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Posted on 17th November 2022
Judging the value of Non Fungible Tokens

Non-Fungible Tokens attempt to place value on a digital asset, but the final price paid has more in common with the traditional art world than you might realise.

Digital technology developments such as Blockchain provide a network-based technology solution that is used to record transactions efficiently and securely, and the most popular cryptocurrency – Bitcoin – has stimulated a mass of new retail and institutional investor growth.

This heightened speculation of opportunistic investments has revolutionised the financial ecosystem and resulted in the introduction of Non-Fungible Tokens (NFTs), a Blockchain product that has gained significant public attention in recent years.

NFTs exist as unique digital token assets which represent tradable digital goods, such as collectable arts, profile pictures, sports cards, videos, music and in-game items.

Although sceptics have mocked NFTs as being simple digital images that can be just as easily copied and pasted, the NFT has become one of the most utilised components of the Ethereum ecosystem, creating a billion-dollar economy.

The unique value of NFTs
An NFT is a unit of data stored on a blockchain. It certifies a digital asset is unique and, therefore, non-interchangeable, while offering a unique digital certificate of ownership. As a result, an NFT can be equated to being a proof of ownership.

The unique value of NFTs signifies them as being ‘non-fungible.’ In other words they cannot be traded, but the digital asset they represent can be. The NFT’s function is to guarantee the value intended by the creator, for an owner or buyer.

The NFT market began to attract attention February 2021 when ‘CrypoKitties,’ a NFT digital collection of artistic images representing virtual cats used in a game of Ethereum, allowed players to purchase, collect, breed and sell ‘cats.’ The emerging purchases made in-game using cryptocurrency reached £1.5 million in value.

In March 2021, the Nyan Cat, designed by the artist, Beeple, was auctioned and sold for the equivalent of $650,000 as an NFT at Christie’s, making it the third-highest auction price achieved by a living digital artist.

Similarly, the Board App Yacht Club, a vastly popular NFT collection of gaudy primate cartoons has become an NFT status symbol for millionaires and pop stars by trading at more than a million dollars apiece.

As the crypto art market boomed NFTs have become taken more seriously. Many digital artists operating outside the mainstream contemporary art sector rushed to embrace NFTs as a means of selling their work. New crypto artwork communities sprang up to feed the market, building on NFT platforms such as OpenSea, Hic et Nunc and others – all of which gained prominence overnight.

NFT market growth is extending into publicly-traded partnerships creating competitive individualism and promoting the cult status of genuine artists. For most artists it is attractive to earn a living that funds their work by cooperating with the market. There is however a downside - as with all markets the emergence of NFTs also produced inequalities, monopolies and fragility.

The value-add of community
So why would an investor be enticed by NFTs? A key motivation, fully reinforced by the wider industry, is a notion of ‘community.’ Investors stress that establishing a community within an NFT project is a precondition of success, as through this automatically ensures inbuilt value.

In the words of one investor, ‘NFTs are all about the community, because this is how popularity and virality are created, leading to a shared belief of investment value.’

Social media is seen as the epicentre of community. This influences changes in the valuation of NFTs, with another investor adding “social media is there as a bridge between buyer and seller, and these bridges only increase with stronger communities and so reflect higher demand for the NFT.’

The greater the number of members a community holds, the greater fluctuations in demand become, along with asset scarcity. All of this makes investment look distinctly attractive.

In reality social media influences and controls pricing. The scale and size of a community determines price shifts on the secondary market. The level of attention this receives is a direct result of social media’s impact.

The price paid for NFTs
How valuable is an NFT? If buyers and sellers are determining digital object desirability in a decentralised and distributed online market, who can say exactly? Dramatic fluctuations occur as NFT markets are highly illiquid in nature, with sale prices proving to be volatile and irregular.

Price prediction models have been used for raw data value sets for cryptocurrencies, but the currency adopted to determine NFT-worth still remains in US dollars ($). To date, a price prediction model is not available for NFTs. The recent emergence of this market and relatively low number of transactions per NFT, accurate valuation is highly challenging. Despite community size advantages, NFT buyers and sellers are made up of only a small niche of collectors.

Despite this, NFT value is clearly determined by four factors:

  • Authentication
  • Collection
  • Ownership by collectors
  • NFT sale history and visual features

The combination of these are a reasonable indicator of price.

For many, NFT purchase is driven by the emotionally satisfying experience of community, but looking to the future an unwelcome challenge is rising.

Owing to the growing volume of transactions, networks can become overwhelmed, resulting in a sharp rise in congestion fees. As a result, by attempting to secure a rare NFT, the bidder is now often paying a premium to ensure their transaction is expedited.

High transaction fees are undermining the very principles of community. Instead, they create a financial derivative, or materialise as a type of gaming which prices certain community members out of transactions.

For buyers and sellers’ community is becoming an end in itself. For investors, community is simply the means of determining value, a principle that has been the foundation of the traditional art world for hundreds of years. While the technology is new, the same old principles apply.