NFTs: Will the bubble pop or float?

According to research from Syz Group’s head of trading Valerie Noël, NFT sales hit $25bn in 2021 compared to $95m in 2020. 

But what NFTs are, and their potential impact on the economy and markets, remain a mystery to many investors.

NFTs are a unique digital token that contain a small amount of code. They seek to create a simulacrum of physical scarcity and uniqueness onto digital objects. The technology began in 2015 as part of the Ethereum blockchain. As well as being able to track the Ether cryptocurrency, the blockchain could track arbitrary blocks of data that can contain a small payload of code.

It is important to note that art NFTs do not contain the art themselves, but a pointer to the art, normally through a static URL, with no cryptographic relationship between the images and the tokens. 

While NFTs are most associated with art, what the token represents is arbitrary. It can be a video game item, a permission slip, a subscription, a virus, or a combination of all of them.

NFTs hit the mainstream at the beginning of 2021, when a string of memes and intangible concepts such as the ‘first tweet’ were auctioned off as NFTs.

In the months since, NFT markets have mutated to comprise mostly of procedurally generated collections of art with names such as CryptoPunks and The Bored Ape Yacht Club (BAYC).

Crypto asset markets could pose ‘threat to global financial stability’

Neil Campling, head of TMT research at Mirabaud Equity Research, said the BAYC alone crossed $1bn in sales and has “sold to celebrities including Eminem, Shaquille O’Neal, Post Malone, Snoop Dogg, Jimmy Fallon and Paris Hilton”.

Concerns

Marzio F Schena, chief executive of music rights exchange platform ANote Music, noted that investors must be cautious of the “authenticity or uniqueness of the NFT”, giving the example of an NFT of the Mona Lisa being created by someone who does not have underlying ownership of it. Tokens can be minted of identical pieces of media on competing chains, or even on the same chain.

This has been combated by investors turning to trusted NFT market places. However, this seems to lose the key part of decentralisation that is a large selling point of NFTs.

Campling added that “owning a digital property right does not mean you own the property”. “What happens in the real world if you need to try and litigate over ownership of a non-real world asset in a real-world legal setting?” he questioned. “The answer is, we do not yet know.”

Scams also remain a serious concern for every analyst who discussed NFTs. 

There are numerous examples in the community of founders abandoning projects, Ponzi schemes, pump and dumps, insider trading and even phishing scams.

Simon Peters, market analyst at eToro, said wash trading is a particular problem in the NFT market, “where the prices of NFTs can be artificially inflated by a seller”. 

“As a genuine buyer or investor, you could be paying over and above the true market value of the NFT,” he warned.

Schena said that applications beyond digital art are where he sees a future for NFTs.

 He pointed to music festival Coachella “which is bringing out Coachella Collectibles that allow owners to unlock festival passes”.

“Or Alfa Romeo with their new electric-hybrid SUV with NFT technology included,” he added.

 Other analysts mentioned using NFTs to represent land deeds, medical records or authenticity of rare items.

However, it is unclear why these technologies should be pushed to an NFT. Manufacturers already maintain a detailed service history of cars through vehicle identification numbers and have done for decades. 

It is also unclear what problem these NFTs are trying to solve, or whether they represent a fad.

Investing?

While NFTs are a new technology, investing in them is even newer, with much disagreement about its potential. NFT investment currently exists far outside the mainstream, with the only NFT ETF – the Defiance Digital Revolution ETF – having already dropped 35% since its launch in December 2021.

Noel said: “NFTs attract a different kind of investor. NFTs are not like stock or bonds with a stream of cashflows, dividends or coupons attached to them. When buying an NFT, you are buying a value, brand or utility.” 

Other analysts such as eToro’s Peters compared NFT investment to “wine or fine art”, with appreciation in mind as “a diversifier, not a core asset”.

However, Mirabaud’s Campling said “there are many signs that the greater fool theory seen in bubble economics could be at play”. 

He cited the NFT sale of a clipart of a stone for $4,800, which then sold three weeks later for over $1.3m. 

He continued: “Then when you read of a 12-year old [becoming a millionaire] by being able to create images of whales wearing baseball caps and selling them as NFTs, does that not send alarm bells ringing? If it seems too good to be true… it probably is.”

Campling concluded that “the risk is that NFTs will require significant regulation, oversight, and a code of conduct before they can even be considered as a form of potential investment – if ever.”

However, Peters noted that for investors, “it need not be about the outright buying of NFTs but investing in blockchains that facilitate NFTs – such as Ethereum or Solana. It is a form of ‘picks and shovels’ crypto investing.”

Clive Hale, chief strategist at Albemarle Street Partners, stated he was not looking at NFTs as potential investments, adding: “There is too much scope for fraud, let alone any appreciation on a pdf file for a questionable piece of art priced in the millions. Why would you?”