NFTs: PIONEERING DIGITAL IDENTITY or leading us astray?

Written By Rob Price

NFTs have taken the world by storm in the past 18 months, potentially unleashing a social movement in digital identity and community. As a macro specialist, non-fungible tokens (similar to collectibles) do not get me particularly excited because they don’t suit my analysis framework. I like to look at monetary, social and economic trends and invest into deeply liquid assets that can best capture those trends. So, I have observed the social trends from the sidelines while others have made fortunes trading NFTs. In this article I will lay out a few of those observations. I appreciate that I may just be salty from FOMO, but I will be as objective as possible. Those who are clued-up on NFTs should skip the definition and history, read the critiques and macro conclusions.

TLDR: I appreciate the excitement and am grateful to NFTs for broadening the social movement and could be a very important social commentary in the years ahead, but I worry that they are an expression of the very monetary problems we need to solve through decentralized sound money.

Definition and history

“An NFT is a unit of data stored on a blockchain that certifies a digital asset to be unique and therefore not interchangeable, while offering a unique digital certificate of ownership for the NFT3. More broadly, an NFT allows to establish the provenance of the assigned digital object, offering indisputable answers to such questions as who owns, previously owned, and created the NFT, as well as which of the many copies is the original. Several types of digital objects can be associated to an NFT including photos, videos, and audio.” - Mapping the NFT Revolution.

Here is a great history of NFTs from cryptokitties to Beeple and cryptopunks:

Programmable, decentralized content ownership

Essentially, NFTs are unique digital tokens, representing a scarce asset, usually an artwork but they could represent music, videos or tickets too. The technological promise is that these tokens allow for decentralization of content ownership. Rather than an artist being reliant on galleries and agents to distribute his/her work, they can issue the art directly to customers. This is the reason why you hear people talking about Web3 – a step up from Web2 which has centralized content ownership by a few digital protocols like Facebook, Youtube, Instragram, etc.

The tokens are also programmable so neat features can be added. For example, royalties could be inserted, allowing the artist to earn income from future sales.

Programmable, decentralized creator owned content is an exciting prospect indeed! 

SOCIETY VALUES COLLECTIBLES

Source: OldSportsCards.com

Another angle through which to view NFTs is a new-age gold rush for a new form of collectibles. For years society has valued collectibles like baseball cards and music records. The most valuable collectibles tend to be the oldest and rarest. The multi million dollar price tag for some of baseball cards provides an indication of the money people are will to pay for scarcity. I am not much a collector so this does not appeal to me, but I am trying to put myself into someone else’s shoes here… If you apply that logic to NFTs and extrapolate the trend forward 50 years, punks and bored apes could be worth a lot more than they are today.

It is very difficult to create a quantitative valuation framework but I can see the logic in digital collectibles.

identity, community and broadening the MOVEMENT

Humans want to identify with a community, to feel part of something, particularly if it feels exclusive. People have identified according many different labels in the past: nationality, religion, language and culture are the biggies but sport, music and fashion have become important in the last 20 years. Exponential growth in the internet, e-commerce and gaming implies that large swathes of the world live online today. Digital communities have flourished that are completely unknown to the rest of us, and some of them are powerful. For example, political movements have been borne out of chat groups.

Saying that you are part of a community usually does not suffice. People want the paraphernalia - jersey’s, scarves and hats; posters and concert stubs. Objects you can own and display prove your commitment to your tribe, and earn you street cred.

NFTs are the seemingly the paraphernalia for the online world, the collectibles which identify your tribe.

A broader social movement has emerged as a result of NFTs with artists, marketers, celebrities and creatives flocking into the space to capitalize on this new form of expression, digital identity, and branding tool. It is particularly exciting to see a new segment of society enter the crypto markets and grapple with the power of decentralized technology. I remember being blown away in early 2021 by the attendance at an NFT meet-up my friend and I hosted Venice LA (a great buying signal in hindsight!). It could have taken years to pull artists, DJs, actors and musicians into crypto but NFTs have generated immediate allure. It is wonderful to expand the crypto community and incorporate different social influences.

Bitcoin and crypto is far more than just a monetary and financial experiment. The social communities that steward and use these networks are critical.

NFT communities have exploded in 2021 and made many people incredibly wealthy! Good on them! But that is not the full story. Below the surface some questions need to be asked about whether the technology is living up to its promises. Here are a few important critiques:

MANY nftS ARE HIGHLY CentralizED

NFTs and Web3 are meant to provide decentralized value transfer, but are they really decentralized? The founder of Signal, Moxie articulates the problem well in this article on Web3. I would highly recommend reading the full article.

Why do centralized platforms emerge in the first place? Because people do not want to run their own servers, and never will. A protocol also moves much more slowly than a platform and it can be more costly as a result. As soon as developers want to execute more complicated functionality for more interesting use-cases, it makes sense to centralize.

Most blockchains are more centralized than bitcoin in order to focus on more complex use-cases. Bitcoin can remain decentralised because it does not try to do a lot more than value transfer and storage, but users still pay for these features through elevated transaction fees. ETH is too centralized for my comfort as a global reserve asset, relying on centralized server providers like Infura to run node on behalf of clients. Bitcoiners often bash ethereum for being too centralised, but, in reality, ethereum is still a lot more centralised than many other blockchains in the ecosystem.

Many users may not care if their favourite NFT collection is centralized. But, if that is the case, we need to pull back the lens and argue whether a blockchain is required at all. It would be far cheaper to maintain a centralised database than a pseudo-decentralised blockchain. One could also argue that digital art does not need to match up to the same decentralisation standards as a global reserve asset so perhaps a degree of cenralisation in NFTs is warranted. Wherever you stand on this, it is important to be aware of the trade-offs and implications. 

Greater centralization does not render eth, defi or web3 useless but it is important to investigate whether the technology is truly matching up to the narrative.

Wash trading & Astroturfing

“Wash trading is the term used to describe the practice of a single owner buying and selling a security, or in this place an NFT, to themselves to simulate an increase in value. It’s illegal on stock exchanges in the United States and has been for nearly 100 years, but the NFT marketplace is unregulated and thus is a prime target for the age-old practice” - PetaPixel

Astroturfing is the term given to inauthentic Twitter accounts being used to create the illusion of support for a project. Geoff Goldberg outlines this in more detail.

Neither of these practices negates NFTs, but new users need to be circumspect. These are idiosyncratic speculative assets that can easily be manipulated by founders who have limited incentive to care about the long-term viability of the project. People worry about bitcoin whales and their ability to manipulate price but these individuals have dedicated years of their lives to the project and given the size of bitcoin’s market capitalization it is far more difficult to actually manipulate.

New users need to be circumspect, NFTs are susceptible to predatory founders and scammers.

DO WE WANT TO REPLICATE TRAD-FI?

Albert-Laszlo Barabasi’s research shows that primary and secondary NFT markets have been dominated by a handful of NFT collectors. This suggests that the market is even more concentrated than the traditional art world, which is often criticized for its exclusivity and concentration.

None of these criticisms dismiss the potential value of the technology. These problems exist in traditional finance so I would be very wary of just leveling these critiques at NFTs alone. Gary Vaynerchuk articulates this viewpoint articulately in this video (LINK on right hand side).

While compelling, lets dig into the conclusions Gary V is drawing...

The description affirms my understanding that NFTs are luxuries - nice-to-have status symbols. I do not have anything against people buying or selling luxuries, but they are not a reflection of what is good with society. In fact, they could be a reflection of the less savoury components of society. Flaunting of luxuries fuels greed and ego. They do not solve any problem other than to satisfy an ego’s need to be inflated in exclusivity.

Celebrities love NFTs  because they are able to capitalize on their brands and make a killing off their fans. Once again, there is nothing new here and I have no problem with celebrities using the tools at their disposal. But I have to ask, is this resulting in any positive societal impact? Are NFTs  truly achieving their stated purpose? Are they decentralizing entertainment? Are they giving power to content creators? Or are they another tool for celebrities, agencies and marketers to extract returns from fame, social status and hype?

Pulling back the lens, I must return to the reason bitcoin exists. For me, decentralized money has the potential to reduce the negative impacts of our centralized monetary system, including inflation, wealth inequality, weak economic growth, over indebtedness, large bureaucratic governments, short-term thinking, and the wider negative social consequences on the world in which we live.

Bitcoin is specifically working towards a secure decentralized monetary system so I can be clear of the way in which it aligns with my purpose. With NFTs, I am less clear.

NFTs are at the far end of the risk-return spectrum

At the end of the day, all financial assets are impacted by the extreme monetary conditions of the 2020s - NFTs are no different. I always like to think about where an investment sits on a theoretical risk-return spectrum to gauge the impact of monetary stimulus.

For example, traditional investors would see small cap equities as riskier than large cap and crypto would be riskier than equities. Bitcoin is low risk on the risk-return spectrum in crypto. I would categorize NFTs at the other end of the spectrum because the assets are idiosyncratic and illiquid. Social preferences for NFT projects could shift at the blink of an eye, leaving investors holding very expensive digital art without a buyer. 

Simplistically, liquidity injections will boost the higher risk assets and contractions result in the opposite effect. Fed stimulus generally impacts small, new, shiny assets more than large, stable and old assets. For example, stimulus has a bigger impact on small cap equities and tech stocks like Tesla than old large cap equities. Crypto is even more impacted because its newer, more volatile and has a wider range of potential outcomes between utopia and zero.

When stimulus is withdrawn an unwind takes place.  So, bitcoin tends to outperform equity on the way up and underperform on the way down, but bitcoin underperforms the rest of crypto on the way up and outperforms on the way down. I expect the similar relationship with NFTs. NFTs have outperformed bitcoin during the late stages of the bull-market and now that trad-fi markets are in a more troubling position and liquidity is being withdrawn, the risk to NFTs is elevated. For example, Bored Apes were initially sold for $190 in April 2021 and are now worth in excess of $400K. Global NFT trading volume data suggests that the market came under more pressure in February. Lets see how the rest of the year plays out.

The biggest risk to any crypto project is that it becomes worthless, which was the fate of most projects from the 2017 era. Very few of the top 10 market cap coins from 2017 are still in the top 20 today. Perhaps the blue-chip NFT collections hold value over the coming years because they are promoted by celebrities who have no reason to sell, but I expect most NFTs will become worthless long-term. 

Surveys suggests that the majority of people do not make money on NFTs. Obviously there are exceptions to the rule. Some people have made life-changing money - good for them! But the average person is not going to make money from buying and holding an NFT. Another survey suggests that 48% of Americans think NFTs are a “safe investment” - this worries me. Famous actors, sportspeople and social media personalities make money on NFTs - not the average investor. I do not have anything against these people but I would rather advocate that people focus on principles, concepts and assets that will enhance their livelihoods long-term.

NFTs are an expression of inflationary global monetary policy and are on the far end of the risk-return spectrum.

Boomer conservatism on NFTS

I appreciate that no one knows exactly how the future will turn out and I could be wide of the mark here. At the end of the day, the market will decide what is valuable and what is not, not me. NFTs can overcome all the criticisms I have leveled at them and a gold rush for digital collectibles could be underway. The crypto social movement is increasingly a very important concept and NFTs are really throwing a cat amongst the pigeons in this regard. Additionally, the technology will be used for all sorts of purposes which we cannot yet imagine. However, it seems pretty obvious to me that too much liquidity has entered the market. Not only is the liquidity leading to exuberance as people speculate on price increases in digital art, but I worry that these effective luxuries highlight less savoury components of modern society which is focused on celebrity culture, status symbols and the social ladder. The average person is not going to benefit from throwing their capital at NFTs.

I know I sound like a boomer, but I am actually just a concerned millennial who continues to think that people under appreciate the extent of the monetary challenges we face in the 2020s. I think we need to focus our attention on technologies which explicitly have the power to foster positive social change. Decentralized sound money with an appreciation of its principles is imperative. I worry that speculative jpeg trading is leading people astray. 

Rob Price
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