Are Cultural NFTs Tulip Mania?

Background: A Non-Fungible Token (“NFT”) is a technical framework enabling unique representations of value on blockchains. Largely powered by Ethereum, NFTs have given rise to new asset classes within culture and gaming. We define Cultural NFTs as tokenized brands, memes or social clubs, and Cultural NFTs represent the primary focus of this piece.

Introduction:

It would be easy to dismiss the performance of Cultural NFTs like CryptoPunks (“Punks”) as tulip mania.

After all, how can a blockchain hash pointing to one of 10,000 uniquely generated JPEGs have any value?

Some Punk owners would argue that their Cultural NFTs are priceless.

In fact, Punk #6046 Owner recently rejected an $9.5 million offer for his Punk. [1]

His rationale?

Regardless of whether this will prove to be a wise economic decision, it would be short sided not to explore it further.

In the metaverse, weirdness generates alpha.

Cultural NFT Backdrop:

Cultural NFTs are a natural development within the token economy.

Decentralized finance (“DeFi) represents the space’s first major application category, largely due to:

“finance [being] the area where centralization sucks the most.” [2]

As a general matter, decentralized innovation is best suited for services that the majority needs (e.g. finance), but only a select few benefit (e.g. J.P. Morgan shareholders).

This principle can easily be applied to the likes of Facebook, Twitter and TikTok, (“Social Networks”) as it relates to community management.

Social Networks monitor, police and capitalize on our online existences — it’s a feudal-like relationship.

Cultural NFTs represent an escape from these authoritarian-like players in terms of governance and value.

In addition to presenting a mechanism for individuals to organize based on their own rules, Cultural NFTs distribute the majority of value directly to community members rather than accruing it on corporate balance sheets.

Decentralized Value Creation

Like most token projects, Cultural NFTs are defined by their communities, which can generate value at an exponential pace due to decentralized ownership.

As a 10,000 unique character collection, Punks’ success starts with the Punk holders themselves.

Due to Cultural NFT holders’ economic agency, they are incentivized to make their community as valuable as possible, which translates to them helping with marketing, product development and community engagement.

In the case of Punks, Steph Curry, Visa, Alexis Ohanian and Punk Owner #6529 all contribute to this powerful value creation loop.

Separately, in what other environment can anyone with an Internet connection have verifiably shared economic agency and incentives with Snoop Dogg?

But at what cost?

With the floor prices on Punks exceeding $400,000, it’s no longer possible for the average crypto investor to join the Punk community. [3]

Fortunately, there are numerous projects that fractionalize Punk ownership, which while not necessarily carrying the same social benefits, provide the same financial upside as owning a whole Punk.

In fact, Cultural NFT communities such as Pandas Paradise acquire blue-chips like Punk to share value with their communities.

Of course, individuals who aren’t interested in Punks are freely available to join any other Cultural NFT project or start their own.

The Future of Work

Cultural NFTs offer a more equitable, flexible framework for the future of work — the token economy values labor more than capital.

The shared economic agency, potential upside and thrill of creating something new offered by Cultural NFTs carries similarities to start-up equity, but with several major differences.

1. There is a broader value distribution: Start-up equity ownership falls off drastically after the first few employees whereas all Cultural NFT holders (e.g. 10,000+) retain material economic agency.
2. There aren’t lock-up periods: Cultural NFTs are generally freely tradable without lock-up periods, and can’t be taken back by the community without your consent.
3. There’s significantly more labor flexibility: Work contributions are task driven without geographic restrictions, and it’s up to the individual how much they want to contribute.

Additionally, the function of paid recruiting is arguably no longer required as the inherent openness of Cultural NFTs make it easier to attract like-minded talent.

And perhaps most importantly, Cultural NFTs can more easily represent an individual’s identity and brand, often expressed by displaying their token on virtual forums.

What Makes a Good Cultural NFT?

Within the token economy, decentralized value creation and a future of the work template aren’t unique to Cultural NFTs.

What is unique to a Cultural NFT is its brand, and the social benefits of owning one, which can range from event access, physical memorabilia and the opportunity to invest in other projects.

As the number of Cultural NFT communities have exploded, ones with longstanding value tend to share five common characteristics.

1. A Unifying Belief: It can be fun, philosophical or impact-driven.
2. Core Contributors: A handful of individuals that actively manage the project and seek to enhance it over the long-term.
3. An Engaged Community: Non-active members who support active ones, discuss ideas and help onboard new potential members in forums like Discord.
4. NFT Utility: Outside of a cute profile picture, offering rewards or monetization opportunities.
5. Decentralized Ownership: Limited concentration of Cultural NFT ownership within a project and a low Cultural NFT to holder ratio.

Cultural NFTs in a Token Portfolio

Cultural NFTs arguably have a modest role in a balanced token portfolio as they can offer material outperformance and decorrelation from the broader market.

As of October 27, 2021, the 30-day moving average of CryptoPunk sales has increased to $473,077, representing an increase of 9,937% and 325,861% from January 1, 2021 and January 2018, respectively. [4]

Source: Non-Fungible and CoinGecko, October 2021.

For fans of modern portfolio theory, Punks’ price action has exhibited a significantly reduced correlation to bitcoin. [5]

Source: Non-Fungible, CoinGecko and Internal Analysis, October 2021.

To cite an example, we allocated 3.5% of our token portfolio to fractionalized CryptoPunks earlier this year, which grew to ~10.0% of our holdings, and while we have since taken profits to rebalance the Metaverse portion of our portfolio, we will seek to directly acquire a Punk in the future to participate in the community’s social benefits.

Cultural NFTs Risks

Not all Cultural NFTs are equal.

And while Punks are blue-chip Cultural NFTs, there are a few key risks to acknowledge, especially as new Cultural NFTs flood the market on a daily basis.

1. Not all Cultural NFTs within a collection are equal. Given each piece within a collection is unique, the market values each one differently. [3].
2. Holder Concentration: Even with a 10,000 collection like Punks, there are only 3,115 holders. [6] A few collectors that decide to simultaneously sell could materially impact the floor price of Punks.
3. Questionable Liquidity. This is not an apples-to-apples comparison given each Punk is unique, but the average daily price transacted for a Punk can vary wildly. On May 18, 2021 (an all-time high for the token economy) 8 Punks were transacted for an average price of $255k. On June 29 (a local bottom within the crypto market) 108 sales were made with an average price of $19k. [4]
4. Cultural NFTs could be a Fad. While a project like Punks has withstood the 2018/2019 crypto bear markets, they are still only four years old. The world’s largest brands have existed for decades, constantly reinventing themselves to stay relevant.

Technology aside, the above risks could easily be attributed to contemporary art, so Cultural NFTs collectors should see value in their purchases beyond the potential for financial gain.

Conclusion

In the next decade, some of the world’s largest brands will be Cultural NFTs.

In the way that there are a finite number of acclaimed artists or brands, the same principle will apply to Cultural NFTs.

This doesn’t suggest that there won’t or shouldn’t be millions of Cultural NFTs used for a myriad of purposes, but rather, that the majority of resources will flock to Cultural NFT blue-chips such as Punks — a trend already exhibited in the token economy. [7]

Aside from the value sharing and future of work elements, Cultural NFTs also help de-risk partnership decisions.

Since a Cultural NFT’s value isn’t driven by any one individual (and the fact that many NFT holders are anonymous outside of their Ethereum wallet identifiers), there is no obvious target in the event of controversy.

The potential for future value creation within a Cultural NFT universe is also vastly underestimated.

In the future, Cultural NFTs like Punks could easily expand to television, film, apparel, gaming and e-sports franchises, with certain Punks becoming modern day superheroes or role models

In terms of a price ceiling for any Cultural NFT, we’d look to LVMH’s $425.3 billion valuation, which would imply 90x+ upside based on Punks’ current $4.7 billion market capitalization. [8]

For us, we seek to primarily invest in the underlying Cultural NFT infrastructure, but at an attractive price, a modest allocation to a Blue-Chip Cultural NFT could help enhance risk-adjusted returns and contribute to our brand as an emerging fund.

Sources

[1] Andrew Hayward, October 2021, Decrypt. CryptoPunks Owner Turned Down $9.5 million.

[2] Vitalik Buterin, July 2021. Things That Matter Outside DeFi.

[3] Larva Labs, October 2021. CryptoPunks.

[4] Non-Fungible, October 2021. CryptoPunks.

[5] CoinGecko, October 2021. Bitcoin.

[6] Etherscan, October 2021. 0xb47e3cd837ddf8e4c57f05d70ab865de6e193bbb.

[7] Address Capital, September 2021. 32k ETH: 10x Risk-Adjusted Crypto Returns.

[8] Yahoo Finance, October 2021. LVMH.