What are NFTs and Why Would Anyone Buy Them?

A JPG file made by the digital artist known as Beeple sold for $69 million at Christie’s auction house

If you’re reading this, you have probably heard about what NFTs are and how it’s an emerging frontier. Everyone and their mother is talking about the latest pixelated punk that sold for $2 million or the crazy historic sale of Beeple’s art for $69 million. But is it an innovation here to stay? How do you decipher all of these projects and identify something that has real value in the longer run?

In this series of articles, we try to breakdown what NFTs are in their essence, what makes certain projects appreciate in value more than others, and share our thoughts on what the next big projects & trends will be.

What are NFTs?

NFT stands for Non-Fungible Tokens. Those sound like big words, but they’re actually very simple. Let’s first start off with talking about what fungibility is all about.

“In economics, a fungible asset is something with units that can be readily interchanged — like money.”

BBC News (https://www.bbc.com/news/technology-56371912)

In layman’s terms, this just means that one item of something is the same as another. Money is a great example because if I have $1 and you have $1, we will both still have $1 even if we were to swap the dollar bills. Our perceived value of the dollar bill doesn’t change, so we don’t particularly care that they were swapped. Other examples of fungible assets can include commodities like barrels of oil or bushels of wheat, or shares of stock within the same class. Simple, right? Many things that we deal with in the finance system are designed to be fungible, so people from all over the world use and exchange them, which ends up creating liquidity. What a great invention!

Money is fungible: one US $1 banknote is interchangeable with any other genuine banknote like it.

But let’s take the flip side of that — non-fungiblity. Basically non-fungible just means something that can’t be readily interchanged because it has unique properties and is generally a “one-of-a-kind”. Let’s take your house for example. Your house is different from your neighbor’s house because it has different properties: say structure, aesthetics, views, and likely price. So the likelihood is that you consider it a “one-of-a-kind”, and you wouldn’t just exchange your house for another house just because they’re both “houses”. You can imagine then that art pieces are most definitely non-fungible, because the original painting of the Mona Lisa is definitely not the same as any prints or photos of the painting.

“Non-fungible” means that it’s unique and can’t be replaced with something else.

Now that we understand what non-fungible means, let’s dive right into NFTs specifically. NFTs are merely a digital representation of a non-fungible asset. Let’s continue with the art example and suppose that Leonardo da Vinci was still alive and minting tokens on the blockchain. If he were to put the Mona Lisa on the blockchain as an NFT and burn the original oil painting, then this would also be one of a kind, just like the original painting. Sure someone could download the image, print it, and hang it up. But the original Mona Lisa NFT, minted by Leonardo da Vinci, will forever be non-fungible by definition, because only one exists. The NFT itself has no tangible form of its own in the physical world, but it can have as much or more value in its digital form to people on the blockchain.

It is worth noting that virtually anything can be minted on the blockchain as an NFT, but the most popular (and obvious) use cases in this current market are pieces of art or characters/items used in blockchain-based games.

So why would anyone buy NFTs?

That’s a great question. Let’s breakdown this complex and seemingly irrational behavior.

Pure Speculation

An investor who buys NFTs for pure speculation is hoping to buy an NFT at a low price in order to flip it for a higher price at some later date, usually in the near future. The reason that the investor believes the price will increase can vary. For example, the NFT may be from a project that’s already wildly popular and the investor expects the project to continue increasing in popularity over the next few weeks. Or the NFT is drawn by a relatively unknown but up and coming artist that the investor thinks is about to blow up. Whatever the reason may be, in the world of investing (and especially in a bubble), the price will continue to go up as long as the buyer feels that someone will buy it for even higher and that they’re not the last person holding the bag. This speculative behavior is likely the biggest reason for the insane price increases in certain NFT projects over the last few months.

Here are some crazy-sounding, but possibly sound, speculative examples:

  • On 19 February, an animated Gif of Nyan Cat — a 2011 meme of a flying pop-tart cat — sold for more than $500,000.
  • A few weeks later, musician Grimes sold some of her digital art for more than $6m.
Twitter founder Jack Dorsey’s first ever tweet has been sold for the equivalent of $2.9m

Utility

With physical art, people can find utility in the pieces they own — maybe it reminds them of a pleasant memory and calms them down, reminds them of a lesson from history, or it helps them gain respect from their peers. Similarly, in the NFT world, people can find utility from purchasing NFTs.

For example, Proof of Beauty (POB) is a project that we love because of its unique minting process. Instead of just buying some art from a lootbox or from a pre-existing list of generated art, POB makes you choose your favorite transaction hash from the Ethereum blockchain. You can then input that transaction hash to mint your generated art. The process of making the buyer choose their own transaction hash is interesting because the buyer spent time digging up the transaction that is meaningful to them (or that they think has value to someone else). The “work” put in gives the piece of art some utility to the buyer — even if the art never gets bought by someone else, the NFT represents something valuable to the buyer.

Proof of Beauty NFT pieces represent a tokenized moment of ETH history

Building on this, we feel that certain purchases of NFTs, like the one of Beeple’s art for $69 million were not necessarily a speculative purchase, but rather purchased for utility. The buyer of the piece was Vignesh Sundaresan, the founder of the Metapurse NFT project. He claims that the reason for his purchase was to show support in the NFT space and showcase the technology to the world. Regardless of whether that’s true, it’s no doubt that he got a ton of positive press for his purchase globally and his NFT project got a lot of free marketing from this purchase. This is a complete valid reason to purchase NFTs and not too far-fetched in our opinion.

Royalties / Dividends

There are some NFTs that can earn the owners some royalties over time. Take EulerBeats as an example. EulerBeats is a limited edition set of algorithmically generated art and music. This project is incredibly interesting because it allows people to buy prints of the original edition on the blockchain, which makes these prints legitimate as well (as opposed to someone downloading the copy and repackaging it as their own NFTs). Each time someone creates a new print (copy) of the original, the original owner receives a royalty. The more popular the original edition is, the more the owner earns!

Euler Beats are a digital art collection of 27 art + music originals based on Euler’s mathematical discoveries

Yet another example is when an investor parted with $222,000 to purchase a segment of a digital Monaco racing track in the F1 Delta Time game. The NFT representing the piece of digital track allows the owner to receive 5% dividends from all races that take place on it, including entry ticket fees.

You can imagine that there will be more and more projects like these where the owners of these NFTs can earn money over time regardless of the actual price of the NFT, making them a valuable investment.

Case Study — Physical Baseball cards

We want to tie this all together with a comparison to physical baseball cards. Take this 1952 Topps Mickey Mantle baseball card for example — this one card is worth several million dollars, and the insurance for this alone costs $12 million!

In January 2021, a 1952 Topps Mickey Mantle has sold for a record-breaking $5.2 million

No one questions rare baseball cards and physical collectibles, and in fact, there are entire TV shows like Antiques Roadshow dedicated to finding and appraising them. People may buy these cards for various reasons, some of which we listed above, but whatever the reason may be, it’s clear that these cards have “value”.

NFTs are really no different. We are just moving collectibles to a digital format where it can be verifiable that there are no replicas and fakes can’t get passed off as the real ones since ownership is provable. Note that art is valuable not only for how it looks, but for its context — both historical and social. Replicas and fakes don’t retain any of that context, making them virtually worthless.

Final Thoughts

It’s clear to us that the way people view art and collectibles has not fundamentally changed. The only difference now is that with the power of the blockchain, people are easily able to prove and verify ownership.

Thanks to this, there has been a huge shift over the past few years from people valuing the ownership of a physical collectible to people valuing the proof of ownership. And if that’s the case, why not make everything digital? Slowly but surely we are moving towards a digital-native world, and the rise in popularity of NFTs is just the first step.

Up next

In the next article, we will talk about what makes an NFT project popular and historic. If you enjoyed this article and want to learn more, please give us a clap and follow us on Medium!

Disclaimer:

NFTs are just like any investment vehicle. We do not provide any investment advice, and please do your own due diligence before purchasing them!

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