The Rise of Non-Fungible Token Assets
By now you’ve most likely heard of CryptoKitties. CryptoKitties is an Ethereum based game and mini economy where users buy, sell, trade, and breed digital cats. To outsiders, projects such as this look like ridiculous applications of blockchain technology that seemingly serve no purpose. While cats on the blockchain sound inherently unimportant, there is significant value in the underlying protocol that allows these assets to exist.
“Fungibility is, essentially, a characteristic of an asset, or token in this case, that determines whether items or quantities of the same or similar type can be completely interchangeable during exchange or utility.— Gerald Nash
The ERC721 protocol was developed in September of last year in order to create non-fungible assets on the blockchain. This enabled a group of developers to design digital cats with unique traits on Ethereum’s blockchain while simultaneously allowing for immutable ownership of these assets for the buyers. On the surface, this seems insignificant. However, the concept of unique, digitally scarce assets on the blockchain have far reaching implications.
(Herein, for readability sake, I will refer to Non-Fungible Tokens as NFT’s)
The most talked about aspect of NFT’s has been the idea of digitally scarce assets as collectibles. Humans have a rich psychological past of collecting things from baseball cards to rare coins. Therefore, many folks in the digital asset space have surmised that people will seek to own NFT’s purely for their unique and scarce traits. However, research regarding the psychology of collecting suggests that humans collect things more often for emotional purposes as opposed to monetary. For example, one of my cousins collects ticket stubs from events he has attended as a memento. These memento’s tie him back to a specific time, place, and feeling associated with that memory.
Currently, NFT’s such as CryptoKitties or Rare Pepes are being bought and sold primarily for the expected monetary gain of selling the asset at an appreciated future value. In comparison to that of my cousin, there is little emotion involved in the purchase of these assets. With that said, I do not believe that NFT’s will be adopted on a wide scale based solely on their scarce and unique properties. We need to develop a usability function for these assets that either increases the emotional response from the user or provides a utility that wasn’t previously possible prior to this protocol standard.
One vertical for NFT’s is within the gaming industry. A few months ago, Forbes stated that e-sports revenues hit $655 million in 2017 with a projected growth of 38% in 2018. Now imagine how NFT’s could impact this already booming industry. For example, say there was a similar economy for Call of Duty characters as there are for CryptoKitties. Users can purchase their character, port them in-game, and play with them. With this application, you transcend NFT’s as solely collectibles. The usability in-game and the pride associated with owning a well sought after character triggers that emotional response humans so desperately crave.
The other significant implication of the ERC721 protocol is the ability for asset’s characteristics to be altered. In the current world of digital cats, you can breed one cat with another to create an entirely new cat with completely different physical characteristics. Now, let’s take this idea a step further. Think of CryptoKitties developing into a 21st century Tamagotchi of sorts. You own your CryptoKitty and have an open world environment where you walk it, feed it, and buy it accessories. Everything you buy for it affects the traits of the cat and, therefore, the value. For example, if you feed your cat cheeseburgers everyday, it will gain weight, become sluggish, and ultimately function differently than if you had fed it healthy meals. This gives way to entirely new facets of the NFT economy. Owners can now directly affect the traits of their NFT’s, impacting the market value of them on the in-game economy. At the same time, this introduces a new revenue stream for the owner of this in-game space. To give you an idea of how lucrative this could be, Activision Blizzard raked in over $4 Billion on in-game purchases alone in 2017. Portability solutions for NFT’s to in-game environments is ambitious for the current state of this protocol and blockchain as a whole. However, it is surely something to keep an eye out for in the future.
The most recent and, in my opinion, most exciting application of NFT’s involves their potential use in licensing. Licensing of software has historically been complicated. Users can purchase software and then pirate it off on the internet to millions of users for free; resulting in a significant loss in revenue for the software company. On a similar note, if you want to simply resell the software when you’re done with it, you can’t. As was made clear in the 2008 case of Vernor v. Autodesk, almost all software today is “licensed” rather than “sold”; thus making its resale to a third party illegal.
“What if all our software licenses were compatible and we could go to a single integrated app store and sell say three days of Adobe Creative Cloud and buy two days of Microsoft Office? This flexibility would be a clear win for consumers but would surely lead to a loss of revenue for software vendors. Hmm, but what if this easy transferability of licenses also reduced piracy?” — John Griffin
As John Griffin alludes to in the above quote, licenses as NFT’s alleviates issues on both the consumer and vendor side of software sales. For consumers, the primary benefits are transferability and privacy. You no longer need to be locked into a year subscription of Microsoft Office. Whenever you’re finished, simply sell your license on an open marketplace on top of the Ethereum blockchain. In terms of privacy, there is no need to share any information with the service provider other than your public Ethereum address.
Benefits for vendors are significant as well. Since NFT’s are just smart contracts, vendors can code parameters into the licenses. Some of these parameters include, but are not limited to, revenue sharing on a secondary sale or restrictions on time periods before and after transfers of the license are made. Licenses as NFT’s also thwart the rampant piracy problem with software today. In order for you to pirate an NFT software license, you would need to share your private key. In that case, you compromise your Ethereum address and risk the license being stolen.
Ripple Effects and Investable Verticals
As you can see, the implications of NFT’s go well beyond digital cats. And, personally, I don’t think we’ve even begun to scrape the surface of the potential for this asset class. However, as exciting as this may be, the ripple effects of rapid growth in this area could be troublesome. The CryptoKitties mania absolutely crippled the Ethereum network in December of last year. If NFT’s continue to grow at a faster rate than Ethereum scaling solutions, expect to see skyrocketing TX fees and major network clog ups in the short term.
Investing in anticipation of NFT growth is particularly tough at present time. The obvious and unsatisfying answer is to buy ETH in anticipation of the increased demand in the network to pay elevated gas fees. In my personal opinion, I don’t believe that the proper investable vertical exists yet. In the coming months, I’ll be on the lookout for novel projects working on custodial solutions for NFT’s, consumer friendly UI’s for interacting with NFT’s, and developments in the marketplaces in which these unique assets can be exchanged.
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