Summary: 2021 saw a huge increase in price and popularity of Non-Fungible Token (NFT) which followed the rise in cryptocurrencies and it was the year that NFT’s became mainstream with celebrity endorsements and even a mention in the Saturday Night Live show. This year, NFT’s have declined in price and volume along with with cryptocurrencies and other asset classes with the rise in interest rates and now doubts are being raised about their future. However there is wide potential use of NFT that has not yet been explored and NFT’s may stay as an alternative asset class and be a feature of the digital asset ecosystem.
What are NFT’s: Starting with basics, NFT is a type of digital asset (along with digital coins and cryptocurrencies) that represents ownership over a physical or a virtual asset that exists on the blockchain. The asset linked to the NFT could be an intangible thing (Jack Dorsey’s first tweet) or a tangible thing like an art piece or a magazine cover. They are called non-fungible because unlike cryptocurrencies which are interchangeable each NFT is unique and so NFT’s are non-interchangeable and indivisible e.g. there cannot be half a NFT unlike a bitcoin. So essentially, each NFT is a digital representation of an unique asset on the blockchain that is not interchangeable. Difference with stablecoins and bitcoins is that each NFT stores data while bitcoin or stablecoins store value and the similarity is that like them NFT’s can be bought and sold over the blockchain.
History: NFT’s first started in 2017 with the release of CryptoPunks which is now a ‘cultural icon’ for the NFT market along with Bored Ape Yatch Club which came later. Both these groups represent crypto (digital) images of 10,000 tokens with proof of ownership stored in the Ethereum blockchain. These two groups of NFT’s are the most heavily traded NFT’s according to OpenSea.io which is the dominant marketplace for trading and creating NFT’s.
Exponential Growth: 2021 saw an exponential growth in NFT coinciding with the explosive rise in cryptocurrencies. The dollar volume of NFT’s traded increased from $82MM in 2020 to $17B in 2021 while market cap of NFT’s saw a similar exponential growth from $372MM to $16 billion as reported by NonFungible.com which is the premier source for the NFT market and the average asset price of NFT in 2021 was $1,882. 2021 was also the year that even venerable auction houses like Christie’s started embracing NFT’s. In fact, the most expensive and well-known NFT sale happened by Christie’s in Jan 2021 and was Beeple’s Everydays: The First 5000 Days. Besides, Christies NFT’s also attracted a wide arrays of celebrities and record prices were set by some celebrities endorsing popular NFT’s or developing their own NFT for their fans.
State of NFT Investments and Markets: A recent study of NFT’s as an alternative asset which used sales of CryptoPunks as a proxy for overall NFT market from period June 2017 to March 2022 has shown that;
– NFTs have higher returns than traditional financial assets (not surprised here) and monthly returns was 16% compared to less than 2% for stocks during the sample period.
– However along with these high returns, investing in NFTs carries extremely high volatility with volatility being 15 times that of stocks.
– NFT prices surge when there is an increase in the increase in demand for alternative investments and a search for yield in a low interest rate environment. So in this sense, NFT’s are the latest alternative assets and growth of alternative investments increases during low yield environments.
– Return on NFT market is strongly correlated with the price of ETH-USD, Ether or the native currency for the Ethereum blockchain which is used by majority of the NFT’s.
– The pricing of NFT also largely depends on a token’s scarceness and investors’ aesthetic preference; Bored Ape NFT’s with unique features sell more than others which have more common features.
– 60% of NFT collectors re-sold their tokens within 6 months and only a minority, 19% have held their NFT for more than 3 years showing that NFT buyers are buying them with the hopes of finding someone who can buy it off them at a higher price and so the NFT market maybe subject to the greater fool theory as Bill Gates has recently pointed out.
Decline – As interest rates have risen in 2022, NFT sales have fallen along with prices of cryptocurrency and overall sale volumes are down 37% from peak monthly sales of $4.9B in Aug 2021 to monthly sale of $3.07 billion in May 2022. The public seems to be losing interest; the resale profit volume is down and for first time some sectors are showing a negative balance according to recent summary just published in the Nonfungible.com. The average price has also come down to $1057 in Q1 2022 and so loss during resell is up 50% in 2022. The primary market has slowed down and there is less new NFT’s being created and the share of secondary market is now 70% of the sales volume in Q1 2021.
Looking Forward: Despite, the decline in NFT volumes and prices, the reality is that NFT is a new asset class and it will impact not just the investing landscape but many other areas of our lives by creating digital certificates to represent ownership of assets. Further since NFT’s are on the blockchain, ownership can be proven any time and can be transferred seamlessly and instantly. NFT’s may end up having a large role in metaverse and become a dominant asset class in the virtual world. To that point, each day, more and more new uses of NFT’s are being found from golf, to wines to cover of the Economist magazine and the possibilities seem to be just endless. The advantage of NFT for these uses is that since it lives in the blockchain it can be programmable through a smart contract and can do things for owners like providing them access to a suite of products/discounts on the internet. Owning a NFT can make you not just an owner but a member, brand shareholder, investor in a loyalty program all at same time as noted in a recent Harvard Business Review article.
While right now it seems pointless that people are paying thousands or millions for owning a digital picture, NFT’s has an interesting potential beyond this use and looks to have a prominent role in the future in the crypto ecosystem.