This article first appeared in The Business Times. It is written by Genping Liu, a Partner at Vertex Ventures Southeast Asia and India, for his Crypto Watch column in The Business Times. Republished on TheLowDown with permission.
My first exposure to Non-Fungible Tokens (NFTs) was back in 2017 when I chanced upon a blog post by Fred Wilson featuring the RarePepe project. I was immediately hooked by this novel concept and decided to get my hands dirty, enduring the then-cumbersome trading processes.
After hours of research, I ended up using a small and obscure Canadian exchange to speculate on Pepe Cash for a bit, before throwing in the towel due to both technical challenges and the small ecosystem around counterparty blockchain. Over the years, I have also dabbled in Crypto Kitties amongst other NFTs, but largely in the role of an observer. It’s fascinating to witness first hand the development of the concept and surrounding ecosystem. I could not have, back in 2017, imagined the kind of global obsession with NFTs that has beset the world today.
Defying Market Conditions
If you have been watching public equity and cryptocurrency markets closely, you would have seen them going downhill in the last 12 months, with the Nasdaq index down by 20 per cent and Bitcoin down by 40 per cent from their peaks.
Defying these broader market trends is the Bored Ape Yacht Club (BAYC) — a leading NFT project — whose floor price (lowest asking price for an NFT in its 10,000-strong portfolio) just reached a new high at 142 ETH/ US$400,000.
Personally, I cannot fathom this current valuation. Even with my venture capital background, which involves working with highly disruptive businesses and technologies and my growing accustomed to relatively higher revenue multiples compared to listed businesses, I can’t wrap my head around the numbers.
A personal friend who is also an NFT collector takes every opportunity to remind me of this: there are only 10,000 BAYC NFTs in the world, but a total world population of 7.9 billion. He implies a long runway for BAYC NFTs’ price appreciation, given the underlying scarcity.
Is NFT a Growing Bubble?
On one hand, there is definitely some truth behind the arguments put forth by NFT collectors, who justify sky-high prices based on the concept of scarcity. On the other hand, traditional value investors are certainly entitled to extrapolating NFTs’ astronomical prices to the build up of a bubble. In fact, many of my friends within the traditional investment fields find it difficult to accept any value for an NFT, given that NFT designs can easily be replicated.
I personally feel that NFTs are certainly worth something. However, I would have to defer judgment relating to how to price NFTs and whether NFTs are currently “in a bubble” or still undervalued.
Valuation models such as the discounted cash flow (DCF) form the basis of most, if not all discussions on valuation in the traditional investment space. Unsurprisingly, my training founded upon these economic theories does not equip me with adequate methodology to value NFTs. But after witnessing developments in the crypto space, learning about unique asset classes, and seeing the distinct consumption behaviours of younger generations, I am impelled to argue that NFTs indeed provide real value.
NFTs drive a fundamental behavior shift in the digital world. To explain, I will delve into three key categories of NFT usage.
I will leave the hard problem of ascertaining the true market value to other experts. Distilling an NFT’s market value via a DCF model is simply impossible — the value drivers behind DCF models are not compatible with those of NFTs. This is what I term as the “Hard Problem of NFT Valuation”, somewhat like the “Hard Problem of Consciousness” and the inherent limits of science in explaining the mechanism behind human consciousness.
NFT Art: Isn’t the Price of Art always a function of Authenticity?
Like many, I was initially in shock when news first broke that digital artist Beeple had sold his NFT “Everydays: The First 5000 Days” for US$69 million. Upon deeper investigation, I could understand the driving factors contributing to its astonishing price.
Firstly, the NFT is a collage of 5,000 pieces of digital art created by Beeple, which divides into US$13,800 per piece of art — hardly an unreasonable price to pay for an artwork. Secondly, the value of art has always been highly subjective. Imposing a rational price on artwork usually does not work. Thirdly, Beeple’s NFT stands at the forefront of the development of the technology, a key milestone revolutionising the way in which digital art will be traded going forward.
For traditional, non-digital art, most people would assume that buyers are paying for the material artistic value. Most artists have a unique way of expressing their creativity and style. Thus, the holder of a particular piece of art by a specific artist has unique access to this artistic value.
Hence, one argument that critics of NFTs usually raise is that the NFT has no value because the artistic elements of any NFT can be easily duplicated down to the pixel level, with no discernible difference. This, however, constitutes a fundamental misunderstanding of what collectors of non-digital art are paying for — authenticity, not material artistic value.
Why else would paintings continue to command such high prices with the advancements in forgery techniques that make it almost impossible for the naked eye to tell the difference without the use of technology such as radiocarbon dating? In fact, museums have been investing into increasingly sophisticated tools such as optical microscopy and machine learning. For instance, computer imaging was used to detect the forgery of Van Gogh’s “The Sea at Les Saintes-Maries-de-la-Mer” that fooled art experts for years.
The astronomic values reached at auctions of famous works are also inextricably linked to the authenticity of the work. If the painting is later proven to be a fake, its value rapidly erodes.
Similarly, NFT collectors, like collectors of physical art, are paying for the authenticity of the digital, unique art. NFT collectors are buying the digital equivalent of the certificate of authenticity, guaranteed by the unique underlying code on the blockchain which captures the transaction log of every digital asset, down to the creator who first minted the NFT. In other words, there might be many Beeple’s “Everydays: The first 5000 days” graphics floating around, but only its collector can claim the authenticity of the original copy.
NFT Profile Pictures: as Identity Markers and Status Symbols in the Digital World?
I see many of my friends displaying prominent NFT projects such as Board Apes or CryptoPunks as their profile pictures on various social media and chat apps. While it is easy to dismiss such indulgence as “showing off”, it also serves another purpose — as an identity marker informing of their alignment with other crypto enthusiasts. In fact, spotting someone with a NFT profile picture helps me to easily identify them as a fellow crypto enthusiast who understands its culture, philosophy and value. Admittedly, I have also been tempted to acquire a CryptoPunk just to identify with the cyberpunk community. But I didn’t, because of its absurd price.
In addition, as popular NFTs tend to cost a fortune, a common assertion about the value of certain NFTs is its utility as a status symbol in the digital world, similar to branded goods or luxury collectibles in the physical world — think of your Hermès bags, Rolex watches etc. Equally, it is not uncommon for the pragmatic to ridicule those who put their NFT images in their profile pictures as the images are by no means unique and can be easily replicated digitally for free. This in fact parallels the thought process of buyers of counterfeit luxury goods such as fake designer bags.
As a pragmatic person, I am not captivated by the thought of amassing luxury collectibles. I can, however, understand why some people adopt such a lifestyle — which boils down to certain personal beliefs and life philosophies. However, the signal of one’s social and economic standing is only valid for holders of the certified “real” goods. This comes down once again to the value of authenticity. A fake Rolex does not command the market prices of a genuine one — hence the demand for authentification services in secondary markets of luxury goods. And owners of fake Birkins are never held in the same regard as those who own authentic Birkins.
NFT Gaming Assets: Holder of Unique Digital Experiences in the Metaverse?
Last year, my kids and their peers started asking for Robux (digital currency in the Roblox gaming platform) for their birthday and Christmas gifts, instead of physical toys or items. With the gifted Robux, they wanted to purchase gaming assets, either cool skins enhancing the appearance of their character avatars, or new equipment enhancing their character’s abilities in the game.
Those who have seen the science fiction film “Ready Player One” would be aware of the immense potential of the metaverse in revolutionizing our way of work and life, with a prevailing sub-theme being the capacity for virtual gaming assets to augment the gaming experience.
Not being a gamer myself, I find it hard to gauge how much gamers would pay, and are willing to pay for these gaming assets with no real value to the material world. In spite of my reservations concerning aspects of Play2Earn and the virtual land boom in the metaverse penned previously, there’s no denying the growing wave of blockchain based games set for release in the coming years.
Some of these games further add differentiated value to the gaming ecosystem, paving the way for a more sustainable metaverse gaming experience. Holders of gaming NFTs might be able to unlock unique gaming experiences — think of cross platform gaming NFTs relating to character buffs (eg. increase movement speed), which enable NFT holders to enhance the speed of their gaming characters across different games. I can imagine a world where highly dedicated gamers are willing to pay millions to enable their conquest across a variety of massive multiplayer online games.
As both a practical person and an investor trained in valuation models grounded upon fundamental analysis, I find it incredibly hard to even put a ballpark figure for the value of NFTs. Likewise, I cannot determine a reasonable price that a Picasso painting or a Rolex watch should command.
This does not mean that NFTs are worthless. I’m pointing out that the alternative types of value they present to collectors are perhaps a microcosm of the diversity that is present within society. There remains a wealth of NFT categories beyond those discussed in this article, and many resemble asset classes in our physical world that can be rationalised with a DCF model. Putting aside unhealthy speculation and occasions of outright manipulation, increasing demand and adoption of NFTs might even be a plus, signifying a shift towards digital ownership instead of over-attachment to physical goods.