando_nft - two prominent collectors in the space) is one of the largest holders of Bored Apes and has collected across the spectrum of rarities. Below are just some of the different traits it has collected: spinner hat; red fur; police motorcycle helmet; cowboy hat; tuxedo tee. Though oftentimes value accrues to the Apes which are most aesthetically pleasing, Apes which have specific rare traits can accrue value from their scarcity too.
On discussing tactics to identify value through rarities, @osf_nft said:
"We consciously try to have as much variety as possible. We use rarity.tools to filter and try to find rarer apes that look mispriced. We then make a shortlist and throw out a few bids, prioritising the ones where traits are most aesthetically pleasing or generally just give off cool vibes."
NB. Just because something is scarce does not mean it will be valuable.
(iv) Utility (Early Access/Community Access/Yield)
Things which are useful will always be in demand.
In NFT land, the most interesting utility provided by an NFT for me has been Punks Comic.
One Punks Comic NFT minted in May 2021 (which is on its own an awesome NFT comic written by Richard Galbraith and beautifully illustrated by Chris Wahl):
allowed you to stake for $PUNKS tokens which represent fractional ownership of 16 CryptoPunks
allowed you to mint MetaHeroes at 0.08 ETH (which were immediately worth significantly more and which allowed you to claim free Planet DAO tokens)
could be burned for a Pixel Vault Founder's DAO token - which represents proportional ownership of the Founder's DAO vault (approx. 600 ETH of value at the time of minting), and early access to future drops.
Cumulatively this is an extraordinary amount of value provided by one NFT.
As Beanie points out in this tweet, it is the NFT's existence in your wallet on the blockchain which makes it possible for creators to reward collectors in innovative ways in perpetuity in a frictionless manner.
(v) Club/Status
With the increased digitalisation of the world two things have become obvious:
(i) people are becoming digitally native and value digital assets;
(ii) the most natural way for people to demonstrate their wealth and status will be to own more digitally native goods - which can be exhibited in online wallets, profiles, and galleries - as opposed to physical objects which reside in their house which hardly anyone can see.
There have always existed exclusive clubs, whose memberships have been desired by many. In some cases, NFTs have come to represent memberships to particular clubs, which the market has come to respect as sought-after and valuable.
@danielgothits, an avid NFT collector, has spoken about this eloquently:
"Punks and Ape owners have the same status level in the eyes of the market. It doesn't mean that I think I'm better than anyone because I own an ape - far from it. But I would be stupid to ignore the market sentiment of the reality that people look at Punks and Ape owners with a certain lens - and with some respect and credibility in the scene."
As Daniel articulates, there could be all sorts of perks to being a member of such clubs:
"I think that we're going to see a lot of big brands coming in and allowing [owners of particular NFTs] to claim free product - and then what do they achieve? Tens of thousands of tweets about that product. That's a lot easier than them figuring out some complex marketing strategy."
Once it is agreed at large that a particular NFT is beautiful, scarce, and/or useful, there seems to be great status attached to owning such an NFT - especially when we are spending more and more of our existence online.
(vi) Store of Value
The finest and rarest goods in history have often been kept as a store of value (instead of holding cash which depreciates with inflation).
@iamDCinvestor thinks the same will be true of certain NFTs, with DAOs being at the forefront of these investments (more on DAOs in a later Paper):
One artist who has achieved a status which has made many comfortable with sinking huge amounts of ETH into their work is @XCOPYART.
At the very top end of the market, @CozomoMedici bought from @2Yeahyeah for 1600 ETH the 'Mona Lisa' of NFTs: Right-click and Save As guy in December 2021. This was bought by @2Yeahyeah for 99 ETH in early 2021.
@XCOPYART editions are also highly prized.
@ape6743 has curated a fine collection of editions which represent a more accessible entry point for collectors, fans and investors and can be found in his gallery (though the valuations have already seen significant growth over 2021 to a point where many find the price points difficult to reach).
Should you wish to consider further the thesis for why @XCOPYART has become such a prominent artist in the space, and learn about more fantastic OG artists who have been producing quality work in this space before many took notice, this thread from @2Yeahyeah is a must-read.
(vii) Fractionalisation
If you collect NFTs which people consider to be strong stores of value, you may find others are willing to buy a 'fraction' of your NFT if they cannot afford the whole piece.
This fractionalisation process - where an NFT can be split into what essentially constitutes a number of shares of an NFT - has been led on the technological front by @fractional_art.
It allows a collector to own an NFT, and get liquidity from that piece without having to sell it. This might be very valuable to a collector depending on their investment profile.
One notable example is the fractionalisation of the @XCOPYART piece Five Eyes owned by @Anonymoux2311.
Closing thoughts
As we spend more and more time in online communities, digital goods will become more prominent in our lives.
NFTs can be valuable because they create meaningful ownership of digital goods - whose proof of ownership and proof of creation can be guaranteed - which can be traded without friction on "perfect" information.
NFTs can only really be stupid to the extent that humans are stupid for being collectors and desiring material things (Ie. Either: humans are stupid for collecting anything; or humans are not stupid for collecting real-life things, nor are they stupid for collecting digital things).
Moving forward
I hope this has proven helpful to conceptualise some of the intrinsic value of NFTs and provided some insight into the collector's mind.
Next week I will focus on why NFTs are an absolute game-changer for creators themselves.
Disclaimer: The content covered in this newsletter is not to be considered as investment advice. It is for informational and educational purposes only.