How NFTs Create Value ?

8 min read

Everydays: The First 5000 Days, a work of art, sold for $69 million at Christie's Auction House in March 2021. Eight-figure art sales aren't uncommon, but this one drew a lot of attention because it was sold as a non fungible token (NFT)–an electronic record corresponding to an image that exists entirely in the digital world.

To put it another way, someone paid nearly $70 million for an image on the internet.

Since then, NFTs have infiltrated popular culture in a variety of ways. Saturday Night Live parodied them, and high-profile celebrities like rapper Snoop Dogg and NBA superstar Stephen Curry endorsed them. Each week, public marketplaces like Foundation, OpenSea, and Nifty Gateway, as well as custom-built applications like NBA Top Shot and VeVe, sell hundreds of millions of dollars in NFT.

However, many people are perplexed how internet tokens could be worth anything at all, especially when many of them simply represent "ownership" of an online image or animation that you could theoretically download for free.

It's easy to see why NFTs elicit both excitement and skepticism: they're a completely new asset class, and new asset classes don't come along very often. But what determines the value of an asset that is essentially a digital token that people can trade? To fully appreciate NFTs, we must first consider what they are and the market opportunities they open up. And once we've figured that out, we'll be able to figure out how to build businesses around them.

NFTs as a Market Design Tool

NFTs have altered the digital asset market. Previously, there was no way to distinguish between the "owner" of a digital artwork and someone who simply saved a copy to their computer. Markets cannot function without simple property rights: before someone can buy something, it must be clear who may sell it, and once someone has bought it, ownership must be transferred from the seller to the buyer. NFTs solve this problem by providing something that both parties can agree on as a representation of ownership. They enable markets to be built around new types of transactions, such as buying and selling products that could never be sold before, or enabling transactions to take place in more efficient and valuable ways.

Each NFT is a one-of-a-kind digital item, as the name "non-fungible token" implies. They're stored on blockchains, which are public-facing digital ledgers that make it possible to prove who owns a given NFT and trace the history of previous ownership. It is simple to transfer NFTs from one person to another — just as a bank might move money between accounts — and counterfeiting them is difficult. We can use NFTs to create markets in a variety of goods because ownership is simply to certify and transfer.

NFTs aren't just a kind of digital "deed." Because blockchains can be programmable, we can endow NFTs with features that allow them to evolve over time or even provide direct utility to their holders. In other words, NFTs can perform tasks — or allow their owners to perform tasks — in both digital and physical environments.

NFTs can act as membership cards or tickets, giving holders access to events, exclusive merchandise, and special discounts, as well as serving as digital keys to online spaces where they can interact with one another. Because the blockchain is open to the public, it is possible to send additional products to anyone who owns a specific token. All of this provides creators with a vector to build a highly engaged community around their brands, besides providing value to NFT holders.

Creators frequently host in-person meetups for their NFT holders, as many did at the recent NFT NYC conference. Other times, having a specific NFT in your online wallet may be required to access an online game, chat room, or merchandise store. Owners of a particular goat NFT, for example, could recently claim a free baby goat NFT that provides benefits besides the original token; holders of a particular bear NFT recently received honey.

Thus, owning an NFT effectively makes you an investor, a member of a club, a brand shareholder, and a participant in a loyalty program all at once. NFTs’ programmability supports new business and profit models — for example, NFTs have enabled a new type of royalty contract, whereby each time a work is resold, a share of the transaction goes back to the original creator.

This means that, compared to other crypto products, NFT-based markets can emerge and gain traction quickly. This is because NFTs have stand-alone value — you might buy an art NFT just because you like it — and because NFTs only need to establish value among a small community of potential owners, whereas cryptocurrencies require widespread acceptance to be useful as a store of value and/or medium of exchange.

NFT Ecosystems Have Arrived

As marketplaces have sprung up around NFTs, creators have taken advantage of their possibilities in different ways.

The digital art market, as mentioned above, and digital collectables platforms, such as Dapper Labs' NBA Top Shot, which allows users to collect and exchange NFTs of exciting plays from basketball games — videos called "moments," which are effectively digital trading cards — are the most well-known examples. Top Shot has been incorporating gamified challenges and other reasons to own the cards that go beyond their collectible value, even hinting that moment holders may receive real-world benefits from the NBA in the future.

But, more recently, a model of active ecosystem-building around NFT-native properties has emerged, leading to the creation of new organizations entirely within the NFT space. These products begin with the NFT series, but they follow a roadmap that allows NFT holders to gain access to a growing number of products, activities, and experiences. Initial and subsequent NFT sales revenue is reinvested in the brand, allowing it to fund increasingly ambitious projects, which raises the value of the NFTs themselves.

For example, the Bored Ape Yacht Club comprises a series of NFT ape images that confer membership in an online community. The project began with a few private chat rooms and a graffiti board, and has since expanded to include high-end merchandise, social events, and even a yacht party. Sup Ducks and the Gutter Cat Gang both started communities around the NFT image series and related online spaces, with the former branching out into a boardwalk-themed metaverse game and the latter focusing on real-world benefits like lavish in-person events.

People often use their favorite NFT image as their public profile picture on social media, making membership in these collectives a part of their personal identity. Each NFT community has its own personality and goals, and there are now so many that almost anyone can find a group to call their own. In this way, NFT ownership creates a shared text that people can use to communicate with one another right away.

In many of these communities, ownership includes partial or full commercial rights, as well as some level of governance over how the community is run, allowing members to build properties on top of their NFTs, increasing the overall brand value. Importantly, this creates a channel for engaged fans to feed back into the brand: "Jenkins the Valet" is a project started by a Bored Ape member that has effectively grown into its own sub-brand. Sup Ducks members have created artwork and character identities based on their NFTs, which have been absorbed into the Sup Ducks metaverse. Parts of the Gutter Cat Gang story arc have been fleshed out thanks to community-created fan projects.

These benefits make owning the associated NFTs more valuable — and almost paradoxically, this increase in the value of ownership comes in a form that helps separate the value of ownership from the purely financial opportunity of reselling.

SupDuck #6484, Bored Ape #9976, and Gutter Cat #234, from left; NFT images used with permission from NFT holders Kominers and Kaczynski; Getty Images/HBR Staff

A few well-known brands have recently introduced NFT series to identify, reinforce, and expand their existing communities of brand enthusiasts, capitalizing on this trend. The Hundreds, for example, have built an NFT project around their mascot, the "Adam Bomb," and reward their community of NFT holders with better access to the brand, including connections with the founders and early access to new product releases.

In the meantime, many new NFT applications are attempting to more explicitly combine online NFT ownership with offline use cases. For example, a few restaurants have accepted NFTs for reservations. And the ticketing industry stands to benefit from this: By issuing tickets as NFTs, venues can provide a variety of benefits to buyers, increasing the incentive to buy while also allowing them to collect royalties on secondary sales.

Other businesses are looking into how NFTs could be used to establish and record people's online identities and reputations. MIT has recently begun offering blockchain-based digital diplomas, which are effectively non-transferable non-financial tokens (NFTs). Meanwhile, established players such as Facebook (now Meta) and newcomers such as POAP and koodos are allowing people to create and share NFTs based on their activities, affinities, and interests.

How Can These Companies Succeed?

Each NFT project, like any other business, must address a real market need. Building in the NFT space, however, comes with its own set of challenges:

These businesses must effectively use the NFT technology.

Because digital rights management is one of the most direct applications of the technology, it's no coincidence that many of the early NFT projects are built around it. Because a given NFT holder can certify their right to have access simply by pointing to the token in their crypto wallet, club membership benefits for NFT holders fit in naturally as well.

NFTs make less sense when digital ownership serves no purpose, such as managing physical collectibles, where people presumably want to receive the objects themselves. (Unless, as with a recent NFT for a 2,000-pound tungsten cube, they're too heavy to move.)

NFTs must also make use of a user community.

Early adopters, like any new product, serve as product evangelists and a source of early feedback. However, with NFTs, these users play an even more important role: their decision to embrace the NFTs literally imbues them with meaning and establishes their initial value.

NFT projects that lack a strong user community may struggle to get off the ground or may quickly collapse as all token holders lose interest. As a result, if an NFT project's value proposition isn't clear enough from the start, it may struggle to attract a large enough — or the right — community. The lack of engagement can then become a self-fulfilling prophecy, lowering the value of NFTs.

NFT project teams must instill confidence in their ability to continue executing in order to maintain community engagement.

In the crypto world, where many people take part partially or completely anonymously, confidence crises in a project can spread quickly, so it's critical that the team communicates frequently and transparently about how they plan to evolve the project. (For this reason, many NFT teams hold regular "community calls.")

NFT projects can rely on well-known brands or institutions, as well as explicit promises of real-world utility, in this case. For example, a sports team or a well-known musician selling tickets through NFTs can rely on their existing reputation and event infrastructure to persuade fans that the NFT tickets are indeed valuable. However, an existing company releasing an NFT with no specific purpose or value may appear gimmicky, failing to engage customers.

For new users, NFT projects require accessible "on-ramps."

NFTs also face several challenges that are common in the crypto world. Most crypto technology is currently inaccessible to the public, requiring interaction with a plethora of complicated cryptocurrency exchanges and wallet providers.

NBA Top Shot has reaped significant benefits from burying most of the underlying crypto structure in its NFT market and allowing users to buy moments in fiat using credit cards rather than cryptocurrency. Other projects have hired onboarding directors to assist first-time NFT buyers with the purchasing process.

In addition, an NFT project must be able to withstand fluctuations in the cryptocurrency market.

Cryptocurrency markets are volatile, and the regulatory frameworks that surround them are still being ironed out. These market swings can drastically alter demand for NFTs, emphasizing the importance of cultivating community and other direct value sources for NFT ownership.

Outlook

The future of NFTs is uncertain, as it is with any new asset class. In the long run, the market will have to deal with the current transaction and environmental costs associated with cryptography. More explicit legal frameworks for NFT ownership will be required, as well as clarify how NFTs relate to existing forms of ownership rights, particularly in intellectual property. Simultaneously, it's likely that the most valuable applications of NFTs have yet to be imagined.

The community-based NFT projects that have taken off so far hint at what may be to come.

By allowing people to create and build on alternative forms of ownership, NFTs enable new markets to emerge. These projects succeed by leveraging a core crypto dynamic: a token's value is determined by users' shared agreement, so the community built around NFTs literally creates the underlying value of those NFTs. And the more engaged these communities become and the more they become a part of people's personal identities, the stronger that value becomes.

Newer applications will make better use of online-offline connections, and token designs will become more complex. People are still making money selling pictures on the internet, which is less surprising than you might think.

Amit Caesar wrote the article:

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NFT non fungible token NFTs token metaverse SupDuck Bored Ape Gutter Cat Facebook Meta crypto cryptocurrency