I apologise for the clickbait title. They are not. You may close this e-mail if you opened it to check on that. I hope you are doing well amidst the shaky macroeconomic situation we find ourselves in. Evergrande, bad economic output from emerging markets, tapering - there is quite a bit to worry about. I am not an expert in any of them, so we won't be talking about it. Instead, we will focus on a niche subset of the digital asset space that may offer insights into where the market is heading. Bitcoin's pull-back from $52k to the $40k range suggests we are in a risk-off environment. On-chain activity with NFTs indicates the same. I wanted to look at how NFT usage behaviour has evolved over the last few months to understand how people perceive the asset, invest in it and what the case for continued investment in them looks like. Let us dig in.
The chart above captures the change in volume on Opensea's ethereum based NFT marketplace. As you can see, the daily volume for ETH based NFTs has declined from ~$322 million to be in the $60 million range as of yesterday. A roughly 80% drop. Would that mean fewer NFTs are being traded? Not really. At its peak on August 29th, close to 80k NFTs were switching hands on a given day. Today that figure is at about 60k. One can tell the same about the monthly users too. OpenSea witnessed an uptick from ~217k users in August to ~228k in September so far. We are likely seeing an uptick in retail interest in NFTs combined with a cool-off period on the speculation around the asset class. But their ability to become a financial primitive that is constantly traded may be being put to question according to a new story from Bloomberg.
Units of Hype
The core argument around NFTs being a possible bubble is that individuals often buy them with the intent of quickly flipping. In the absence of a signal that accrues from a celebrity like Jay Z, Snoop Dogg or Steph Curry endorsing an NFT - the asset may be perceived to have a "signal issue". An NFT becomes desirable generally when it is perceived to be valuable due to famous individuals associating themselves with it. Art on its own can be hard to price. Connect it to specific social circles, and we see it re-pricing itself. A different way NFTs garner value is through organic community building and use-cases that emerge from it. NFTs used in Axie Infinity will likely always have a certain amount of capital pursuing it because you can generate an income from the game itself. Don't believe me? Let's look at Loot - one of the most anticipated NFTs released a few weeks back. It was launched by Dom Hofmann - the man behind viral app Vine. By all means, the concept is genius, and the price action is not a reflection of loot, the project itself.
As you can see, while the NFTs themselves had all the attention and interest of the prominent Silicon Valley names - the fiscal interest in trading the asset itself has been in decline. One way to explain what may be going on is by suggesting individuals are no longer selling their NFTs. This theory might hold true if we did not see a substantial decline in the price of Loot NFTs. According to Nansen.ai, the average price of a Loot NFT has declined from a high of 21 ETH to 6 ETH as of writing this. In other words, those that may have purchased the asset with the intent of making a quick flip likely find themselves locked in in the absence of new liquidity.
Some NFTs buck the trend, as I had suggested earlier. These are ones whose value are linked to time. Consider Crypto Punks. According to Cryptoslam, 9 of the top ten NFT transactions have been related to a Crypto Punk NFT, with the costliest one trading for north of 4200 ETH. They hold a unique place in NFT history for being one of the oldest in existence. According to Nansen, they were released ~1553 days ago. The closest peer in terms of age is Cryptokitties - at 1399 days back, but the supply models of both NFTs are different. There are only 10,000 Crypto Punks, while there are over 2.01 million crypto kitties. How does this affect price? It would cost you at least ~111 ETH to buy a crypto punk. Cryptokitties, on the other hand, cost less than 0.0001 ETH. Part of the reason "aged NFTs" will continue to have value so long as their supply is not over-inflated is that one can't go back in time and issue new NFTs. The novelty of being the "oldest" NFT cannot be stolen from it. The same mental model applies to the pyramids and other constructions of social interest that were built back in time. Also, for aged wine. This has helped the asset retain its price over time. The chart below shows the volume and average cost of a crypto punk NFT in comparison..
Now I understand that it is a very apple to oranges comparison to take the oldest NFT in existence and compare its price action with something released barely a month back. By no means is this a comment on Loot's fiscal success. Instead, it is a look at how assets are bifurcating in the NFT realm. More on that in the paragraph below, but let me explain the rationale for suggesting that first. As of writing this piece, there are north of 1200 NFT projects being tracked on Ethereum alone by Nansen. Collectively, they did ~21,000 ETH in volume yesterday between 88,772 transactions. So the idea that the price of an NFT would rise solely because it has a capped supply is likely flawed. As the barriers to issuing an NFT reduces with tooling and infrastructure evolving, the way founders think about using the asset have to develop.
Excluding use-cases of NFTs as debt instruments, cash-back points and digital access tickets, we will see them evolving to three forms of assets, in my opinion.
- Time linked instruments - The Crypto Punk example I gave above is one. NFTs that mark an event and signal an individual's involvement then will begin to be highly valued. These instruments will likely appreciate as the amount of time they are held in a wallet increases. The frequency at which a time linked instrument switches hands tends to be quite low. People have no incentive to keep selling them.
- Community linked instruments - These assets derive value from the number of people engaged with the NFT. Axie Infinity's NFT pricing surged as the number of gamers on the platform rose. Developers will hack value towards in-game assets through growing a captive userbase and making specific NTFs highly desirable within that community. These instruments work very similarly to the current in-game asset economy. A community linked instrument will drop in price rather quickly if a team launches one and does not focus on finding traction quick enough.
- Veblen goods - Bored Apes Yacht Club fits outside the realm of instruments mentioned above. They are less than six months old, have a community of fewer than 10,000 members and are still highly desired. This is because these instruments have trended towards being status symbols by means of association. They are the Rolex or Gucci equivalents of the NFT world, deriving value from proximity to celebrities.
NFTs can and will have all three properties at the same time. It is only fair to argue that an instrument like a BAYC NFT is desired specifically because it has a fanatic community behind it. This shift in the nature of assets being traded as NFTs brings several changes to how one thinks about investing in them. For starters, it is going to be highly unlikely that one can "flip' NFTs in a matter of days without substantial information asymmetry going forward. Secondly, the lack of liquidity in the NFT market would mean individuals buying into one have to make a conscious decision to own one because exiting profitably may not be as easy as one considers. The frequency of transactions has drastically declined in the recent past. Lastly, with the proliferation of lower-cost chains and rising retail interest - the focus will shift towards NFTs being instruments that spur user activity instead of enabling retail speculation. I am biased here, but Axie Infinity is an excellent example of this. They focused on building the game, which in turn on-boarded users and increased the price of the instrument. Financially engineering NFT prices alone may not lead to desirable outcomes.
So Where Do We Go From Here?
Remember how ICOs were touted to replace VCs entirely in 2017? It was a case of being overly optimistic about where the markets were headed. VCs are very much here in 2021, but they may not be as relevant by 2040. That is how the human mind tends to work. We are overly optimistic in the short run and massively dismissive about what the long term trend could look like. NFTs are undergoing a similar phase of "re-discovery". The short term hype is caving into a period of repricing. Many industry pundits would rush in to call it the "death" of the space. The same folks likely built a career shouting the end of the internet in the early 2000s. Technology takes time to find its ways. One way I already see this play out is in the realm of gaming. Developers have begun holding off on launching random speculatory NFTs and are instead asking themselves more profound questions of in-game economics and the overall gaming experience. The cool-off period is necessary for the industry to take a step back and reassess how NFTs are priced, used and transacted.
I think the ecosystem has more or less trended towards parity with DeFi, which is a big win. The chart above from TokenTerminal captures revenue generated by Uniswap, Metamask, Open Sea and Axie Infinity. As you can see, Open Sea and Axie Infinity generate almost as much revenue as Uniswap. Large institutional investors are aware of this, and that is part of what is leading the recent $680 million investment into Sorare by SoftBank this past week. NFTs are symbolic of the retail consumerisation of the digital asset space, and as such, declining volumes & prices fail to tell the entire story. The asset class has made it possible for traditional web2 native talent to enter the space. It is only a function of time before we see large gaming studios and existing web2 native platforms embrace these instruments.
I will see you guys on Friday with another long-form on Sorare. Hop in to our newly set up community here to argue, debate and critique everything said in this peace.
We now have a forum
The Telegram group I set up when this website was launched ended up having 500+ members way earlier than I thought it would. Naturally, we needed a new place to discuss and share notes without information overload. The forum is a way for readers to discuss, share and debate what is going on in the realm of digital assets. It is also aimed at letting founders share their job posts, launches and challenges in an open-access forum. You may receive an email from the forum to help ease with signing on. We are already at ~100 members and my hope is to have ~1000 folks on by Christmas. You can sign up for it here. See you there!