NFTs & the Blockchain
Short-lived Hype, or a Revolution for the Art Market?
On March 11, 2021, the first non-fungible token, or NFT, to be sold at a major auction (Christie’s) closed at a total of $69 million. Within a few months, there were more NFTs on the market compared than people available to purchase them.
NFTs are becoming incredibly mainstream among blockchain enthusiasts, as celebrities and social media personalities promote various pieces. With so much speculative volatility in the NFT market, it is hard not to question whether it will ultimately reach equilibrium. This begs the question: Will this new wave of digital art has a lasting impact on the market for visual art?
What is an NFT?
The word non-fungible in NFT means that a certain object cannot be directly exchanged for another object or substituted. Conversely, fungible items, such as the Canadian Dollar, can be exchanged for another item. To illustrate, if you were to borrow a ten-dollar bank note from a friend and returned two five-dollar banknotes, your friend would still have the same monetary value.
NFTs represent ownership of a unique item on a secure distributed web-based database called a blockchain. The blockchain certifies a person’s ownership of an NFT where the digital asset has its own unique token name and symbol. Purchases of NFTs are usually processed with decentralized Ethereum instead of centralized fiat currency. The word decentralized means that there is no central intermediary, such as a commercial bank, investment bank, mutual fund, or pension fund. Rather, the blockchain relies on the computing power of millions of users to validate and verify the legitimacy of the transactions that the system processes. In effect, the blockchain allows for trustless transactions, where the need for a financial intermediary is bypassed by an algorithm.
The Inherent Value of NFTs
The perception of value is highly subjective, and its definition is often difficult to articulate. However, the diamond-water paradox provides a good starting point in defining value in the context of financial assets. Subjectively, diamonds are more expensive than water because people perceive diamonds as luxurious. However, it cannot explain why a diamond should be valued more than water, which is essential to survival.
With art, and most other markets, supply drives demand—but all value is lost if the blockchain disappears into oblivion. This will continue to be a permanent risk when purchasing anything virtual as websites can shut down, online wallets can be hacked, and passwords can be stolen.
With his concurrent success in his sales and his passion for boxing, Logan Paul took it one step further by collaborating with Blockfolio – a website that provides services to buy and sell cryptocurrency – during his show match against Floyd Mayweather. A $100,000 USD sweepstake was held for all viewers who scanned a QR code and entered; unfortunately, the website crashed due to an overload of traffic as fans swarmed for a chance to win the rare token.
This is just one instance of celebrities promoting NFTs and is indicative of how the technology could be used to enhance the fan/content creator relationship.
Problems with NFTs
The biggest question that most people ask when first hearing about NFTs is, “is it not possible to screenshot the NFT and store it on a local device?” Despite there being some truth to that, factors such as copyright and ownership must be considered. The best comparison is to music: If an artist releases a song and you download the song to your phone or music streaming service, you do in fact, have a copy of the song; however, you do not own the rights to it. This is precisely how NFT technology works. Nonetheless, many are still hesitant to speculate or invest in NFTs as they are still a novel concept, with no physical copy of the artwork as society has come to expect.
Since the first notable discovery of an artistic image over 45,000 years ago, art has remained as a physical medium rather than coloured pixels on a display. It is a complex concept to grasp, and this may turn potential investors away from purchasing NFTs altogether.
Similarly, what makes an NFT special is that it will only be one of one. Even if a user on the blockchain purchases an NFT, virtual verification will be the only confirmation of ownership.
Although these issues may seem alarming, the biggest problem is that price is driven by demand. With hundreds or even thousands of NFTs flooding the market today, fear, uncertainty, and doubt (FUD) can cause severe issues, making it difficult to assess the true long-term value of an NFT. Combined with thin trading liquidity in most NFTs, this could result in poor purchase decisions and a loss in a person’s investment in digital art.
Hype and the Fear of Missing Out
Human psychology has an influence on the price of NFTs. Perhaps humans are hard-wired to desire in-demand products. When we turn to Maslow’s hierarchy of needs, we can see that NFTs reside in self-actualization. Once the human body decides that its basic and psychological needs are satiated, it craves self-fulfillment—this is where a person’s wants arise. Exhibit 1 precisely depicts how the fear of missing out can have a drastic effect on the human mind, with the largest spike taking place the day the $69 million NFT was sold. Everyone who wanted an NFT created a wallet; however, as time progressed and the hype surrounding NFTs costing millions of dollars subsided, the market followed the downwards trend. Similarly, the number of people with such a large enough sum to make a purchase is limited, resulting in significantly more active wallets than real buyers. The current NFT market trend is heavily based on hype, and it will definitely take time to approach true price discovery.
Exhibit 1: NFT Market Activity (Source: nonfungibles.com)
Should you buy an NFT?
The simple truth is, that the current NFT market is driven by hype and perceived scarcity. With newer and more eye-catching NFTs coming out every day, it will be challenging to keep the public’s attention on one specific item that may quickly lose relevance. NFTs are still a very novel concept, and there will continue to be breaking news highlighting sales of NFT art for exorbitant price tags. In "The Future of NFTs May Not Be Fine Art” reporter James Tarmy states, “[a] Picasso is just oil paint on canvas. It’s worth noting, it does nothing. It is valuable because we as a society have decided it has value.”
Overall, the current trend suggests that NFTs will not live up to traditional practices of purchasing physical artwork in terms of its overall impact and scale; however, they may have other use cases that investors and digital content creators have yet to imagine.