What are NFTS? And Why They May be a Smart Investment
Figure 1: Example NFTs, using the popular “CryptoKitties”. Source: https://www.bitcoininsider.org/article/36579/what-are-nfts-non-fungible-tokens-explained
What are NFT’s?
Increasing interest and speculation in the world of blockchain now surrounds the revolutionary concept of NFT’s. NFT is short for non-fungible token. (1) A token represents a virtual asset; fungibility is in reference to the items’ uniqueness. If an item is fungible, replicate interchangeable items of identical value exist. (2) Examples of this in the physical world include printed currency or commodities,(3) or blockchain currency as a digital equivalent. (2, 4)
A non-fungible item is by definition unique and non-interchangeable,(3), for example, a work of art is a real-world equivalent. Therefore, a non-fungible token is a unique cryptographic item. Like works of art can be authenticated, so too can NFTs. As such, they hold value in cryptocurrency. (3) They represent an opportunity to create digital scarcity in a marketplace, in addition to digital ownership. (1, 2, 4) There are three characteristics that an NFT must fulfil in order to be differentiated from regular cryptocurrency. (3, 4) The item must be:
Unique: Unalterable, permanent meta-data exists within the coding of the digital asset, meaning it cannot be replicated exactly, and additionally serving as proof of authenticity. (3) Part of their value lies in their capacity for ownership rights. (3, 5)
Rare: NFTs present an asset diversification opportunity for those invested in cryptocurrency, as whilst the currency in circulation may be increased by developers to an infinite extent, NFTs are by their very nature finite and irreplaceable. (3)
Indivisible: As a non-fungible asset, they cannot be split into smaller components- nor may they be multiplied. (2, 3)
NFTs in Action
To give context, NFTs are typically applied to unique digital items of value, such as collectables (shown above in the “CryptoKitties” example (which was the first NFT to go viral)(1)), gaming or trading cards. (2, 4)
The Ethereum Blockchain (ETH) has become a popular cryptocurrency to trade NFTs with,(1-3) and many NFTs now hold considerable value in ETH. Although the majority of the market share is through ETH, other cryptocurrencies such as TRON, EOS, NEO, and Dapper Labs’ Flow blockchain also support NFTs.(2, 3) The reason that the majority of NFTs are valued in ETH is a result of the ERC-721 has become the token standard for NFTs. This is a standard based on ETH which codifies the creation of an NFT and ensures a smooth interface in the exchange of NFTs across the ETH platform. (6)
Returning to Figure 1, and the CryptoKitties as an illustration of what kind of value these tokens can hold, the most expensive NFT ever sold was a CryptoKitty known as “Dragon”. This sold for a whopping 600 ETH, at the time equivalent to roughly $170,000.(3)
Some other expensive NFT purchases lie in gaming, with the “1-1-1” car from the F1 Delta Time blockchain game. (7) As the most expensive NFT purchased in 2019, standing at 415.9 ETH (or roughly $113,000),(3) and with an audience of over 1.6 billion at launch,(7) this example represents the interest and value that already surrounds these tokens. For the interested reader, nonfungible.com provides an overview of the NFT marketplace, including recent sales and the market value of different collectables. NFT’s are not traded on contemporary cryptocurrency exchanges but tend to be purchased or sold on separate digital platforms, such as OpenBazaar.(2)
The use of NFTs is currently being investigated, or preliminarily implemented, within the following markets:(2, 3)
Virtual assets e.g website domains, social media handles
Real-world assets e.g property, designer handbags, ticketing(5)
What determines the worth of an NFT?
The value of an NFT is determined by the following equation:(8)
Utility + Ownership History + Future Value + Liquidity Premium
The value may be weighted differently across each individual component of the equation, depending on the asset in question. (8) What’s more, the speculative investor may examine how each of these components may change with time.
The utility is dependent on how the NFT may be used, for example, if it is an in-game item that can be used in gaming. (6) Its value in this regard may vary if the number of users on the particular game increases or decreases over time, as well as the potential for cross-platform gaming, where the item could be implemented into another game. (1)
The ownership history refers to both the issuer of the NFT and the parties that may have previously held it. Branding generally increases the value of an item produced by that company, and this holds true for NFTs also(8). Nike and the NFL represent longstanding, trusted companies that are beginning to look at NFTs, and this will be reflected in the value of any NFTs they produce. (3) If an NFT is held by a person of influence, the market value of the NFT is likely to increase upon resale.
The future value of an NFT is largely determined by speculation and is a product of their intrinsic scarcity. (4) An investor may speculate as to the decreasing availability of a given NFT, and then hold the item before re-auctioning it on a less crowded marketplace for a premium. Interestingly, there is potential for an NFT to reward the original owner with royalties for each subsequent sale on the secondary marketplace; something that can be easily tracked as a function of their unique encryption(8). This both rewards and incentivises digital artists, which may lead to increased innovation within the space.
There is high liquidity with most NFTs, especially those holding value in ETH. (8) As the ETH market grows, the potential buyer’s market for NFTs will similarly grow.
The NFT industry and projected growth
For the potential investor, the state of the NFT industry as well as its anticipated growth, and perhaps the risks involved, maybe key determinants in their decision to purchase an NFT asset.
NFTs have existed since as early as 2016. (1, 5) By 2017, their market cap was worth just under $31,000. In 2018, the industry grew in value by a whopping 482%, and by a further 19% in 2019 to sit at $210,500. It is expected to grow by 50% by the end of 2020. (3) The reduced growth in 2019 is reflected in the user base, which only grew by 1%. In 2020, it is expected to increase by an impressive 30%. (3) The dollar value of NFTs is expected to sit at roughly 250 million USD this year, an absolute rise of 64%.(3)
In the second week of September 2020, just under 1 million USD in NFT sales were reported. (9) So far in 2020, it appears that the NFT market is not only expanding, but becoming more robust. (9) This data altogether points towards the growing potential of the industry and projects favourably into the future, although it is worth mentioning the distribution of growth is not equal. Like many competitive markets, few companies succeed whilst it is the many that ultimately simmer out of existence. (3)
Although the NFT market is still relatively small, and many projects ultimately struggle to get off the ground, there is tremendous promise for those that do. With many large companies and brands likely to take advantage of the potential for authenticated, unique digital assets, opportunities are limitless. Already, select industries have seen rapid growth, such as in collectables and gaming; one need only observe the “CryptoKitties” case study as proof for the value which may be held in NFTs. The inspired crypto-investor should seriously consider diversifying into this space. Future issues will involve delving further into some case studies of promising NFTs, beginning with Pepemon, a digital card trading game, and subsequently Sply.t – a game-changing NFT project in e-commerce.
1 Wikipedia. Non-fungible token 2018 [cited 2020 30/11/20]. Available from: https://en.wikipedia.org/wiki/Non-fungible_token#:~:text=A%20non%2Dfungible%20token%20(NFT,that%20are%20fungible%20in%20nature.
2 Kramer M. Non-Fungible Tokens (NFT): Beginner’s Guide 2020 [updated 09/11/20. Available from: https://decrypt.co/resources/non-fungible-tokens-nfts-explained-guide-learn-blockchain.
3 Non-Fungible Tokens: The Quick Guide. Cointelegraph Magazine. 2020.
4 Chevet S. Blockchain technology and non-fungible tokens: Reshaping value chains in creative industries. Available at SSRN 3212662. 2018.
5 Regner F, Schweizer A, Urbach N. NFTs in Practice – Non-Fungible Tokens as Core Component of a Blockchain-based Event Ticketing Application2019.
6 Garner B. What Are NFTs? Non-Fungible Tokens, Explained 2018 [30/11/20]. Available from: https://www.bitcoininsider.org/article/36579/what-are-nfts-non-fungible-tokens-explained.
7 Robery J. Five of the Most Expensive NFTs Sold in 2019 2020 [27/11/20]. Available from: https://cointelegraph.com/news/five-of-the-most-expensive-nfts-sold-in-2019.
8 Chang H. medium.com. 2020. [cited 2020]. Available from: https://medium.com/@changhugo/understanding-the-value-of-non-fungible-tokens-nft-49d2713bdfc4.
9 Redman J. NFT Economy Grows Exponential: $1M in Non-Fungible Token Sales Last Week Bitcoin.com2020 [29/11/20]. Available from: https://news.bitcoin.com/nft-economy-grows-exponential-1m-in-non-fungible-token-sales-last-week/.