NFTs have captured the popular imagination. Everyone from the Vatican to Madonna is creating their own NFT collections, while the number of industries that this new form of digital ownership can seemingly disrupt continues to grow. That fervour makes it easy to miss the point of NFTs and just jump straight on the bandwagon. So this article will try to explain what gives NFTs value or utility before exploring the different approaches that can be taken to investing in NFTs.
What is an NFT?
The term NFT is shorthand for a non-fungible token which doesn’t do a great job of explaining what it is or does. So let’s start by unpacking what fungibility is. If something is fungible it is interchangeable with another item that has identical properties.
Money is a good example of a fungible item. Each dollar may have a unique serial number but their properties are otherwise the same, so you can comfortably exchange one-dollar bill with another, knowing they have the same utility and value. Fungible money is essential for frictionless commerce.
A non-fungible token possesses the opposite quality as it is a digital representation of something with unique properties that isn’t interchangeable like-for-like because it is a one-off.
The underlying concept isn’t new. If you buy a piece of art, sports memorabilia or collectible action figure you’d demand a certificate of authenticity proving that what you’ve bought is genuine and unique, as that is where it derives value.
NFTs provide a record of ownership but without the need to trust whoever issues that certificate of authenticity to prove your boxed ‘Hans Solo’ figure is genuine. Instead, NFTs rely on the power of blockchains to record information and make it almost impossible to alter or counterfeit.
So NFTs are a type of cryptographic token that represents digital proof of ownership of unique assets - digital and physical. Note, that the actual file isn’t stored on the blockchain but its record points to the location.
What makes NFTs more interesting than just acting as a new form of digital receipt is that there is a set of programmable standards, called ERC-721, that underlies them.
The ERC-721 framework makes NFTs adaptable to a whole range of use cases where it is really useful to be able to define a set of attributes that make something unique.
Subscribe To The NGRAVE Academy
Knowledge for all levels. Join our newsletter to receive the latest articles.
What are the different types of NFT?
Though to newcomers the NFT market might seem to be predominantly associated with variants on a cartoon Ape theme, because of the programmable attributes there is a growing number of very different NFT use cases:
Collectables - Limited edition collections of themed characters with variable attributes. Like crypto versions of Pokemon cards. Some famous examples include Crypto Punks and Bored Ape Yacht Club (BAYC).
Art/Photography - NFTs can act as a record for digital and physical art and photography, as well as directly generating unique pieces of art via Smart Contracts. Some famous artists include Beeple and Justin Versano.
Gaming - the programmable attributes of NFTs make them ideal for defining gaming characters and items, as well as allowing them to be traded outside the game, building value for the player, not the platform. Some famous examples include Axie Infinity and Illuvium.
Real Word assets such as property - NFTs offer the potential to disrupt the traditional property market and make fractional ownership easier. For example, TechCrunch Founder’s Kyiv apartment and a Florida house.
Identity - NFTs can make your identity portable across virtual worlds (the Metaverse); or act as a more usable proxy for complex pieces of information like Ethereum addresses. Two of the most popular providers are ENS and Unstoppable Domains.
We go more in-depth with these use cases in our blog article How Are NFTs Changing Everyday Life?
What gives an NFT value?
As a new class of digital asset, for which the ownership and transaction history is recorded on open-source blockchains, there is a wealth of data that is freely available to help you quantify the historic value of an NFT.
In fact, modelling the NFT marketplace using AI is becoming increasingly common, with predictive engines trying to pinpoint future value.
But knowing what the last person paid for an NFT isn’t the same thing as knowing its value which comes down to subjective reasoning. So any effective NFT investment strategy must balance data and insight.
Quantifiable NFT Characteristics
In the analogue world of fine art and collectables, age is probably the first characteristic an inexperienced buyer would consider for the simple reason that it correlates closely, though not exclusively, to value.
The same is true of digital assets. The older the better, but as with physical collectables that relationship isn’t a simple linear one because the NFT timeline is so short and supply has been geometric, with a huge explosion in 2021. This data from Nonfungible.com illustrates the point.
We are, of course, talking about a market that is barely four years old, so age really is relative. If you are willing to hold an NFT for long enough, its age may increasingly contribute to value, because what we are seeing today in terms of market activity might represent a tiny % of future sales. However, age alone will not guarantee value.
Another factor which is carefully weighed in the sale of art and collectables is provenance - the record and chronology of ownership. A 16th-century painting may have value based on age, but if its provenance can be traced to Henry VIII that value would skyrocket.
The same applies to NFTs where provenance includes immutable details about the NFT:
Contract Address - the address of the Smart Contract that minted the NFT; you can put this into Etherscan and see details of the Creator
Token ID - The unique number of the NFT within a collection
Token Standard - the applicable token standard e.g ERC-721
Blockchain - the chain the NFT was minted on
Metadata - Specific traits that the NFT might possess relative to the collection/type and details of where the actual asset is stored.
In addition to these standard elements that every NFT will possess once created, collections may have their own approach to proving that the creation process itself was fair and transparent.
If metadata and image information are made available before a mint is completed (minting is the process by which NFTs are committed to the blockchain) the final distribution cannot be guaranteed to be fair. The simplest analogy is a false shuffle in a game of poker. To understand more look at the approach taken by the Bored Ape Yacht Club.
In addition to the objective provenance that the blockchain provides, you can infer information about buyers despite buying an NFT being a decentralised process where identity isn’t shared. This is because blockchains aren’t anonymous but pseudonymous allowing the identity of wallet holders to be figured out.
Sometimes that inference is easy because the wallet holder has publicly associated themselves with an NFT, for example using it as their Twitter or Instagram profile, essentially doxxing themself. Marketplaces like Opensea also allow accounts to provide information about themselves, such as linking Twitter and Discord accounts.
Provenance can also include what the account/wallet that owns (previously owned) an NFT also owns or owned which is built into NFT marketplace dashboards. You can think of this as value by association.
Even if the ownership history doesn’t throw up any notable former owners it is useful to know some basic sale history metrics for an NFT such as the number of Lifetime Owners, which tells you how buoyant historic demand for the piece has been, which should be viewed in combination with the Number of Unique Owners, to rule out obvious manipulation.
NFT Liquidity & Volume
Price is the most obvious indicator of NFT value with Floor Price - the lowest available price for an NFT within a collection - the most widely referenced metric. Though Floor Price is the common denominator for valuing an NFT what really matters is liquidity.
Liquidity within trading refers to the ease with which an asset can be sold for cash. It is a crucial consideration for any investment. If there isn’t a liquid market you cannot sell your investment.
Bitcoin is liquid because there is a 24/7 market of buyers and sellers, but that is natural for a fungible item with significant demand. One which is designed to be interchangeable.
NFTs are the literal opposite. Nonfungible - unique items that aren’t interchangeable. As a consequence, NFTs are described as illiquid and measuring how easy they might be to sell for cash is imprecise.
Marketplaces provide information that can help, such as the number of items within a collection that have sold within a period of time, divided by the total number within that collection or category. In short, how quickly are those types of NFTs selling?
Another useful metric is volume - a dollar value of NFT sales. Total volume can give you an insight into the state of the market when graphed over time, but you really need to drill down to the specific collection/category that you are looking at.
Be aware that on its own volume is a crude metric that can be skewed by wash trading - fake buying and selling - and the assumption that demand across a category or collection is uniform.
Bitcoin introduced a new concept; unforgeable digital scarcity. This is why it is often described as digital gold. Its value derives from that scarcity and the same is true across all commodities and collectable items, including NFTs. But it is important to understand that rarity doesn’t guarantee value. The most valuable NFTs are rare, but not all rare NFTs are valuable
The world’s most expensive painting, Salvator Mundi, a one-off created by Leonardo da Vinci in around 1500, was sold for $450million in 2017.
The fact that there is only one Salvator Mundi by Da Vinci contributes to its value, but if a one-off child’s doodle from the same era were put up for sale I doubt that an auction at Christie’s would get close to half a billion dollars.
An often overlooked piece of data that is relevant to an NFT’s value is the investment that creators put into marketing a collection. The absence of a meaningful budget and roadmap can indicate a lack of ambition and desire to cash-in, while committing a significant proportion of sales to market the project tells you the opposite.
Subjective NFT Characteristics
What gives Da Vinci's painting value is a combination of factors such as his skill and fame, the cultural significance and symbolism of the subject matter and style, as well as the story behind its creation. This is equally true for collectable NFTs.
The most expensive NFTs derive their value from what they represent as much as what they are - aka intrinsic value. The Salvator Mundi is just some oil paint on a canvas and CryptoPunk Punk #7523 is just a 24x24 digital pixel image, yet it sold for just under $12million dollars in June 2021.
Punk #7523 combines rarity, significance and intrinsic value. Its rarity is absolute given it is the only one of its kind, and the blockchain proves that, but its attributes are relative to the collection in which it sits.
It is one of 10,000 unique images algorithmically generated by computer code assigning sex (male/female), a character type (human, zombie, ape, alien) and 87 attributes that a profile style image can possess.
CryptoPunks were created in 2017 and offered for free to anyone prepared to pay the Ethereum gas fees to claim one, but given the way NFTs have since exploded as a wider crypto and cultural phenomenon,Punks now represent a significant point in the evolution of art and technology. That significance gives them value.
If NFTs hadn’t caught on, the significance of Punks would be hugely diminished, reducing perceived financial value, but their intrinsic value would be the same. Intrinsic value is what they represent as a pleasant visual image without reference to anything else.
One of the consistent themes you’ll notice talked about in relation to the success of new NFT collections is the role of the community. The enthusiasm for a project and the wider goals - which might include a game, access to an exclusive community or content - can translate into loyalty which makes holders less like to sell.
The power of an NFT project's community can be measured in quantifiable metrics such as the number of Discord users or Twitter followers, but it is more important to get a sense of the community’s commitment, enthusiasm and ambitions for the project.
Catching the Wave
Given rarity can be objectively judged making successful investing decisions will come down to predicting perceptions of intrinsic value - whether people like the style/image and want to own it for its own sake - and whether an NFT collection has symbolic value.
“These virtual rocks serve NO PURPOSE beyond being able to be [bought] and sold, and giving you a strong sense of pride in being an owner of 1 of the only 100 rocks in the game :)” Founder of EtherRock, one of the oldest NFT projects, reproductions of royalty-free clipart. #55 sold for $4million in October 2021.
That significance could come from a trend within society or specific to the evolution of NFTs. Two examples are Generative and Dynamic NFTs.
Generative NFTs are created by Smart Contracts taking random inputs - wallet address, gas fee, transactionID - to autonomously generate a unique piece of NFT art; early examples being Art Blocks or Autoglyphs.
Dynamic NFTs use external events and data to change the image. The most simple example might be a character wearing sunglasses in summer but there are interesting applications emerging all the time such as NFTs that react to achievements in the real world.
Examples of this exist in sports such as LaMelo Ball CollectiblesNFTs representing the performance of the NBA star, LaMelo Ball, powered by Chainlink sports data oracle feeds. The NFTs within the collection will evolve with LaMelo’s career and confer specific utility to the holder, which is the final broad category that contributes to value.
The sales volume of NFTs in dollar terms is dominated by art and collectables - accounting for 91% of sales in 2021 according to Coin Telegraph research - but in terms of sheer transactions, gaming dominates. This reflects the difference in utility of the various types of NFT category including those which can translate into a return on investment.
Gaming covers a diverse range of different models including play-to-earn and more recently move-to-earn. In both cases, the basic premise is that in order to participate in the game economy you need to purchase NFTs.
In play-to-earn, the NFTs might represent characters or vehicles that you can evolve, gaining utility and value through activity within the game. In play-to-move that might mean a creature or a pair of sneakers that acquires greater utility from your physical activity in the real world.
Establishing the value of an NFT based on utility requires you to understand the incentive model behind the game, the specific game mechanics and the tokenomics behind the project. You then have to decide on a strategy to leverage the game mechanics and build value, which moves us on to thinking about specific NFT investment strategies.
Simple NFT Investment Strategies
If you are considering buying NFTs as an investment, the common strategies are generally split between utility-based value and perceived value. Whichever you might pursue it is crucial to account for the costs of transactions - minting/buying/selling - which are often overlooked by can make a huge difference to profitability.
“One study sampling a week's worth of NFT data found that the majority of primary sales were for under $300, with 34% under $100. When selling NFTs for less than $100, the price paid to host an auction, as well as the gas fees, could cost more than the NFT itself.”
Cointelegraph Research, Nonfungible Tokens: A New Frontier, 2021
Buy & Build - This approach relies on you focusing on a specific play-to-earn or play-to-move application, investing in an NFT and then committing your time to build value into it through the specific platform mechanics.
Your efforts won’t necessarily translate directly into profit because what you earn in terms of the token will have a fluid value, which might go down as well as up. Illustrated by the recent massive Terra-induced market dump.
Buy & Rent - As above this approach relies on you focusing on a specific play-to-earn or play-to-move application, investing in an NFT but with a crucial difference. You rent out the NFT to someone else to build the value which for example in STEPN is split 70% to you and 30% to whoever is renting your sneakers, like an affiliate model.
Where your strategy is to rely on the perceived collectable value increasing there are three broad approaches: The Primary Market - Presale and Public Sale; The Secondary Market; The Creator Market.
Buy from a Pre-sale - Buying through the pre-sale market guarantees you the right to mint an NFT from a given collection. This requires research and commitment on Medium Discord and Telegram to get on what is known as a White List for upcoming NFT collections, which gives preferential access to the mint.
Getting on a White List isn’t easy which is why insiders describe it as ‘grinding’. Grinding is essentially jumping through whatever hoops the project sets to earn preferential access to the sale. That might be based on engagement on Discord and Twitter, or some other meaningful commitment, such as buying official merchandise.
Though getting on a pre-sale removes a lot of stress it is still a lottery in terms of what type of NFT you end up with.
Buy from Public Sale - If you can’t get on a White List you’ll have to take your chances on the first-come-first-served basis of a Public Sale. If the collection is popular you should expect to have to pay more gas to get your transaction confirmed; you’ll often hear this referred to as ‘gas wars.’
If this is bringing back horrible memories of trying to get into a club, you’re not far wrong. And just as queueing for hours to get into a club doesn’t guarantee a good night, paying over the odds to elbow your way into a Public NFT Sale doesn’t guarantee what you end up with will be valuable.
Buy from the Secondary Market - If the pre and public sales sound like too much effort then the most obvious alternative is to acquire one on the Secondary Market, on public auction sites like OpenSea and Rarible.
The NFTs acquired in the Pre and Public Sales are almost certainly destined for the Secondary Market so you have to accept that they’ll be listed at a significant margin to the price paid at mint.
This doesn’t guarantee that the demand will be there, so you can shop around, place below floor bids and try to take advantage of poor liquidity.
An alternative approach is to use a service that allows you to own a part-share in an expensive NFT, known as fractional ownership. This requires more research and due diligence as the value of your share relies on the behaviour of other owners as well as liquidity
Create, Mint & List on a Secondary Market - The way to capture the greatest amount of potential value is to create a piece of art, a photograph or an NFT collection with intrinsic value and unique utility, then mint it yourself and try and promote it via social media, and sell it on a Secondary Market.
This is so much harder than it sounds, as you need a combination of artistic skill and creativity and a good eye for what is trending. Despite the challenge, it hasn’t stopped marketplaces like Opensea from being swamped with low-quality NFTs that are no better than screenshots.
The reality of investing in NFTs
When investing in NFTs it is crucial to understand that there are different types of NFT. Some derive value from the utility they give you within a protocol or game. It’s down to you to judge whether the underlying mechanics make sense and to then put in the time and effort to leverage that utility to generate rewards and potentially increase the NFTs value.
For NFTs that have perceived value, you should judge how rarity, significance and intrinsic worth combine to define what people are prepared to pay, which crucially will also be heavily influenced by the state of the crypto market in general which has turned decidedly bearish.
In both cases, there is a significant risk, especially if you are completely new to NFTs. The euphoria of 2021 brought a huge wave of first-time buyers and sellers into the market but the majority of sales is attributed to a minority of sellers.
NFTs aren’t a get rich quick scheme. If you are new to NFTs and want to experiment, buy something simply because you like the way it looks (its intrinsic value) rather than expecting it to shoot up in value.