NFT’s: Big Potential in a Goofy Wrapper

By now, unless you live under a rock, you’ve probably heard of NFT’s – non-fungible tokens. They are the first crypto project since bitcoin to scale that summit of popular consciousness, the Saturday Night Live skit.

Others complain that NFT’s are a stupid fad, a jokey tulip mania for crazy people who probably got wiped out on Beanie Babies. Of course, “crazy” is what critics said about Bitcoin for years, while “everybody’s crazy” isn’t much of an investment theory.

Still, when a “digital painting” sells for $70m, animated gifs from Elon Musk's girlfriend goes for $6m, and Lindsay Lohan’s digital portrait fetches $59k, the word crazy does come to mind. And it’s not just the headline-grabbers; according to BNP Paribas, the value of the NFT market tripled in 2020, now passing $250 million – about one-tenth of Hollywood’s domestic box office.

So are NFT’s a revolution, or are they as stupid as they look?

First, the stupid: NFT’s are probably overvalued, and I certainly wouldn’t invest the college fund in them. Still, as Keynes once said, “markets can remain irrational longer than you can remain solvent.” Nobody knows if NFT prices will hold up or even rise from here. The best we can say is, in the famous words of investor Warren Buffet, “they will fluctuate.”

Now for the revolution. Love them or hate them, I think NFT’s are here to stay. Because NFT’s are a legitimately better mousetrap for a number of existing markets that are big enough to sustain and improve the technology. While NFT’s could evolve to be a better mousetrap for enormous markets that are world-changing in scale.

So, first, what is an NFT? It’s simply a piece of content, like a photo, video, or tweet, that is verified as coming from a specific source. It could be a song from an artist, a video of a slam dunk by LeBron, or a pdf. Anything you can attach to an email, you can probably make it into an NFT.

The “token” is, essentially, the limited-edition certificate. And “non-fungible” means each one is unique, unlike fungible things like grains of rice, cups of water, dollars or bitcoins.

Non-fungible tokens is actually an old idea, called “colored coins” in a 2013 white paper and widely popularized in the 2017 “Cryptokitties” craze. In the case today’s NFT’s by artists, usually you’re not buying the copyright, rather one of a limited number of copies. It’s similar to a limited-edition print, then, but in digital form and one that can’t be forged.

NFT’s can even be programmed to bundle specific rights, such as the right to display it at a museum but not a for-profit event, or to display it for a couple months but not forever. And, like limited-edition prints, most buyers might keep it because they like owning it, or they might resell it since it’s verifiably genuine.

Consider current techniques of doing this: To authenticate art you either need laborious documentation, even an expert with a magnifying glass to verify artist signatures or paint-strokes. Meanwhile, current techniques of distributing art require middlemen such as Sotheby’s who take a big cut of the proceeds and will only deal with big names. So simply automating authenticity and distribution makes NFT’s a better mousetrap for the art and collectibles world.

Of course, collectibles isn’t a very big market, so where does the revolution come in? For starters, because NFT’s make the issue, verification, and trading process so much cheaper and easier, these markets could grow much bigger.

Celebrities might offer NFTs the way they today offer cameo appearances, fans-only content, special Patreon rewards, or simply the good feelings from supporting your favorite artist. We’re seeing early examples such as a new “NFT’s for people” service called Bitclout that disintermediates and monetizes celebrity-fan interactions.

Now add the fact that NFT’s can be preprogrammed, and they can be bundled with licenses determining whether works can be displayed and under which conditions or how long -- for-profit, pre-approved venues, only in certain countries, and so on. Or the NFT could be programmed to pay, say, 5% of future re-sales to the artist, which is very hard to set up and enforce today. Taken together, these allow artists to monetize their work far more easily and flexibly than today.

A second major area where NFT’s are already superior is in-game assets. This includes unique “skins” for your character in a game, limited-supply in-game weapons or vehicles, or parcels of virtual land. These may seem silly if you’re older than 40, but if you have kids you know it’s a big deal.

This is a surprisingly large market; one group recently paid $1.6 million for a “kingdom” in a yet-unreleased game, topping the previous record of $1.5 million for nine plots in a virtual pet universe. Again, because NFT’s let these assets be verified and bought or sold very easily compared to scrounging around on eBay, they could substantially grow these markets.

So that’s the starting point: NFT’s are a legitimate tool for decent-sized markets today. What’s far more interesting is what happens next.

Easy extensions of the concept are university degrees or professional licenses, ticket sales that can't be scalped, or tracking supply chains where each item has an NFT as it rolls off the assembly line – useful for quality control, inventory management, or ensuring a given supply chain is “ethical” or uses a given ratio of domestic inputs.

A second area of easy extension takes advantage of NFT’s programmability. For example, music licensing is an extremely inefficient industry that urgently needs simpler and less burdensome ways to create, use, and trade rights.

Then there’s the big one: applying NFTs to legally-binding documents. These include contracts, loans, mortgages, titles to any property from equities to bonds to custom debt instruments. These are enormous markets – $170 billion is traded on the NYSE per day, and trillions of dollars are locked away in documents that cannot be traded, or even verified with certainty, without costly effort.

While the crypto industry has had previous false-starts on such tokenization of real-world assets, the dream here is, say, a stock market based on digital representations of, say, Apple shares, each uniquely numbered and verified as genuine. Lower costs of such markets could then extend access to smaller players, for example a small restaurant startup crowdfunding via equity, something that regulators and high costs have so far crippled.

Of course, just because something could be a better mousetrap doesn’t mean it will be. There are many crypto applications that work in theory but still lack wide uptake outside crypto enthusiasts, from Augur to Brave to Filecoin. So far NFTs seem to have overcome this barrier and reach normal people with little crypto experience. Still, the most we can say is there are enormous applications where NFTs can do it better in theory, but it will take entrepreneurial effort and a benign regulatory environment.

Bottom line, NFT’s may or may not be a bubble. But they, or a similar technology, are here to stay and could turn into a very big deal. Pricing could be “too high” because NFT’s are new and there aren’t many good ones for sale yet — the market isn’t yet flooded. Or prices could be “too low” because a rush of buyers is coming. But, either way, I think they are an innovation worth exploring and worth encouraging.

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