NFTs, Bitcoin, and the Foundation of Value
Why NFTs may not disrupt art the way bitcoin is doing with money
In November 2017, “Salvator Mundi”, a depiction of Jesus Christ presumed to be painted by Leonardo da Vinci, became the most expensive painting ever sold, selling at auction for over $450 million. What justified this price tag? It’s hard to say exactly. Until very recently, there wasn’t even a consensus that the painting was authentic or even actually painted by the famous Renaissance man but rather more likely to be by a student (The Invention of the ‘Salvaltor Mundi’). As recently as 2005, the painting had been sold at auction in New Orleans for a mere one thousand dollars. Just over a decade later and that price has pumped up to nearly half a billion.
The growth in popularity of Non-Fungible Tokens (NFTs) in 2021 offers up similar questions around value and collectibles. With a total market cap in the tens of billions of dollars and a record-breaking sale of an NFT by digital artist Beeple for $69.3, it’s clear NFTs have value because people are spending money on them. While the current discourse around NFTs is quick to embrace them as poised to disrupt art and collectibles in the same way bitcoin has money, what’s not as clear is if the assumed value propositions, particularly is they relate to NFTs as art, hold up to close scrutiny. Given how much money is being spent in the sector, it is both helpful and responsible to try and understand how such things can and are valued at all.
What gives an asset value is one of the central questions of economics. It has become of particular interest since the inception of bitcoin, which defied all precedents by seemingly creating value out of thin air. Each bull cycle since bitcoin’s first exchange rate has been accompanied by some other fad in the cryptocurrency space. First the copycats (Litecoin, Dogecoin), then the “next generations” (Ethereum, Monero, Stellar), then ICOs (Dentacoin anyone?), and most recently Non-Fungible Tokens (NFTs) and Decentralized Finance (DeFi). With each cycle, billions and then trillions of dollars in value have been generated, again seemingly out of thin air.
It can be easy for these narratives to get intertwined and confused. If bitcoin forks or is duplicated, does that violate the scarcity principle that supporters say contribute to its value? If money doesn’t need to start off as something tangible like gold or backed by a central organization, then can art similarly be valuable if it’s not tangible? If non-fungibility is what makes art valuable (who doesn’t want to own something that’s “one-of-a-kind”?), then can the same be applied in the digital realm? It all comes back to what gives a good value and how it is priced.
Without having a rational and consistent basis for value, then valuations are little more than speculative bubbles. It has become axiomatic that bitcoin has value and can act as a store value because of its historic performance and the nature of its network. But bitcoin’s primary use case is as money. Understanding why this is can be informative beyond just bitcoin and money.
The Value Function of Collectibles
In order to bring a more concrete picture of how to think about this problem, it will be useful to devise a framework, a value function, to describe the characteristics that people tend to, consciously or unconsciously, apply when ascribing value to collectibles. In this way we can attempt to more deliberately describe the information that is or, more importantly, will be contained in the price.
For the purposes of this post, I am proposing that the value of a collectible can be summarized as a function of the following characteristics, most of which are either an increasing or decreasing function of time:
Intrinsic Value (relatively stable over time)
Scarcity (Non-fungibility) +
Novelty (decreasing function of time, increasing function of scarcity) +
Cost of Preservation (PoW, increasing over time) +
Utility (relatively stable over time) +
Store of Value (function of time in either direction)The remainder of this post will be spent going through each of these characteristics in turn and how they relate to NFTs.
The Intrinsic Value of a Collectible
When many gold bugs make the argument for gold as money (and against bitcoin), they talk about the metal’s “intrinsic value”. The thinking goes that gold is valuable as money because it is valuable on its own for non-monetary purposes (e.g. jewelry and in electronics). Applying this to collectibles such as artwork is instructive in the broader context of cryptocurrency and the characteristics of money, but it can also inform our understanding of the NFT market.
It should be obvious that what makes a piece of art valuable is more than just the “intrinsic value” of its materials, which actually depreciate over time. Its aesthetic value, however, could be described as intrinsic to the artwork, such as the value to its owner of hanging it on their wall. So, the $450m da Vinci must be hanging in a museum somewhere right? Or as part of a private collection in someone’s home? While it was planned to be put on display at the Louvre, no one other than the owner actually knows (or has admitted to knowing) where the da Vinci painting ended up after being sold. The best guess as to its most likely location is it is hidden from the world in a dark, climate-controlled storage container at one of any number of “freeports”, international, tax-free zones that exist in airports and ports in places like Singapore, Cyprus, and Geneva (one of the major action sequences in the Christopher Nolan movie Tenet takes place in a freeport art collection).
Regardless of whether or not the half-billion dollar Salvator Mundi is stored in a freeport, much of the world’s most valuable art is, which seems to indicate that the value is not at least solely in the intrinsic, material or aesthetic, even if it once started off that way. It’s impossible to measure how much art is stored in these hidden, private storage units but it is almost certainly in the many billions of dollars. In 2016, The New York Times described some of the pieces that have been found in free ports:
[R]are Etruscan sarcophagi discovered in Geneva by the Italian police two years ago, found among 45 crates of looted antiquities[…] $28 million worth of works by Andy Warhol, Jeff Koons, Joan Miró and others now stored in the Geneva Free Port[,… a]nd the $2 billion collection of the Russian billionaire Dmitry M. Rybolovlev.
This trend seems rather to point to art and collectibles being valued in part for their aesthetic value but perhaps in greater degree as long term stores of value, especially given the tax implications (or lack there of) of freeports.
The Subjective Theory of Value
It should go without saying that digital currencies have no tangible intrinsic value, but despite having a visual, and thus arguably tangible, component, the same could also be said of digital art. Art enthusiasts may not value an aesthetically pleasing piece of art on their computer screens in the same way they do on their wall. This then leaves open questions about their longterm capacity for artist empowerment, as is often promised, and further erodes the argument for the ability of an NFT to preserve long term value in the same way.
Can a digital collectible like a Beeple NFT be a store of value like a da Vinci or a Monet?
Despite the above questions, it is nonetheless indisputable that NFTs are valued by a relatively large number of people with large amounts of capital they are willing to spend on them. There are prices associated with collectibles whether they be physical art, a rare baseball card, or a digital, non-fungible token like a Beeple, a tulip, or a digital rock, and prices are the way that markets signal value.
Specifically, according the Austrian School of Economics, they signal “subjective value”. As first described by Mises in “Human Action: A Treatise on Economics”: “It is ultimately always the subjective value judgments of individuals that determine the formation of prices.” Or, presented in more detail by Carl Menger in Principles of Economics:
Value is therefore nothing inherent in goods, no property of them, but merely the importance that we first attribute to the satisfaction of our needs, that is, to our lives and well-being, and in consequence carry over to economic goods as the exclusive causes of the satisfaction of our needs.
So, if a good doesn’t have to have value “inherent” to it in order to be valued, but rather satisfies some subjective need, i.e. the “value does not exist outside the consciousness of men” (Menger, attribution), then subjective measures can be applied to collectibles in a similar fashion. But, if the characteristics used for the valuation of physical collectibles cannot be transferred to digital ones, perhaps this signals a misvaluation if not an overvaluation.
The Value of a Scarce Collectible
Intrinsic Value (relatively stable over time)
Scarcity (Non-fungibility) +
Novelty (decreasing function of time, increasing function of scarcity) +
Cost of Preservation (PoW, increasing over time) +
Utility (relatively stable over time) +
Store of Value (function of time in either direction)Next let’s talk about one of the most important parameters and the one often touted as the innovation of NFTs: scarcity.
The heart of the argument for digital collectibles, NFTs, rests primarily in their uniqueness: they are valuable because they are non-fungible, a characteristic that is cryptographically enforced by the blockchain. Put crudely, an original Leonardo da Vinci is valuable because it is non-duplicatable and “rivalrous”. It is unique and therefore if you happen to own one, it means you are the only person who owns one, scarcity that translates to a certain amount of speculative value. This makes some logical sense, since a near perfect recreation of a Picasso, recognized as such by only trained professionals would still only sell for a tiny fraction of an original that sells for $179.4 million despite it being able to serve many of the same purposes, such as an accent in a well decorated hallway, with no perceptible difference. There is still only one original Picasso.
On the other hand, there’s plenty of unique art that has been created in human history and new art created every day that is barely worth the canvas it’s painted on. In fact, most artists will choose to sell prints (i.e. copies) of their original pieces rather than focusing on originals because they can earn more with a fungibility strategy.
This method of measuring value becomes even murkier in the digital realm. Original physical art is inherently rivalrous meaning that my owning a piece of physical art necessarily makes it such that no other user or consumer can also own that art. Further, while art technically is non-excludable, in that multiple people, not just the owner, can derive enjoyment from the art by, for example, it being loaned or donated to a museum, this really is left up to the discretion of the owner. We see this in the example of the Salvator Munti above which was originally expected to be put on display in a museum. As long as it remains in storage (or on a private yacht for that matter), no one else is able to derive utility from the good, due to its non-fungibility in the physical realm. But how can this be true of digital art, which can be copied and distributed without limits?
A story of two auctions
The New York auction house Christie’s has been responsible for two of the biggest auctions in the art world in recent memory: the biggest physical art sale ever of Leonardo da Vinci’s Salvator Mundi for $460m and the biggest digital art sale ever, Beeple’s EVERDAYS: THE FIRST 5000 DAYS for $69.3m. In light of this idea of non-exclusivity, comparing Christie’s auction pages for these two pieces of art is instructive.
One thing that sticks out immediately besides the technical language on the Beeple listing is the need to explicitly describe the digital piece of art as unique (emphasis added).
Minted on 16 February 2021. This work is unique.
Of course there is no need to attest to the da Vinci’s uniqueness. It is inherent to the piece of art itself and so those bidding on the piece can safely assume they are getting the original. Even if several had been painted, it would’ve been physically impossible for there to be more than one first, or for the artist to have even produced more than one at the same time. In fact, Salvator Mundi is believed to be one of da Vinci’s most copied works, with “dozens of replicas hang[ing] in museums around the world” (source), i.e. we know it’s not unique, but that’s not what the bidders care about; they care that it is the original, which is not the case for digital art.
Further examining the listings we can look at what was actually bought. The da Vinci’s physical details are described (“oil on panel”, “25 7/8 x 18 in.”, etc.). While we know that this oil painting on a 25 7/8 x 18 in. panel was bought, only a handful (if that) of people on the planet know where it is or even if it is still in existence. All we have is essentially a receipt of purchase. While the holder of this receipt can prove in a court of law that they are the legitimate owner of the art, it does not guarantee possession. Said another way, proof of purchase does not guarantee you have the item you are proving you purchased (which is how you end up with stolen art).
Thanks to the magic of the blockchain, we can track down the authenticity of the Beeple. We know from Christie’s that it was minted as token id #40913 via a smart contract deployed at address 0x2a46f2ffd99e19a89476e2f62270e0a35bbf0756 on the Ethereum blockchain. Inspecting this address on Etherscan.io and querying the tokenURI for this particular tokenId we get the following result:
ipfs://ipfs/QmPAg1mjxcEQPPtqsLoEcauVedaeMH81WXDPvPx3VC5zUz(note that this URI is incorrectly formatted, with an extra ipfs/. We'll come back to that in a bit)
Querying the (correct) URI from a browser that can access the IPFS network (like Brave) we get a JSON with the following data:
In this, we see much of the same information available on the Christie’s listing (nice for verifiability), but we also see a property for raw_media_file which contains yet another web url that brings anyone that navigates to it to the full resolution, 21069x21069 pixel digital image as described on the auction site.
There is an obvious convenience attached to an auction “run on the blockchain” compared to the da Vinci. The Ethereum contract gives a nice, convenient record of purchase and ownership whereas with the physical art, the purchase is just the first step in a long line of attaining proof of ownership, independent verification, storage and transportation. On the other hand, we can see a clear difference here in how the Salvatore Mundi has effectively been made an excludable good in that all anyone other than the owner can enjoy of it is its digital representation and proof of purchase from Christie’s. The Beeple, however, is non-excludable, and, since anyone can access it, all that was actually sold seems to be merely a proof of purchase, i.e. the receipt.
Adding insult to injury, legitimate purchase of that receipt does not even guarantee authenticity of the underlying artwork being purchased, which still needs to be left up to trusted third parties. This effectively makes NFTs a more efficient system by which to exploit the artists many proponents say it will help:
Complicating things even more is that the proof of purchase sold for the Beeple NFT actually leads to a broken URI. So what do they own? The claim is that NFTs bring the objectivity of ownership from the physical world to the digital one, in the same way that bitcoin did for money. But if we took this idea to its logical conclusion, then the owner of the Beeple objectively owns a broken URI. It is only because we presume that the seller meant to transfer ownership of the valid URI that we subjectively attribute ownership of the art presumably sold. This implies that while ownership likely would hold up in a court of law, it does not seem to hold in the objective court of “the blockchain”, which defeats the purpose entirely.
Novelty and The Regression Theorem
Intrinsic Value (relatively stable over time) +
Scarcity (Non-fungibility) +
Novelty (decreasing function of time, increasing function of scarcity) +
Cost of Preservation (PoW) +
Utility (relatively stable over time) +
Store of Value (function of time in either direction)The Regression Theorem is another of the pillars in the Austrian School of Economics first described by Mises in his 1912 book, The Theory of Money and Credit. Briefly the theory states that any good used as money can trace its value back to a point in time where it was not used as a medium of exchange but had some non-monetary use.
If in this way we continually go farther and farther back we must eventually arrive at a point where we no longer find any component in the objective exchange-value of money that arises from valuations based on the function of money as a common medium of exchange; where the value of money is nothing other than the value of an object that is useful in some other way than as money
(Theory of Money and Credit, Reference from Mises’s Regression Theorem, Bitcoin, and Subjective Value Theory)
The creation and subsequent success of bitcoin, which has been used as both a store of value (SoV) and a medium of exchange (MoE) for years, including now even by nation states, has brought this theorem into question. A common criticism of bitcoin is that it cannot act as a MoE since its value can’t be traced back to a “direct-use value”. And yet it has been used as such so either Mises was wrong or we’re all living in a collective delusion and the price is going to zero.
There are several theories that make good efforts to square this seeming contradiction, but we won’t spend much time on them here. However, it bears mentioning that bitcoin the currency did have a direct-use value prior to being money or a medium of exchange with an exchange rate, and that was as a points system awarded to nodes that win the Proof of Work competition at the heart of bitcoin’s security model. It was only after this points system was established, that bitcoin was later adopted as a medium of exchange and developed an exchange rate.
Konrad Graf posits that bitcoin’s original direct-use value was as a social signaling mechanism (emphasis added):
In other words, mere possession, knowledge, and use can carry social membership signaling functions in various sub-cultures, much as wearing certain styles of clothing does. These are also direct-consumption values to those concerned with such signaling. Direct-use values, whether psychological or sociological, do not have to be recognized by anyone other than those in a given sub-culture actually doing the valuing (according to methodological individualism and subjective value).
So, bitcoin were first desired not in exchange for goods and services or to store value but rather as literally a token to show you were part of a specific clique, i.e. it was a novelty. Further, “[g]oods do not have to be tangible to inspire the relevant types of human action; they only have to be scarce”.
This may overstate the case for bitcoin, as there were plenty of other ways to signal to cypherpunk programmers that you were part of the in-group (code and mailing list contributions for a start) and the actual possession of bitcoin, especially in the early days was fairly obscured. Consider for example that we don’t even know for sure which early bitcoins were mined by Satoshi Nakamoto or some other entity (see Sergio Demian Lerner’s 2013 essay researching the movement of early mined coins).
NFTs on the other hand are perfectly crafted for social signaling since they are primarily used as a stand-in for explicitly consumable media, usually digital images. This becomes obvious after just a simple Twitter search for the term “NFT” and noting all of the CryptoPunk and BoredApe avatars that show up in the top results. There is no way (at least for now) to directly, cryptographically prove ownership by the Twitter user of the image; it is enough to simply have the avatar to show that you’re part of the tribe.
The fact that you can also publicly put on display how much disposable income you had to spend on it has its appeal and novelty too. This is what’s known as a Veblen Good: a good where demand counterintuitively can increase with the price usually because it is “desirable as a status symbol in the practices of conspicuous consumption and conspicuous leisure. A product may be a Veblen good because it is a positional good, something few others can own” (Wikipedia).
This whole idea is somewhat reminiscent of what might be, if not the first certainly the most blatant digital Veblen good: the iOS app called “I am rich” which sold for $1k on the app store.
The red icon on your iPhone or iPod touch always reminds you (and others when you show it to them) that you were able to afford this.
It’s a work of art with no hidden function at all.
So, literally, a piece of art to show people you’re rich enough to spend a thousand dollars on it.
Novelty x Time x Scarcity
As noted in the formulation of the value function, time and scarcity play a role in novelty’s contribution to it. The novelty can wear off as a once novel good exists in the marketplace long enough and more competitors and alternatives come online, watering down the market. Scarcity does increase the novelty, particularly earlier in the adoption cycle. It is worth noting though that part of the novelty comes, not from the specific type of NFT (whether it is a CryptoPunk, CryptoCoven, BoredApe, Pudgy Penguin, or Rowdy Roo) but rather, if we take the novelty as being a signal of being “in the know” of what’s new in crypto, it’s just being an NFT at all. That is to say that the novelty across all NFTs including those not yet minted decreases over time and thus each new NFT, despite being superficially unique and non-fungible, dilutes the value of individual NFTs across the market, and certainly for each new one minted.
Novelty + Time = Nostalgia
One form of novelty that deserves honorable mention and is positively impacted by the passage of time is nostalgia. Nostalgia can provide a price floor of sorts when market participants develop an emotional tie to the collectibles. Maybe a piece of art has been in your family for generations or perhaps you have a personal connection with a baseball card because of childhood memories of seeing your team win the World Series. In either case, such a bond increases the novelty and the power of that novelty increases with the passage of time which in turn can increase the subjective value of that good. It is not clear that it is impossible for NFTs to have such a characteristic, but we can only know for sure as more time passes.
Cost of Preservation
Intrinsic Value (relatively stable over time) +
Scarcity (Non-fungibility) +
Novelty (decreasing function of time, increasing function of scarcity) +
Cost of Preservation (PoW, increases over time) +
Utility (relatively stable over time) +
Store of Value (function of time in either direction)This is one of the areas where physical and digital commodities most diverge in my opinion and is the most novel and least explored area on this subject.
Let’s consider a Michael Jordan 1986–87 Fleer rookie card (one of which just recently sold for $150k). These are useful for comparison since there are now sports based NFTs like Top Shots. When the Jordan rookie cards were first made available, they were obviously limited since there were only so many that could or would be printed during Michael Jordan’s first year in the NBA. This would be the same (and provable) for an NFT of Zion Williamson.
Something else happens however, to make that Michael Jordan card more valuable. Let’s say only 100 were ever printed and Alice, Bob, and Carol each happened to buy packs of cards that included one in 1986.
Let’s say that Carol’s house has some flooding in 1990, four years later, and the box containing her card gets water damage. This effectively reduces the total supply of the card by 1%.
Bob thought Jordan was overrated (he was only drafted #3 after all) and wouldn’t be able to compete with the likes of Magic Johnson or Larry Bird. So Bob never thought much of the card, throwing it in a drawer where it got worn down and ripped. Another reduction in supply of 1%.
Alice, on the other hand, has been watching Jordan’s career through college and knows there’s something special there. She buys a case for the card. When she has to move, she makes sure to keep close track of it, always keeping it nearby. After Jordan’s first championship, she invests in a dehumidifier to keep it in mint condition so she can pass it on to her children.
What’s notable here is that what’s adding to the value of Alice’s investment is not just the novelty (Jordan becoming the G.O.A.T.) or the scarcity, but she also is literally investing her own time and resources into first establishing (seeing Jordan’s potential) and then maintaining its value, forgoing the opportunity cost of spending those resources elsewhere. This is a process reminiscent of bitcoin’s Proof of Work where miners consume (and produce) electricity that could otherwise be used to produce widgets to secure the bitcoin blockchain instead and consequently be compensated for it in bitcoin. What guarantees bitcoin’s value in the long term is the foregone opportunity cost used to secure it.
[I]n the digital realm there is no equivalent of expending resources to preserve the item with increased resources necessary for greater chance of preservation
While it is true that with an NFT you will have item loss (custodian or wallet hacks, forgotten passwords, etc) that would contribute to a reduced overall supply, in the digital realm there is no equivalent of expending resources to preserve the item with increased resources necessary for greater chance of preservation. One of the great innovations of bitcoin is that the means to secure billions of dollars worth of the digital currency is open source, effectively commoditized, such that it is as affordable and accessible for someone to secure $10 worth as it is $1,000,000,000 worth. In contrast, a single storage unit used for preserving one piece of art cannot be used to preserve any others, and the more you want to preserve your item from risk, the more resources you have to invest in protecting it.
This factor becomes even more stark when considering Leonardo da Vinci’s Salvator Mundi. Alexander Parish, who was the speculator that bought the painting for $1k in 2005 describes bidding at auctions as being like gambling: “You get a good feeling about a piece of art, and you place a bet that you know more about it than the auctioneer does.” This isn’t just betting on the future speculative value of the painting though. The painting was only as cheap as it was because it was assumed to be a replica da Vinci (and a bad one at that) rather than the genuine original. So, first resources were expended in making a bet on a poorly preserved replica, good for little else than the aesthetic utility in improving the painting. It was then a ten year investment in time and money that went into restoring and studying the piece. Had it turned out to be just another replica, or painted by a student of da Vinci’s, as many at first believed, those resources would have been no more recoverable.
And this is to say nothing of what it takes to preserve the painting for over 5 centuries. Some believe that the art that humanity has lost to the slow erosion of time is the equivalent of “more masterpieces than all of the world’s museums combined.” Sometimes they’re destroyed by accident and sometimes the art can be lost to natural or manmade disasters, such as the estimated $100m worth of art lost in the 9/11 attacks. In contrast, you can secure your digital art with cryptographic backups at no marginal cost, with geographic distribution and reusing the same security setup across any and all digital assets. Compare that to to what it would take to protect a piece of art from something like a terrorist attack, and there really is no functional equivalent in investment in resources, an advantage for digital money like bitcoin. Freeports represent an example of this type of investment, providing not just a tax shelter but also a place where “property is protected in climate-controlled environments, often under video surveillance and behind fire-resistant walls.” If you thought rent in San Francisco was high, imagine a Geneva freeport.
These costs are foundational to the long term value of a collectible, whether a playing card, a basketball sneaker, or a priceless painting. They represent forgone enjoyment on where those resources could have otherwise been spent. These costs are also a bet. Investing now to protect, preserve, or evaluate a collectible is a gamble that the piece will provide a greater return in the future, though that return is far from guaranteed. But because the market as a whole is investing in these costs, they in turn provide valuable price signals about the long term viability of these assets beyond just speculation.
Utility
Scarcity (Non-fungibility) +
Novelty (decreasing function of time, increasing function of scarcity) +
Cost of Preservation (PoW, increases over time) +
Utility (relatively stable over time)
Store of Value (function of time in either direction)There are two ways in which utility can manifest in computing the value function: intrinsic and network. Intrinsic value has already been covered. In art, it’s the aesthetic benefit (which you can effectively achieve with a good forgery). Of course there are many cases where an object may demonstrate both intrinsic and network value, as demonstrated by the ever growing sneakerhead community, where we can find a pair of shoes selling for $16k but not just for its use in a game of pickup basketball.
The value of network utility has a bit more promise when trying account for the value of a digital illustration being minted as a non-fungible token. Consider for a start that this is how money works. The bitcoin that I own has more value because there are other people willing to accept it in exchange for goods and services. For NFTs, aside from their network utility as a social signaler, they may also offer particular usefulness when applied within the rules of a given network, most notably as a tool or character in a game. In the physical realm we have Pokémon and Magic the Gathering (MTG) as examples. A MTG card like the infamous Black Lotus gets value not just from its relative scarcity like a sports card but also the popularity of the game and even how lucrative it can be playing it (there are MTG tournaments with $1m+ prize pools). This means that having a powerful card can translate into better performance in the game, i.e. utility.
There’s no reason why the above can’t effectively be translated to the digital realm (and in fact is in many cases even without blockchains). Provably scarce digital items that impart their owner with unique abilities in a game will be viewed as valuable by other players of the game (see Subjective Theory of Value section above). The stronger the network effects of the game the more valuable those items become to existing players. Furthermore, there is something of a flywheel effect here where the game items becoming more valuable can bring more people to the game and improve the game itself, which in turn makes the game items more valuable.
However, of note in the above is that this type of value is completely reliant on the centralized focus of the game itself. Most, if not all, of the most successful video games operate at very large scales with big teams across creative, technical, sales, and marketing and big, expensive server and network infrastructure supporting game play. This centralization, which clearly provides value, then begs the question: does this need to be on a blockchain at all? The ability to trade and sell digital, supply-constrained items can be done via a centralized server, just as the printers of MTG cards can enforce a limited supply of Black Lotuses (or conversely increase the supply to improve game mechanics). The application itself is inherently centralizing, while none of the characteristics of a utility NFT require it to be decentralized to get the value.
An argument could be made that being able to trade outside of the game ecosystem adds value, but I believe this to be mostly superficial. It’s often claimed that because the game items are fully open, anyone can take over maintenance of the game or create a competing game on top of the same items. But why would anyone do this? The primary motivation for issuing (and selling) NFTs for a game is as a fundraising mechanism to bootstrap a game and a community. Building a game on top of an existing NFT ecosystem means you incur all of the cost of game maintenance without many of the monetary benefits.
This ability to bootstrap a game and community seems to be the primary value add that a system like blockchain-based NFTs offer: circumvent the typical fundraising channels and issue some limited release avatars for your game. None of these advantages, however, have anything to do with a single line of code written for the smart contracts.
When you’re effectively working off hype, decentralization is a minor factor in this calculation; any team looking to maximize the utility of the NFTs they’re building will likely care less about decentralization and more about whatever increases their initial fundraise and bootstraps their community. This in turn can have a further centralizing pull. Why incur the added engineering costs of building the NFTs and supporting the extra engineering efforts and blockchain-based infrastructure. It’s hard to imagine game-based NFTs sustaining current valuations once the air has been let out of the hype balloon.
Store of Value — The Holy Grail
Scarcity (Non-fungibility) +
Novelty (decreasing function of time, increasing function of scarcity) +
Cost of Preservation (PoW, increases over time) +
Utility (relatively stable over time)
Store of Value (function of time in either direction)When the above start to fall in to place and are able to persist over a long period of time, a collectible can begin to establish itself as a store of value, moving from pure speculation (or utility) to longer term investment.
This is precisely why upward price trends in the area of collectibles have been accelerating over the past decade and a half since central banks became more assertive and interventionist after the Financial Crisis in 2008. For example, an audit of the Geneva freeport “revealed a huge increase in the value of goods stored in some warehouses since 2007, led by an increase in high-value goods like art.” Bluechip art has been outpacing the S&P 500 over the past 20 years by over 250% (source). Even Pokémon cards are starting to look like a good long term bet with a 2020 sale of a Charizard setting a new record at $220k.
Scarcity is at the heart of the argument for a commodity becoming a store of value. There can only ever be 21 million bitcoin. There can only ever be one original Salvator Mundi painted by Leonardo da Vinci. There can only ever be one year of Michael Jordan rookie cards. So is it enough that there can only ever be 100 digital rock purchase receipts such that demand will continue to increase as the supply stays static?
Time will tell. Markets are usually rational in the long run but are unreliable in the short term as they search for equilibrium. Cryptocurrency markets are particularly frothy now and with the trigger happy money printers, multiple rounds of economic stimuli, and low interest rates around the world, speculative investments in volatile assets make for a good place to get returns on your cash, but bad for fundamental price signals.
It’s possible that the social signals of early NFT adoption will provide enough of a base from which to build a sustainable long term store of value commodity á la Mises’ Regression Theorem. However, I think it’s important to acknowledge that many of the characteristics of physical collectibles are not as easily transferable to the digital realm; even the nature of the scarcity can’t be applied in the same way. A unique proof of purchase is just not the same as a unique piece of art. So, if the argument for current or future NFT valuations is based on their mirroring the characteristics of physical collectibles, in the same way that the argument for bitcoin is in its mirroring and improving upon the characteristics of money, those arguments may not be able to sustain beyond the current speculative bubbles.
No matter how we value them, it is undoubtable that NFTs are here to stay, if for no other reason than the blockchain is immutable. Current owners are invested in their success and clearly perceive some value in the goods they purchased. Nevertheless, price discovery will continue and new use cases will be explored as the actually novel characteristics of the medium are experimented with. NFTs may have a viable path forward and perhaps with convincing valuable proposition such as fundraising mechanisms, uncensorable domain names, dissident empowerment tools, or social signals for your tribe. Perhaps less so as the promise for a new frontier of artist empowerment, collectibles for a new Web3 generation, or as a long term store of value.
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