Right-Click Save #1: A framework for thinking about NFTs
Why NFTs are different, what drives narratives + value. And a simple ontology for NFTs
2021 marks the rise of NFTs - what a year it’s been! We’ve witnessed a Cambrian explosion of artistic creativity, technological innovation and financial inflows to the space in a very short period.
I’m excited to see many developers, innovators and artists experiment with this technology as a new medium for their creations. Every project that utilises NFTs in an interesting new way gives me chills (in a good way).
A key reason for this hyper-growth is because NFTs enable the financialization of global culture. Culture is a manifestation of our everyday lives. It is easy for the man-in-the-street to relate to collecting cool stuff, unlike DeFi which requires a minimum threshold of technical and financial knowledge. Buying an Axie to play a card battle game similar to Pokemon is 100x more intuitive than buying and depositing USDC into a Curve pool to farm governance tokens.
This is further catalysed by a growing number of mainstream celebrities such as Jay-Z, Snoop Dogg, Stephen Curry, Paris Hilton, Steve Aoki embracing NFTs as their digital identities and igniting the mimetic desire of their millions of fans.
We’ve seen a lot of speculation these past months, with some NFT prices rising 10 - 100x and crashing 90% within a span of weeks.
The huge volatility in NFTs arises because:
NFTs are relatively illiquid. Trading that happens at the margins move floor prices very quickly
It is in constant price discovery because of limited price history
Much of the intrinsic value of NFTs such as culture is intangible and difficult to quantify
No consistent valuation frameworks that have been adopted
And most importantly: 5. NFTs are highly narrative-driven. We’ll get into that later.
The first NFT I bought was a Non-Fungible Ape back in Jan 2021. It was pixel art in the likeness of various character tropes and celebrities as “apes”. I chanced upon the discord just as they did their 1st stealth drop and I didn’t know what I was doing. Browsing through each drop on OpenSea, it ignited a burning desire in my heart to buy and collect apes with the rarest traits. Today they are worth 0: no buyers. Lesson learnt.
In hindsight, I should have predicted this because the market was kept afloat entirely by speculation: it had no historical value, anonymous unknown artist who just joined twitter, tiny community, zero utility, mediocre art. It attempted and failed to create narratives in any of the 5 NFT domain areas I will outline later.
Look at Board Ape Yacht Club, Fidenzas, XCOPY, mystic axies and many others. What makes them so valuable now and how do we identify value opportunities early?
No wonder we’re all asking ‘wen next fidenza?’
Why NFTs are different
I’m fascinated with NFTs because they inherently represent a unique complexity layer that fungible tokens do not have. This layer comprises of both the intangible (eg. culture) and tangible, making it a fun intellectual exercise.
At the highest level, NFTs exist and share the same base layer blockchain infrastructure as with all other crypto applications, with Ethereum being the most common chain. This includes NFT-specific chains and L2 solutions such as Flow and Immutable X.
The next level - the platform layer - enables the financial services for NFTs: think exchanges, liquidity provision, loans, fractionalisation etc. These are platforms because they usually serve multiple different tokens rather than a single one.
Unlike fungible tokens, NFTs yet another layer, where an individual ‘application’ is packed into the token itself. NFT standards (ERC-721 typically) enable tokens to be linked to on-chain or off-chain assets through its metadata, while retaining the provenance, immutability and network security of the blockchain.
Let me oversimplify with a Web2 analogy:
(1st level) Base-layer blockchain = Internet + Mobile phones.
eg. TCP/IP, iPhone. Widespread & openly available
(2nd level) Application/Infrastructure = Internet platforms.
eg. Apple’s App Store
(3rd level) NFTs = Individual mobile apps.
eg. Facebook app
Platforms are very powerful and capture huge value through their network effects and broad market reach. Good platforms take a lot of time to build, grow and hit terminal velocity on the adoption curve. Individual apps often represent the layer with the highest level of variety, innovation and creative inputs - because anyone with an idea can create and launch a (basic) mobile app fairly easily these days. A web3 equivalent here is NFTs.
To further illustrate this, let’s consider Aave (platform) and CryptoPunks (NFT):
The value of 1 AAVE is tied to the success of the Aave application/protocol as a whole: Total value locked which comprises of largely of different LP tokens, revenue generated, user growth.
The value of 1 CryptoPunk is… how cool it looks, how rare it is and how much people really want it. Not dependent on any external application.
A Simple Ontology for NFTs
So I set out to explore a framework for thinking through NFTs.
How do you identify NFTs with narratives that can potentially go viral?
How might you determine if a NFT is under or overvalued?
The goal of this is not to quantify a specific fair value for NFTs - there is no Discounted Cash Flow model for NFTs. Instead, I lay out a dynamic framework for NFT project creators and NFT investors to consider so they can make better decisions.
I dissect deep into what gives value to a NFT and distill it down to 5 major domains. This is different from the typical categorisation of NFTs that we are all familiar with: collectibles, generative art, virtual land, games etc. Reason being is that there are often significant overlap between these categories. These 5 domains apply to all NFTs, though their relative importance varies from project to project.
NFTs have a cultural and aesthetic premium over their fungible counterparts. Along a spectrum of the intangible to tangible, these 5 domains are:
This is the most interesting component of NFTs and also the hardest to value.
Culture is broad and encompasses the shared experiences, perceptions and beliefs of a society.
Cultural components include but not limited to:
Mimetic desire: We desire what other people desire because we imitate their desires
Flex value: Am I perceived as showing wealth, culture and class?
Refers to the aesthetic appeal of the media (eg. artwork, music) that is linked to the NFT
Do you like it? How many other people, particularly tastemakers, like it?
Does ownership signal that that you have a good eye for beauty?
Refers to a summation of the existing owners of the NFT collection
As with most things in Web3, community is everything.
What are owners’ demographic profiles, psyche, wealth and vision? Are they more likely to be diamond or paper hands? Are they loud and crass, or quietly sophisticated?
Measurable metrics: Is the community growing, stagnant or receding? How many contributors are there?
Refers to benefits that directly arise from ownership of the NFT, as such as private membership groups, early access to mints, farming of tokens, physical merchandise
Major component of game and metaverse NFTs: e.g. Axies, Sandbox land, Star Atlas spaceships, Ember sword badges. In play-to-earn games, these can generate yield too.
NFT-fi (NFT + DeFi) is very interesting.
Refers to digital or real-world assets that owners of the NFT are entitled to, in addition to the NFT itself
Eg. project treasury, other NFTs, intellectual property, real estate
In the coming articles, I will be exploring each of these 5 domains in deeper detail and with examples.
In a nutshell,
NFT = Culture + Aesthetics + Community + Assets + Utility
This is a summation (+) equation: meaning all NFT projects that intend to maximise their value and become an investable asset should think about how they play in each of these 5 domains. Even though they may have a primary focus in one of the domains.
A generative artist whose talent is creating algorithms that produce wonderful artwork that the world needs should also consider:
how he/she can engage with and build a positive community of collectors, instead of disappearing entirely “to work on my art”
how he/she can add utility to owning the artwork through memberships, early access to new works etc.
Even though aesthetics is the primary domain here. Aesthetics can be difficult to judge, but community and utility are more tangibly measurable.
A couple of factors related to the blockchain that are not captured in this framework but can contribute to narrative and/or value of a NFT:
1. Base chain of the NFT
Ethereum is currently the network of choice for NFTs, especially high value NFTs. This is partly due to the security guarantees on the network.
NFTs on chains or roll-ups outside of Ethereum (e.g. Polygon, Solana, Avax, Arbitrum) are significantly discounted by the market today though this may not be the case in the future.
2. Permanence of metadata
Arweave > IFPS > centralised website
3. (Gen Art) On-chain vs Off-chain
Art that is stored entirely on-chain appears to have a premium over art is stored in an off-chain location. Block space is very expensive which makes on-chain storage often impractical.
e.g. Autoglyphs as the oldest on-chain generative art project
4. Derivatives vs Original
It is the law of crypto that successful projects will be cloned and forked multiple times. As we’ve seen play out multiple times, derivatives can rise steeply in price in the short-term due to speculation but in the long-run value usually returns to the original.
e.g. Cryptopunks ← Phunks, Fast Food Punks, Picasso Punks, Bastard Gan Punks…
Why bother with this? Aren’t NFTs supposed to be simple: just buy them if I like them? Yes, that works too.
I put this framework together to help me better understand and systematically identify factors that can drive a NFT’s value. And to avoid FOMO on projects with weak or temporary narratives. I hope it can be useful to you too.
I believe that for NFTs to go mainstream as a truly investable asset, we need to starting thinking and speaking the same language as people in the traditional investing world. Frameworks which are understandable by non-crypto natives and demystify crypto tech and concepts. Akin to a ‘value investing’ approach.
What is culture in the context of NFTs?
How do we identify substantial cultural narratives to pay attention to?
Can we assign a value on the different components of culture?
How might an artist (gen artist, photographer, musician etc) price his/her artworks?
CryptoPunks vs Bored Apes : A case study
Let me know what you think, I always love to hear feedback and discuss.
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Thanks for bearing with my spew - happy minting!