NFTs or Non-Fungible Tokens is taking the digital world by storm. But what are NFTs exactly and why are they important?
Earlier this month the 101 Bored Apes NFT collection made headlines when it sold for over $24 million in an online sale at Sotheby’s auction house. The collection contains 101 cartoon images of apes, with an additional 6 that the winner can create using a special “serum”. But wait… What are NFTs exactly? In order to fully understand what NFTs (Non-Fungible Tokens) are, we have to delve a bit deeper into assets and what they are.
In order to fully understand the term Non-Fungible we will look at assets first.
An asset is something of value. Ownership of an asset is transferable from one person to another. An asset can be physical, digital, abstract or anything that helps you generate income. For example, it can be gold, bitcoin, expertise or even a computer or cellphone. There are a few variables that determine the value or price of an asset:
- How well they preserve value over time
- Efficient transferral of ownership
- Supply vs Demand
- The ability to generate income or produce cash flow over time
Currently NFTs are speculative in nature and therefore bears a high degree for risk. Whereas investing in Amazon stock, for example is relatively lower in risk. Liquidity describes how quickly and efficiently you can convert an asset to cash. It also describes the level of activity in the market. So, how frequently and how many people are buying and selling it determines liquidity. A house have low liquidity because it takes longer to convert it to cash. Whereas Bitcoin/Ether has a higher liquidity, because lots of people are trading it at a high frequency.
You can evenly swap a fungible asset with another of the same type. If I swap my $20 bill with your $20 bill, the value stays the same. We both will still have $20 each. The same goes for cryptocurrencies, like Ether and Bitcoin. One whole Bitcoin/Ether is no different from another whole Bitcoin/Ether. The value stays equal, which makes them fungible assets. Fungible assets also are divisible and shareable. I can take my $20 bill and exchange it for 20 x $1 bills and still have the same value. Or share it with 19 others and we will still collectively have $20.
Assets that are not interchangeable and not divisible are Non-Fungible Assets. This means that no one can make exact copies or replicas of the original asset. Real estate, land, houses, buildings, used cars all fall into this category. Multiple people therefore cannot share a non-fungible asset. Think about it, you cannot buy 20% of a car or half a house.
NFTs are non-fungible, because each one is unique. It cannot be swapped or exchanged with another NFT for the exact same value.
Stores of Value
What are stores of value? All assets are stores of value. The following factors determine the degree to which an asset is a good or bad store of value:
- Limited Supply
- Social Agreement
- Subjective Value
Assets with limited supplies, like gold, diamonds, Bitcoin and NFTs are better stores of value, than those with unlimited supplies. The unlimited supply of an asset decreases its value over time, like currencies. The more currency a government prints and circulates, the less it becomes worth over time.
An asset with a limited supply allows it to keep its value and may even increase over time. There is a real limit on the amount of gold or diamonds in the world. There also is a limited supply of gold/diamonds mined and available for actual use. In a sense this applies to NFTs as well. The supply of NFTs are programmed and limited. It is enforced by code and logged publically on a decentralized blockchain ledger. Making it almost impossible to destroy or alter.
Durability refers to the ability of an asset to retain its value over a period of time. This includes the ability to transport and exchange between buyers, sellers and inheritors. Diamonds are chemically stable and strong, making them physically durable. They are and always will be desirable as jewelry and useful in making tools like diamond tipped drills.
NFTs as a digital asset is extremely durable in terms of its ability to exist. Their existence on a decentralized blockchain ledger is transparent. The nature of the blockchain makes it hard to destroy. It also is making NFTs easy to transport and exchange between buyers, sellers and inheritors.
Social Agreement is simply when a substantial amount of people agree that something is valuable or has value. Diamonds and gold has formed a ton of of social agreement over time. Either because of the durability, beauty, usefulness or desirability thereof.
In modern times it is actually extremely difficult for social agreement to form around potential new assets, like NFTs. This is because it requires a lot of variables coming together at the right place and the right time. Things like laws, regulations, institutional and retail recognition and adoption to name but a few. It also requires trusted technological platforms, capable of maintaining a new potential asset.
As social agreement of Bitcoin formed and solidified over the last decade, it paved the way for new/upcoming digital assets. NFTs secured social agreement by forming strong expanding communities. These communities continues to expand and solidify, which in turn secures social agreement for NFTs. Another abstract factor to consider in some NFT communities are the subjective value of any given digital asset.
Subjective value is the idea that an item’s value is dependant on a person’s beliefs, perceptions or preferences. Which is why there are people willing to pay over $3 million for a Mike Trout baseball card.
@Topps 2009 Bowman Chrome Superfractor @MikeTrout graded @beckett_grading 9.5 sells for $3.93 million at goldin auctions “ goldin elite” tonight. Session 2 ends Sunday night at 10pm …highest priced ever for ANY trading card.. pic.twitter.com/axV4sXjMcC
— Goldin Auctions (@GoldinAuctions) August 23, 2020
And why others are willing to shell out over $6 million for a Honus Wagner baseball card.
— Boardroom (@boardroom) August 16, 2021
Many people would not even consider paying $5 for those cards, because it is not their “thing”. But clearly there is a market for it out there. There is a substantial group of people willing to buy, sell and invest in sports cards.
And if we look at the $24 million sale of the 101 Bored Apes NFT collection, it is clear that in the social agreement realm there are communities that place high subjective value on some NFTs.
But I can screenshot/copy a NFT for free, how is that durable?
Yes, that is true. It seems like insanity. Until you think about it. You can copy a NFT image as easily as I can obtain a printed copy of the Mona Lisa. But I do not own the REAL Mona Lisa now, do I? I cannot resell it as the real thing or even claim it to be real. I do not have ownership of the original artwork. And this applies to NFTs as well.
What most people don’t realize is the mere act of copying and sharing NFTs actually increases their value. So, when that naysayer brags about the copy of the Bored Ape he “saved for free”, he is unknowingly promoting social agreement of NFTs. He still doesn’t own the original NFT and cannot resell his copy. It is as much a “print” for him as my copy of the Mona Lisa is for me.
The durability of a NFT lies within a code that is embedded in the original. This code cannot be copied or edited. It refers to the block in which the image was minted on the blockchain and authenticates a NFT.
Why will NFTs become a powerful investment vehicle?
Once we understand and accept the current reality and the new global financial system we are operating in, everything will make a lot more sense.
The New Digital Generation
Let’s consider the new generation for a bit. Millennials are getting older and closer to inheriting one of the greatest wealth transfers in history. However, they are not interested in physical bars of gold or hanging the original Mona Lisa in their homes. They also are not interested in owning precious gems like diamonds. This generation, and in all probability all generations to follow, will and do live in the digital world. This is where the value of NFTs comes into play.
Currently, NFTs are static images, but eventually they will have other attributes. Like the ability to move or interact within virtual worlds. The digital value within gaming ecosystems have long been proven. Imagine the in-game assets or equipment you collected for years, are actually worth a lot of real-world money. A new potential to earn income from accumulating valuable/rare in-game assets is enticing to say the least. NFT technology is still new, but it will only be a matter of time before we see them in existing major gaming titles.
NFTs will continue to grow and become quality assets. Given the global asset shortage, NFTs are already an accepted, adopted and investable asset class. This is exciting because of the nature of the blockchain where NFTs ultimately are created, transferred and stored on. The creation of these assets are democratized. Which means that everyone has the ability to create durable, limited and verifiable digital assets. Digital assets that can easily be owned, stored, transferred, bought and sold on a global decentralized database.
Social agreement is arguably one the most important aspects of stores of value. Just have a look at the baseball cards again. So, yes, NFTs are mostly static images. For now. The value lies in the social agreement NFTs has managed to attain and harbor. Social agreement or value are created by the people behind them, through stories, provenance and lineage within communities. NFTs will continue to take the digital world by storm, bringing new quality, creative and interesting digital assets for people to invest in.