The Not-So-Crazy Madness of NFTs

What are NFTs?

NFTs are non-fungible tokens. These tokens represent ownership of unique digital items through transactions recorded on Blockchain technology[1]. Each token has a unique identifier and owner, all of which is publicly available[2]. Most NFTs currently are tied to the Ethereum blockchain and can be purchased with Ethereum tokens. So, when we talk about NFTs that have sold for ‘millions’, we really mean millions of dollars in cryptocurrency.

While NFTs have hit mainstream headlines in 2021, they truly rose to prominence in 2017 through Cryptopunks, a limited collection of 24×24 pixel art characters. In the years following, tokenisation was also adapted to games and virtual worlds. This includes the launch of Cryptokitties, a game that enabled people to buy and sell virtual cats[3], as well as Decentraland[4], a VR platform where virtual real estate can be traded.

Understanding fungibility[5]

The greater the fungibility of an asset, the easier it is to interchange it. To understand the value-added of an NFT, we should first understand that fungibility is a spectrum. On the upper end of the scale are perfectly fungible commodities- goods which are perfectly interchangeable. Gold, regardless of its form, is a pure element equally as valuable as other gold. Money is also highly fungible; dollars are identical and, for the most part, exchangeable for other dollars.

At the opposite end of the spectrum, we reach NFTs. The blockchain technology stores data related to a digital asset, acting as a ledger that certifies its properties and ownership. Hence, NFTs can be constructed as completely unique goods and treated as one-of-a-kind items. In the same way that luxury brands combat counterfeit goods with verification cards, NFTs bring the value of scarcity and uniqueness to digital items, which have previously been easy to replicate.

Value in the free market

There are two main types of NFTs. Firstly, there are NFTs linked to an underlying asset. Like traditional financial instruments, the value of the underlying asset is the main determinant of the price. In this case, the NFT serves only as a certificate of authenticity. A recent example is the sale of Beeple’s digital artwork for US$69.3 million[6]. While the price may be inflated, the value is mainly derived from the artwork itself. These are existing markets where the introduction of NFTs has helped make trading more efficient by reliably identifying ownership.

However, it is the second type of NFT that has revitalised the discussion on economic definitions of value. NFTs can also be sold as exclusive products, with buyers receiving nothing but the digital token itself. In February, the internet was left baffled by the sale of a Nyan Cat gif for US$587,000. The buyer did not receive legal rights to Nyan Cat, nor are others prevented from downloading and sharing gifs of Nyan Cat. The same applies to a US$2.5 million sale of a tweet from Twitter CEO, Jack Dorsey. Why pay hundreds of thousands of dollars for something you can access for free online? Fungibility and scarcity are only part of the picture.

Traditional concepts of value define worth based on production costs and utility, but when it comes to art and culture, the notion of sign value may be more important. Sign value, as coined by philosopher Jean Baudrillard, is derived from the prestige of owning the item[7]. The value of owning original fine art is tied to the reputation of the artists. Similarly, ownership of seemingly silly digital items is associated with societal perception of the creators’ reputations or the good’s legacy in pop culture. This results in a concept of value that is purely speculative.

Beyond artwork

NFTs have largely been associated with digital art, but as we have seen with applications to gaming, its adoption has branched into the world of sports, fashion, and music. In 2019, Nike patented ‘CryptoKicks’, an NFT system to digitally verify the authenticity of sneakers. In 2020, the NBA officially licensed NBA TopShot to capture videos of NBA highlights. Then, in March this year, American rock band Kings of Leon and rapper Lil Pump released albums in the forms of NFTs. While the speculative nature of NFTs and cryptocurrency invites volatility and bubbles, its broad applications show its potential to revolutionise value for artists across a variety of industries.

Conclusion

NFTs have been branded as a vehicle for “ascribing value to a category of cultural phenomena that people already want to pay for”[8]. While digital goods were previously replicable and free, they are now monetizable. In this way, NFTs are establishing a functioning market for digital pop culture and niche collectibles. Regardless of whether certain NFT markets are a fad or a bubble, it is a valuable innovation for the creator economy and a reminder of how value has changed in modern times.

[1] For a detailed explanation of blockchain, see ESSA article http://economicstudents.com/2020/05/the-bitcoin-conundrum-cracking-the-code-on-decentralised-digital-currency/

[2] Ethereum. (2020). Non-fungible Tokens (NFT). https://ethereum.org/en/nft/#what-are-nfts

[3] Boscovic, D. (2021). How Nonfungible Tokens Work and Where They Get Their Value. https://theconversation.com/how-nonfungible-tokens-work-and-where-they-get-their-value-a-cryptocurrency-expert-explains-nfts-157489

[4] Marquez, A. (2021). Welcome to Decentraland, Where NFTs Meet a Virtual World. https://www.nbcnews.com/tech/tech-news/welcome-decentraland-nfts-meet-virtual-world-rcna553

[5] Economics Explained. (2021, March 26). Why the NFT Market is Not As Crazy As You Think. [Video]. Youtube. https://www.youtube.com/watch?v=UpXCUEOcyNs

[6] Weiner, C. (2021). Beeple JPG File Sells For $69 Million, Setting Crypto Art Records. https://www.npr.org/2021/03/11/976141522/beeple-jpg-file-sells-for-69-million-setting-crypto-art-record

[7] Kellner, Douglas, “Jean Baudrillard”, The Stanford Encyclopedia of Philosophy (Winter 2020 Edition). https://plato.stanford.edu/archives/win2020/entries/baudrillard/.

[8] Gottsegen, W. (2021). Can NFTs Change How We Value Music? https://decrypt.co/61241/can-nfts-change-how-we-value-music