2021 marks the rise of NFTs – what a wonderful year! In this short period of one year, we have witnessed an explosion of artistic creativity, technological innovation and capital inflows in the space.
I'm excited to see many developers, innovators, and artists experimenting with this technology as a new medium for their creations. Every project that leverages NFTs in interesting new ways chills me.
A key factor contributing to this high rate of growth is that NFTs have enabled the financialization of global culture. Culture is the embodiment of our daily lives. NFTs have a low barrier to entry for ordinary people, unlike DeFi, which requires minimal technical and financial knowledge. Buying an axis to play a pokemon-like card battle game is 100 times more intuitive than buying and depositing USDC into the Curve pool to create governance tokens.
A growing number of mainstream celebrities such as Jay-Z, Snoop Dogg, Stephen Curry, Paris Hilton, Steve Aoki have made NFT their digital identities and ignited millions of fans to follow suit, further fueling the trend.
Steve Aoki loves his CryptoPunks
NFT mania
We've witnessed a lot of speculation over the past few months, with some NFT prices rising 10 to 100x and plummeting 90% in a matter of weeks.
The reasons for the huge fluctuations in NFT prices and the difficulty of valuation are:
- NFTs are relatively illiquid. The transactions that occur on the margin change the floor price very quickly
- Due to its limited price history, it is in constant price discovery .
- Many of the intrinsic values of NFTs, such as culture, are intangible and difficult to quantify.
- A consistent valuation framework is not adopted.
- NFTs are highly narrative-driven. (The most important point, I will expand on it later)
The first NFT I bought was the January 2021 Non-Fungible Ape, a type of pixel art that likens various characters to "apes." I stumbled upon discord while they were doing their first stealth airdrop, but I didn't know what I was doing at the time. Browsing through every image on OpenSea, it ignited a strong desire in my mind to buy and collect apes with the rarest characteristics. Today they're worth 0: no buyers. This manager taught me a profound lesson.
Chart A: Donald Trump Non-Fungible Ape, a rare ape worth 0.7E
In hindsight, I should have anticipated this, because the market is entirely insulated by speculation: it has no historical value, anonymous artists who have just joined Twitter, small communities, zero utility, mediocre art. It tried to create a narrative in any of the 5 NFT domains I'll outline later, but without success.
However, the prices of other NFTs have soared to dizzying heights. CryptoPunk, which was purchased for just $35 in 2017, could be worth as much as $9.5 million today.
Check out board Ape Yacht Club, Fidenzas, XCOPY, mystic axies, and more. What makes them so valuable now, and how should we identify these NFT value opportunities early on?
No wonder we're all asking 'wen next fidenza'?
Why are NFTs different?
I'm fascinated by NFTs because they essentially represent a unique layer of complexity that alternative tokens don't have. This layer includes both intangible (e.g. cultural) and tangible, making it a fun intellectual exercise.
At the highest level, NFTs exist and share the same underlying layer as all other cryptographic applications, namely blockchain infrastructure, with Ethereum being the most commonly used blockchain. This includes application chains and L2 solutions specific to NFT applications, such as Flow and Immutable X.
The next layer — the platform layer — provides financial services to NFTs: think exchanges, liquidity provision, lending, decentralization, etc. These are platforms because they typically serve multiple different tokens rather than a single token.
Unlike alternative tokens, NFTs are another layer where a separate "application" is packaged into the token itself. The NFT standard (typically ERC-721) enables tokens to be linked to on-chain or off-chain assets through their metadata, while preserving the provenance, immutability, and network security of the blockchain.
Let me simplify with a Web2 analogy:
(First level) underlying blockchain = Internet + mobile phone.
For example: TCP/IP, iPhone. Widely available and publicly available
(Level 2) Application/Infrastructure = Internet Platform.
For example: Apple's App Store
(Level 3) NFT = Personal Mobile App.
For example: Facebook app
The platform is very powerful and captures tremendous value through its network effects and vast market reach. Good platforms take a lot of time to build, evolve, and grow at a high rate on the adoption curve. A single app typically represents a layer with the highest levels of diversity, innovation, and creative input – because now anyone with an idea can create and launch a (basic) mobile app fairly easily. The web3 equivalent here is NFT.
To illustrate this further, let's consider Aave (platform) and CryptoPunks (NFT):
The value of 1AAVE is closely linked to the success of the entire Aave application/protocol: the total value of the lock-in consists mainly of different LP tokens, revenue generated, and user growth.
The value of 1CryptoPunk is... How cool it looks, how rare it is and how many people really want it. Does not rely on any external applications.
A simple ontological framework for NFTs
So I started exploring a framework for thinking about NFTs:
- How do you identify NFTs with narratives that are likely to spread?
- How do you determine whether an NFT is undervalued or overvalued?
The purpose of this is not to quantify the specific fair value of the NFT – the NFT does not discount the cash flow model. Instead, I developed a dynamic framework for NFT project creators and NFT investors so they can make better decisions.
I delved into the factors that give NFT value and distilled them into 5 main areas. This is different from the typical classification of NFTs that we are all familiar with: collectibles, generative art, virtual lands, games, etc. The reason is that there is often a large overlap between these categories. These 5 areas apply to all NFTs, although their relative importance varies from project to project.
NFTs offer cultural and aesthetic advantages over their alternative counterparts. In the range from intangible to tangible, these 5 areas are:
Culture (Intangible)
- This is the most interesting part of the NFT and the hardest part to value.
- Culture is broad and encompasses the common experiences, perceptions and beliefs of a society.
- Cultural components include, but are not limited to:
Brand value
Historical significance
Imitation desire: We desire the desires of others because we imitate their desires
Elastic Values: Am I seen as a showcase of wealth, culture, and class?
Aesthetics (invisible)
- Refers to the aesthetic appeal of NFT-related media (e.g., artwork, music).
- Do you like it? How many other people, especially fashionistas, like it?
- Does ownership indicate that you have a good insight into beauty?
Community (tangible-intangible)
- Refers to the sum of the existing owners of an NFT collection
- Like most things in Web3, community is everything.
- What is the demographics, psychology, wealth and vision of the owners? Are they more likely to be diamond hands or paper hands? Are they loud and rude, or quiet and complex?
- Measurable metrics: Is the community growing, stagnating, or declining? How many contributors are there?
Practical (tangible)
- Refers to benefits derived directly from owning NFTs, such as private membership groups, early acquisition of mints, token cultivation, physical goods
- The main components of the game and Metaverse NFT: e.g. Axies, Sandbox Land, Star Atlas Spaceship, Ember Sword Badge. These can also generate gains when playing money-making games.
- NFTfi (NFT + DeFi) is very interesting.
Assets (tangible)
- Refers to digital or real-world assets that NFT owners are entitled to own in addition to the NFT itself
- For example: project vaults, other NFTs, intellectual property, real estate
In the following articles, I'll explore each of these 5 areas in more depth with examples.
In short, NFT = culture + aesthetics + community + assets + utility
(NFT = Culture + Aesthetics + Community + Assets + Utility，CACAU)
This is a summation (+) equation: this means that all NFT projects that intend to maximize their value and become investable assets should consider their performance in each of these 5 areas. Even if they may focus on only one of these areas.
example:
A generative artist with creative abilities, whose talent is the algorithm for creating the wonderful works of art that the world needs, should also consider:
How he/she interacts with collectors and builds a positive community instead of completely disappearing "working for my art"
How he/she increases the utility of owning artwork through membership, early access to new works, etc.
Although aesthetics is the main area here. Aesthetics can be difficult to judge, but community and utility are easier to measure.
note
Several factors related to blockchain are not captured in this framework, but may contribute to the narrative and value of NFTs:
The base chain of the NFT
Ethereum is currently the preferred network for NFTs, especially high-value NFTs. This is partly due to the security guarantees on the network.
NFTs off-chain or on L2's Rollup (e.g., Polygon, Solana, Avax, Arbitrum) are heavily discounted in today's market, although this may not be the case in the future.
Persistence of the underlying data
Arweave > a centralized website for IFPS >
(Gen Art) on-chain vs off-chain
Artwork stored entirely on-chain seems to have an advantage over artwork stored in an off-chain location. Block space is very expensive, which makes on-chain storage often impractical.
Autoglyphs, for example, is the oldest on-chain generative art project.
Derivatives and originals
Successful projects will be cloned and forked multiple times, which is the rule of cryptography. As we have seen many times, the price of derivatives may rise sharply in the short term due to speculation, but in the long run, the value usually returns to its original level.
例如 Cryptopunks ← Phunks、Fast Food Punks、Picasso Punks、Bastard Gan Punks……
summary
Why bother with this? NFTs shouldn't be simple: buy as long as I like? Yes, this also works.
I put this framework together to help me better understand and systematically identify the factors that can drive the value of NFTs. And avoid FOMO on projects with weak narratives or ad hoc nature. I hope it's useful to you too.
I think for NFTs to go mainstream as a truly investable asset, we need to start thinking and using the same language as people in the traditional investment world. A framework in which non-crypto natives can understand and demystify cryptography and concepts.