NFTs: why are they valuable?
December 14, 2022
In this article, we answer a (literal) million-dollar question: how much are NFTs really worth? The value of a non-fungible token is determined by several factors, including the underlying blockchain technology, the actual usefulness, the community interested in the project, its scarcity and finally the market factor. In this article, we delve into each of these aspects in order to understand why non-fungible tokens can cost millions.
How much is an NFT worth?
Non-fungible tokens have proven that images on the internet can have value. Just think of Beeple, the artist who sold a single large NFT-collage (consisting of 5,000 creations) for more than $69 million. Anything that has a price and can be bought has a value. The logic is simple, but what everyone is asking is why. How can a set of pixels have a cost? How does an NFT have value?
Discussions about this often have ironic overtones. Many show screenshots of CryptoPunks, wondering why anyone would want to buy them if it is so easy to get them ‘for free’. Perplexity is widespread, but perhaps this is because not everyone knows exactly what NFTs are. The answer is tokens that prove the authenticity, uniqueness and ownership of digital and sometimes physical objects, by storing identifying information on blockchain.
Simply put, you cannot claim to own a non-fungible token simply by downloading a screenshot. You cannot also claim that it is the original, because there is a public ledger that proves otherwise. Screenshots are only anonymous copies, whereas non-fungible tokens find a guarantee of authenticity in the blockchain, which is a core part of their value.
Property: the first value factor of an NFT
Each non-fungible token is represented by an identification number (ID). On blockchain, it is associated with its legitimate owner, recognised by a wallet address. The process of creating NFTs (minting) requires a wallet address to which ownership can initially be assigned. However, in most cases, ownership can also be transferred by sale operations.
The blockchain, which is transparent and can be consulted by all, also keeps a history of exchanges. The traceability of transactions is fundamental to certifying changes of ownership. Through a blockchain explorer, anyone can reconstruct the ‘history’ of a token, composed of transfers between wallet addresses. The blockchain also recognises originality, being able to trace the creators of non-fungible tokens. Everyone can verify that it was the actual artist who issued the token. This is an advantage that has economic significance. The ability to easily distinguish forgeries and counterfeits protects the value given to an NFT by its creator. The mere name of the artist, especially if they are capable and renowned, sometimes already implies a high price.
In addition to proving originality, the ability to trace ownership makes the blockchain an effective tool for defending copyright. Each non-fungible token will carry its creator with it forever, written immutably in its code. Thus, this integrates intellectual property rights into the work itself. This has the potential to revolutionise the so-called “creator economy”. Digital art will be able to receive proper recognition, and artists will be able to claim their deserved profit in a more transparent manner. Opensea and other marketplaces allow for a royalty percentage to be set: a guaranteed fee to the artist for each resale of the work. Following the first purchase, creators can continue to generate revenue from their NFTs: a constant economic flow that rewards content on the Internet.
This is particularly important for music. Through tokenisation, singers and producers can escape the management of streaming platforms, which today retain most of the profits. In this respect, any digital object can be made non-fungible. Part of the value of NFTs comes from their broad applicability, which opens up multiple functionalities.
The usefulness of NFTs
Non-fungible tokens are created through smart contracts. They are essentially software programmed on the blockchain that regulates the technical functioning of a token. In particular, most non-fungible tokens follow the Ethereum ERC-721 standard. These are a set of guidelines to be respected in order to make an NFT compatible with the ecosystem. Among these, we also find fields to be filled in to characterise the work. Within each smart contract, data is entered to be associated with the respective token (or collection), which helps to define its value. In addition to the aforementioned ID, each non-fungible token is characterised by other information, called metadata. Any aspect of an NFT can be defined by its code, from graphic components to use cases.
If we go beyond the ‘visual’ aspect, even outside the realm of art, we will find out why this flexibility is an added value for NFTs. Often, the aesthetic factor plays a secondary role in pricing. Utility plays a more important role in giving economic weight to a non-fungible token. For instance, in-game items earned in a blockchain metaverse can be represented by a non-fungible token, so as to give the player back control over his or her progress. This can guarantee ownership of the earned tokens and the possibility to sell them, a mechanism commonly referred to as play-to-earn.
Applications for NFTs are not limited to the online environment. They could be a ticket to an actual event, such as a concert, theatre performance or conference. So-called POAPs can certify attendance at that occasion. Other non-fungible tokens can certify university degrees, essentially recording certificates such as a degree on blockchain.
The community: belonging and identity
Non-fungible tokens can also be access passes for elite groups. Owners of works belonging to collections such as the Bored Ape Yacht Club form restricted communities. These are distinguished by benefits such as governance powers over the project, exclusive airdrops, discounts on branded products, as well as access to real life events. In a way, we could say that the real value of an NFT that is part of a collection lies in the community aggregated around the project. It is the users who create meaning and make the tokens valuable.
In order to determine how much a non-fungible collection is worth, we have to consider its ability to arouse interest, retaining those on the inside and attracting curious observers from the outside. On the other hand, those who buy a token may be looking for a sense of community. It allows them to fit into a group of like-minded people with the same interests and values. Aggregation naturally is a human tendency, but at the same time we also seek to assert individuality. We might recognise ourselves perfectly in the image of a non-fungible token, so we choose it to represent our online identity.
NFT PFPs (profile pictures) are a good response to the need for identity. They are created to be profile pictures, forming collections of thousands of them based on a common prototype. Each has a different combination of distinctive features.
In other words, the value of an NFT is both subjective and socially recognised: the community and individuals justify the cost, and consequently the market will appreciate the tokens. Indeed, the virtuous circle generated by shared community ideals and tokens as an ‘extension of personality’ drives demand for certain collections.
The market: who determines the value of an NFT?
Creating and selling NFTs is a simple operation. You decide on which blockchain to create it, upload the file, define the metadata (title, description, collection it belongs to, unlockable content, etc.) and finally choose the price of your non-fungible token. The artist will set a figure consistent with his or her expectation. However, as we said before, the community plays an important role. In an auction, the perceived value of the work counts more.
So is it possible to establish a ‘mathematical‘ estimate of how much an NFT is worth? Actually, even in the crypto art market, the law of supply and demand applies. A non-fungible token has limited availability by nature. It can be a single copy, or have a precise number of copies. This factor is defined at creation. Thus, if the quantity in circulation is fixed, the supply of an NFT cannot vary over time. Therefore, as demand increases, the price should rise.
Scarcity is part of the price calculation. The ‘rarer’ a token is, the more valuable it will be, at least according to the law of supply and demand. However, when a non-fungible token is unique, but part of a larger collection, its ‘traits‘ and attributes determine its rarity. In a nutshell, for projects such as the CryptoKitties and Axie Infinity, but also for mass-created PFPs, characteristics such as body shape, facial expressions and accessories are randomly chosen by an algorithm. The degree to which individual qualities are spread out over the entire collection will make tokenised characters more or less rare.
To measure this, rarity tools can help. By analysing the metadata of non-fungible tokens, they rank them according to each specimen. For example, the rarest character in the Moonbirds collection, according to Rarity Sniper and Rarity Sniffer, is #668. This token has a very high rarity score, given by the low occurrence of its traits, so the value of this NFT should be equally remarkable.
Finally, one has to consider market liquidity. If no one were willing to buy a non-fungible token at the ‘recommended’ price, due to scarcity and rarity, its value will inevitably decrease until it meets demand. This is the case of the first tweet in history, which was tokenised and bought for nearly $3 million. It is now struggling to receive ‘adequate’ offers on Opensea.
Truth or hype?
Once your model for ‘calculating’ the price of an NFT has been defined, the exceptional figures of the most expensive ones are still out of scale. Million-dollar prices are impossible to fit into the proposed canons. They are determined by highly situational factors that are difficult to predict and systematise.
In general, collections could be driven by momentary enthusiasm (hype), generated for example by the interest of a famous person, or by psychological biases such as FOMO. The real question is: is the value of an NFT maintained in the long term? Only an active community, true utility and constant demand can achieve this, turning a non-fungible anonymous token into a blue chip collector’s piece.