Why I strongly believe in Non-Fungible Tokens (NFTs) as serious Asset Class
The news in the blockchain and crypto scene is currently overflowing with regard to a new asset class: the so-called non-fungible tokens (NFTs for short). Starting out as a small niche for crypto connoisseurs and blockchain enthusiasts, NFTs have grown into the mainstream. But what exactly are NFTs and what potential do they have as an investment?— Authors: Duc Au, Nadine Ladnar
1. Blockchain-Technology as the Foundation
In order to understand the investment world of NFTs, basic knowledge about blockchain is required. A blockchain can be viewed as a decentralized network that maps a database and is made up of blocks. Decentralization is of crucial importance here, as there is no central institution that controls or could even influence the network. In the case of a transaction, no bank can stop or prevent the money transfer as the central point of contact. Instead, transactions are validated collaboratively by the existing network. The transaction data is stored decentrally in the blocks and is assigned a unique value that ensures the validity of the data. This value is also known as the “hash value”. Put simply, the data in a blockchain is protected against manipulation.
2. NFTs as new Asset Class
Assets or items can be created on a blockchain by issuing so-called tokens. Tokens form a superordinate category and can have different functionalities depending on the intention of the blockchain developer. Certainly the most well-known type of token is represented in the form of bitcoin (BTC), the function of which justifies the creation of a new digital currency. All tokens of a cryptocurrency are considered fungible, which means interchangeability. An example to be cited is our physical banknotes, which are also fungible and are therefore suitable for carrying out a payment transaction. A 10 euro note has the same value as another 10 euro note. The same is also true for the units of cryptocurrencies.
As the name suggests, non-fungible tokens are not fungible because they represent the uniqueness of a token. As already mentioned, tokens are used in the blockchain world to represent assets, for example. In this way, real assets such as art paintings or other values can be “tokenized” so that they are available in the digital blockchain world. Because NFTs are unique and non-fungible, they are particularly well suited to securely and reliably represent digital assets. NFTs have “virtual certificates of authenticity” stored on the blockchain, proving ownership in a secure manner.
Figure 1: All Time Key Metrics of NFTs and Top 5 NFT Collections (as of 24th February 2022); Source: Coinmarketcap
According to Coinmarketcap, the NFT market is a fast growing industry with high sales volumes ($641,491,273.78) and with a billion-dollar-market-capitalization (6,211,497,392.12). The impressive figures presented in Figure 1 just show an excerpt of the whole market, which is currently developing dynamically. Art is not the only focus of NFT projects around the world. Looking at the biggest NFT market place “OpenSea”, the platform distinguishes between the following:
- Art
- Collectibles
- Domain Names
- Music
- Photography
- Sports
- Trading Cards
- Utility
- and Virtual Worlds
The renowned and internationally renowned auction house Christie’s has confirmed that an NFT artwork by digital artist Beeple called “Everydays: The First 5000 Days” has sold to an investor for a record $69 million (see Figure 2). The auction started on February 25th and ended with the sale on March 11th. Another popular NFT example is the sale of a tweet by Twitter founder Jack Dorsey. The tweet’s digital artwork sold for approximately $2.5 million.
Figure 2: Beeple’s “Everydays: The First 5000 Days”; Source: theverge
The exemplary art transactions laid the foundation for the NFT hype, which has now reached the mainstream and is also inspiring private investors. New NFT marketplaces and platforms are regularly emerging on the internet, offering artists a stage to offer their digital artworks for sale. One of the largest marketplaces is the Rarible platform, which brings supply and demand together. Since NFTs are blockchain-based, the purchase of digital art objects cannot be made using classic payment methods (e.g. credit card, purchase on account), but a buyer must be in possession of a “digital wallet”, which is a wallet specifically for cryptocurrencies and digital assets in general.
3. Serious investment opportunity or bubble?
Without a doubt, the NFT market is at the beginning of its potential. However, entering the art scene is impressive proof of the potential that lies dormant in this form of investment. Critics often argue that NFTs represent a current bubble that will burst in the near future. But how are NFT art paintings different from physical art objects?
A physical art painting such as the Mona Lisa consists of physical paper, paint and the artist’s invested time resource. Often the personality of the artist and the personal story behind it as well as the narrative of the art image give the value of an art object. From a purely objective point of view, papers and paint do not have such a high value that could justify the intrinsic value of an art painting in the millions. Nevertheless, art lovers and investors from all over the world are willing to pay millions to acquire such paintings and create veritable collections. This is also mostly a non-fungible asset, since there is only one original that represents the value of the painting. Copies or modifications of the painting cannot damage the uniqueness of the original. The value of physical art paintings is also determined by the people themselves, who are guided by certain aspects such as the origin or history of the art object. Confidence in the future value also plays a decisive role here.
If you now make a comparison with digital assets, it quickly becomes apparent that the aforementioned aspects of physical art can also be applied here. It is true that a work of art does not consist of paper and paint here, but of “digital materials”, which can also have a certain value. Furthermore, the digital works are created by an artist who brings time resources and creative energy into the creation process. Both digital and physical materials are objectively and rationally incapable of justifying the millions of dollars worth of art objects. In this respect, digital art must also be evaluated with “emotional standards” and people’s trust in the future value. There do not seem to be any significant differences to “classical art”. NFT art objects as well as physical art paintings currently enjoy a high financial value due to the trust and interest in the market. It remains to be seen to what extent this will continue in the future. However, given the comparison to physical art, it seems premature to dismiss NFT assets as temporary hype or even as a bubble.
4. Concluding Thoughts and Outlook
As mentioned before, NFTs have a great variety in terms of use cases for various assets. As digitization progresses and the Metaverse is getting closer and closer, people’s interest in digital possessions will gradually rise. Big companies such as Nike, Adidas and celebrities such as Mike Tyson and Floyd Mayweather are already laying the foundation to benefit from this trend.
Figure 3: Mike Tyson NFT Collection, Source: OpenSea
I strongly believe that there is a sustainable demand for unique digital assets. NFTs are not just digital representations of assets because they can come along with a bunch of useful tokenized rights. For instance, VIPs can launch NFTs and provide certain rights to the holders as a new form of marketing or customer retention. Possessing an NFT or token from a famous sport star may give me the right to have a private interview or training session.
However, not everyone can afford to pay millions of dollars or euros in order to enjoy this asset class. It can be assumed that the market will “cool down”, thereby making NFTs more affordable and thus attractive for the rest of the interested individuals. If this will happen, then the rest may be a smooth self-fulfilling prophecy.
Remarks
A similar article can be read in German language on Heinrich Heine Consulting Blog. Here the direct link to the publication.
About the authors
Cam-Duc Au is currently doing his PhD at the Masaryk University in Brno in the field of crypto robo-advisory and, as Manager Holdings at P. Keppler Verlag, accompanies the digitization of the WM Gruppe together with CEO Michael Reuther. He also works as freelance lecturer at FOM Hochschule für Oekonomie & Management in Frankfurt am Main, Essen & Düsseldorf and as Research Fellow at the isf Institute for Strategic Finance. You can contact him via mail (cam-duc.au@fom-net.de), via LinkedIn, or Xing.
Nadine Ladnar is working full-time as a supply chain performance manager in the chemical industry and is a consultant at Heinrich Heine Consulting e.V. In addition, she works as a freelance lecturer at the FOM Hochschule für Oekonomie & Management in Düsseldorf and as a Research Fellow at isf Institute for Strategic Finance. Her research interests include corporate finance, digital transformation and sustainability.
