NFTs: Will the Bubble Burst?

December 8, 2021

Memes being sold for the cost of a Tesla. Tweets fetching seven-figure bids. Welcome to the wild world of NFTs.

Since September 2020, the monthly volume of traded NFTs has exploded, growing from a few million to a whopping $241 million in February 2021. As of May 2021, an estimated 85,787 NFTs were sold for a total $5.8 million value per day.

But are NFTs a brilliant innovation, or the next iteration of tulip mania? Has the NFT bubble already burst? Here’s what investors should know.

What are NFTs?

NFTs are the next biggest blockchain craze. Supporters consider NFTs the next phase of art collection. Skeptics call them a waste of money for a PDF. But what are NFTs?

In economics, a fungible asset is something broken into units which can be readily interchanged with other units while still retaining the same value. The classic example is money—you can swap out a $10 bill for two $5 bills, or ten $1 bills, or any combination you’d like, and it would all be recognized as $10. But if something is non-fungible, such a trade is impossible. The unique qualities of the asset make it impossible to interchange with something else.

Non-fungible tokens, or NFTs, are digital assets which exist on blockchain. They have a unique digital signature which makes them wholly unique from any other digital asset and makes them impossible to reproduce. This makes them unique from other digital assets, which can be reproduced endlessly.

Because of this, NFTs can be bought and sold like any other piece of property, despite the fact that they don’t physically exist. The digital token acts as a certificate of ownership, and NFT transactions are recorded on blockchain.

How They Work

Picture a Van Gogh—an original museum piece, not a replica. Such a painting has recognized value in the world because it is one-of-a-kind and impossible to reproduce (or at least, you can paint a copy, but it’s a copy, not the original Van Gogh).

In ye olden days of fine art, before the advent of the Internet, art had value because it was a physical object with unique properties. There was only one version of it, and it could not be replicated while retaining the qualities of the original.

NFTs deliver those one-of-a-kind qualities to digital art. While you may be able to copy and paste an image, you can’t copy its digital signature, nor can you forge its transaction history in blockchain (at least, not without hacking the entire chain at once).

Basically, think of NFTs as one-of-a-kind collector’s items, much like physical fine art.

As artists began making digital art, they quickly discovered that they couldn’t make money from their work. After all, digital art could be easily replicated online (or copied and pasted from a page), which made it difficult to pitch selling a digital image when you could copy it for free.

NFTs change the game for digital artists.

Thanks to NFT digital signatures, digital artists can now create digital art that cannot be replicated. Like physical art, NFTs have unique qualities that cannot be replicated, and unlike past generations of digital art, blockchain makes it possible to easily trace legitimate ownership and provenance of NFTs (some of the key value drivers for fine art).

NFTs: Innovation or the Next Tulip?

Sounds pretty great for digital art, right? In fact, digital artists across the world are cashing in—including some well known names like Beeple (who sold the first-ever NFT at auction, The First 5000 Days, for a staggering $69 million) and Grimes (who cashed in on the NFT gold rush by selling a collection of NFT art tallying $6 million).

But art world experts (and savvy investors) are wary, and some are asking whether NFTs are really the next big development for art investing or just the latest iteration of tulip mania.

Has the Bubble Burst? Is It Bursting Now?

Some commentators have speculated that the NFT bubble is already collapsing. They argue that the NFT craze was not based on strong innovation, but rather a frenzy brought on by wealthy young investors newly flush with stimulus money.

And yes, we’ll admit, it’s easy to look at some particularly nutty NFT sales ($85 for a 52-minute audio recording of farts, for example) and think the whole NFT thing is ridiculously overblown. But there are some warning signals on the market already, suggesting it may not be as stable as it looks.

The biggest concern is the shift toward NFT fractionalization, best exemplified by a “public art project” called B.20. B.20 holds a bundle of virtual assets anchored by 20 Beeple NFT artworks, with ownership shares of the collection (though not the assets themselves) divided into 10 million tradeable virtual tokens. Visitors to the open-access virtual museum can purchase these tokens for partial ownership.

Fractionalization is concerning—especially for NFTs—because value is something that accumulates over time. Cutting up ownership of a digital item with already-volatile valuation makes future valuation even more complicated, perhaps even impossible. Either way, it introduces significant volatility to an already volatile NFT market and makes it increasingly difficult to understand the true value of the art. This is especially true of the B.20 approach, which does not divide valuation of individual assets but rather the whole asset collection, making it nearly impossible to know the real value of the share you just purchased.

Are NFTs Alternative Investing Worth It?

So, are NFTs worth investing in?

Time will tell if NFTs stick, but for now, at least, art investors should be wary of trends like fractionalization that make it extraordinarily difficult to value items that are already volatile in value. Instead, stick to tried-and-true art investment practices, consult the experts, and apply your common sense.

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