What are NFTs and Why Do They Have Value?
An overview of NFTs for complete beginners.
What are NFTs?
NFTs stand for non-fungible tokens and are often referred to as digital assets. Fungible means that one unit can be interchanged with another. A $1 bill is fungible because all $1 bills are the same. Your car however is non fungible because your Ford Explorer is different than someone else’s.
NFTs live on a blockchain, most notably Ethereum and Solana. The most common type of NFT is digital art, and the biggest platform is OpenSea. Browse through the myriad of art on there and you’ll see why they named it such; it’s easy to get swept away in the current.
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Art isn’t the only use case of an NFT. There’s digital land, weapons in video games, and trading cards too. However, know that in pop culture when most people speak of NFTs, they are referring to digital art.
The first question I receive when I tell people I trade and invest in NFTs is, ‘why can’t I just save the photo?’ To which I tell them, ‘you can, but you don’t own it.’
We respect this boundary between an original and a reprint in the physical world, so why wouldn’t we do the same in the digital world too?
The original Mona Lisa is priceless, yet you can buy a copy on Amazon for $20. Heck, you can even take a photo with your phone and print it out for free. The reason the former has value is because it’s unique. There was only one Leonardo Da Vinci and he only painted one Mona Lisa. That painting encapsulates his work and talent in a medium called art that can far outlive its creator, and therefore its value is immense. The latter can be infinitely replicated by anyone from anywhere with zero talent nor cost, and therefore its worthless.
These same first principles exist in the digital realm of NFTs. An artist creates a unique digital work of art which can be bought, sold, and transferred on the open market. This is not the same as being able to right click and save a photo and then using it as your desktop background. Just like in the physical world, one person owns it, anyone can use it.
Why NFTs Have Value
NFTs and digital art have value for the same reasons physical art have value, because one can verify ownership and store their wealth in a scarce asset which they hope will appreciate over time.
A bet on art, whether digital or physical, is essentially a stake in the artist who produced it. If the artist does well, so too will the value of your art. One can say then that purchasing art is essentially a trade: the investor gives the artist capital to survive, and the artist does the work to grow the wealth of the investor. Depending on one’s motive for purchasing, there’s also the intrinsic value to the art, which is the ability to enjoy it.
I personally believe that the intrinsic value of art is far less than most will lead you to believe. The reason is simple. One can derive the same enjoyment from a copy as they can from an original. Since the copy is free, the intrinsic value is only but a small component of the true arts worth. Put another way, one pays for an original piece not because it has superior intrinsic value, but because it’s a better financial investment. This is true of both physical and digital art.
Properties of Art
For art to maintain its value it needs to satisfy a few characteristics. First, ownership must be verifiable. You may have heard about the many scams in the art world, where savvy hustlers’ fake originals for profit. Verifying an original piece is very difficult with physical art, and in the high-end niche, large sums are paid to third parties for authentication to ensure a piece is genuine before it’s bought and sold. This acts as a rake of sorts, just like the house taking money out of every hand at the poker table.
Due to large cost and sunk time involved, this service is simply not feasible or economical for 99% of art trades. This creates a risk for investors and an inefficiency in the market.
Digital art improves upon this as ownership is verified on the blockchain for anyone to see. You can literally see the entire transaction history on OpenSea on every piece of art and be 100% certain that the piece you are purchasing is in fact an original.
Art is a Flex
The second required property of art is that it can be used to convey social status. One derives value in owning an original Picasso because they can show it off to their friends and family.
Here’s where digital art really shines. A celebrity can flex their profile picture (PFP) NFT to millions of people, a process that scales exponentially. Yet even if they own a Picasso, perhaps only a hundred people will ever see it hanging on their wall.
Since ownership is verifiable on the blockchain, one can prove to anyone that their NFT is real. This truth is much harder to verify with other collectibles, such as physical art, jewelry or handbags.
Reese Witherspoon spent 2 ETH ($8,000) on a World of Women NFT that she now uses as her profile picture on Twitter, flexing this to nearly 3M followers.
Another advantage of digital art is that it’s a soft, tasteful flex. Since it’s so new and novel, people perceive you as modern and trendy instead of obnoxious and superficial, as in the case of people posting lambo photos on Instagram.
Flexing digital art is far superior for the investor. In the case of Reese, the floor price of WoW was 1.85. After her Tweet, it immediately jumped to 2.25, an increase of 18%. People have far more incentive to share their digital art than their physical art, since global liquid markets give rise to opportunity.
Art Must be Transferrable
The third property of art is that it must be transferrable. If one wants to sell their Picasso, there needs to be an easy way to recapture their investment. Again, the digital world improves upon the limitations of the physical world.
If Reese gets tired of her World of Women and wants to upgrade to a Bored Ape, she can simply go on OpenSea, click ‘Sell’ and, if it’s priced fairly, the piece will sell in a matter of hours. She can then use that liquidity to buy another piece of her choosing.
These sales are all done using cryptocurrency, so presumably one can be anonymous while transacting and not have to leave the comfort of their own home. Compare that to the countless hours it takes to find a trustworthy reseller and buyer of high-end physical art, and one can see why NFTs are poised to explode.
Conclusion
Digital art is superior to physical art in nearly every way. It’s more easily verifiable, can reach more people as a flex and can be transferred in a matter of minutes, allowing investors to rest assured that there’s sufficient liquidity for their piece.
Although I have expressed concern that NFTs may be in a temporary bubble, like crypto was in early 2018, the underlying trend is here to stay.
With major companies like Coinbase due to launch a marketplace for NFTs to their 60 million users to Twitter allowing for NFT verification as one’s profile picture, digital art and collectibles are going to explode this decade.
In future articles, I’ll write about my favorite NFT projects, the bets I’m making, and how to get exposure to this growing asset class.
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Thanks for your attention.
Alec
P.S. What questions do you have for me?