2021 saw an extreme economic explosion in the sale of NFTs (“Non-Fungible Tokens”), with total sales from the year hitting over $12 billion. Essentially, people have been paying unprecedented amounts of money to own JPEG images that could freely be downloaded from the internet. Why is that?
What Even Are NFTs?
To put it simplistically in a single sentence, an NFT is basically a piece of data (a “token”) that declares that somebody has 100% complete and undisputed ownership of a unique asset (often digital art). An NFT can be compared to a deed for a property; it proves who the owner is.
As of now, NFTs usually declare ownership of images such as JPEGs. However, NFTs are also commonly used for GIFs, short videos, items in video games, music and other types of (usually digital) assets.
Check out this JPEG here:
This JPEG isn’t worth $69.3 million, but the data file (the NFT) that states and proves ownership of this JPEG is worth $69.3 million.
However, it’s worth noting that the term “NFT” is commonly used to refer to the asset itself (such as a JPEG image), even though the actual “NFT” is really just the “deed of ownership” that simply points to the asset.
The intricacies of NFTs are more complex than that; we’ll get a bit more into those details later.
For now, possibly the more important question is:
Why Are People Spending So Much Money on NFTs?
In order to answer this question, it’s important to understand the psychology and nature of human beings. The real question is, what makes something valuable to people?
The Psychology of Value
A History of Value
For millions of years, humans were focused solely on surviving. Rudimentary tools vital to food collection and survival were the only objects that had value. Nothing else was worth creating and possessing.
Then at some point, humans began to value certain objects that weren’t used strictly for survival purposes. Flowers were likely the first objects valued by primitive humans that didn’t offer any practicality besides being beautiful.
Later on, humans came together to establish the first remnants of civilization. After advances in agriculture and pottery, surpluses of food were able to be stored in ancient granaries. People had excesses of food and as a result, more free time. With their newfound “wealth” of extra food and free time, citizens of early civilizations became able to afford to value objects solely for their aesthetics.
(Compare this concept loosely to 2020 and 2021 COVID-19 lockdowns. Many people had excess free time and excess wealth, as they weren’t able to go out and spend money. This is the environment that contributed to breeding the exponential rise in value of NFTs.)
The first artisans rose; people who didn’t contribute any survival value to a community, yet who were valued for the beautiful and unique items that they brought into the world. Even before currency, people would feed specialists such as artisans so that those special people could dedicate their time and energy toward creating objects that were valued by society for their aesthetics.
This is what happens with humans; once people have enough of an abundance to meet their basic needs, they will begin to spend resources (wealth) on other objects that hold only aesthetic value. Basically, people will always find something to spend their excess wealth on; it’s what gives life meaning for many.
What Determines Value?
When it comes to possessions, and art especially, people generally want to own something that is significant and valuable in the eyes of other people. In determining the value of a piece of art, two of the most influential factors are how popular it is and how rare/exclusive/scarce it is. Age and historical significance can play a part too.
If nobody in the world had ever talked about the Mona Lisa then it probably wouldn’t be worth too much. Leonardo da Vinci was even already famous when he painted it. As well, the highly publicized theft of the Mona Lisa in 1911 made its value skyrocket. Popularity creates value.
Additionally, if everyone in the world had an authentic Mona Lisa, then it’d be worth nothing. Scarcity creates value.
It’s not only applied to art though; these are the same phenomena that give value to precious materials (diamonds, gold, etc), luxury brand-name clothing, collectibles of any type (trading cards, coins, etc) and certain restaurants/bars. Nobody would pay thousands of dollars for a Louis Vuitton bag if they’d never heard that name before. Diamonds would be worthless if they rained from the sky.
Being able to have something that most other people want but can’t have is a concept that gives many things in this world value.
What Makes Some NFTs So “Valuable”?
NFTs are, in a way, the epitome of popularity (hype) and scarcity creating value. As an example, let’s take a look at this NFT (CryptoPunk #7523) that sold for $11.7 million in June 2021:
That’s it, right there. How much talent did it take to create this NFT? How much time and effort? How much pure creativity originating from the deepest corners of the subconscious mind and soul? Clearly, it’s not really the talent of the artist that makes this NFT worth $11.7 million.
So what makes this NFT so valuable? There are a few reasons.
For starters, this type of NFT (a “CryptoPunk”) has historical value as being one of the first types of NFTs ever minted (created). CryptoPunks officially became NFTs back in June 2017; so they’re pretty much ancient art in the world of NFTs.
Another of the main reasons why NFTs such as CryptoPunks are so valuable is simply because enough people talk about them and agree that they are valuable. When they were first created, CryptoPunks were worth between $1 to $34 each. Then, CryptoPunks gradually started gaining more and more hype in crypto communities.
Then one day, Bob spent $100 to purchase a CryptoPunk NFT, which made Tim “realize” that these NFTs are worth at least $100, so Tim paid $125 to buy one. The escalating pattern repeated until these things were selling for hundreds of thousands and even millions.
Something is “worth” simply what the last person was willing to pay for it. Actually, this is kind of what happens with most cryptocurrencies too.
Another ingredient that is completely necessary for creating value in NFTs is scarcity. There were only 10,000 “CryptoPunk” NFTs created and there won’t ever be any more CryptoPunk NFTs created again.
“Really? So, then what’s to stop someone from taking 5 minutes to plop a few pixels into Microsoft Paint and just duplicate a CryptoPunk? How about if I just right-click that image and save it to my computer? Won’t I also have an $11.7 million image then?“
Well, this is where we need to talk about blockchain technology. Without blockchain technology, these multimillion-dollar JPEGs would be worth peanuts (or nothing).
Blockchain Technology & NFTs
For a full, thorough explanation of blockchain technology check out this post here:
Otherwise, here’s a rundown as to how blockchain tech applies to NFTs.
What Data Is Contained in an NFT?
An NFT is essentially just a file of data that identifies ownership of something, such as a digital piece of art (like the CryptoPunk JPEG image).
(NFTs can identify ownership of other things besides just pieces of digital art, but let’s use an NFT identifying ownership of a piece of art as an example.)
Contained in the data file (the NFT) is a unique digital signature for the particular piece of art; no other NFT will have the same signature. Each NFT is authentic and one of a kind, just like each person’s signature.
As well, inside the data file (NFT) there will be a link to the actual original piece of art (the image, GIF, video, etc).
This data file (NFT) also specifies who the creator of the piece of art was, who the current owner of the piece of art is and all previous owners. (Keep in mind that the data file will only contain the anonymous wallet addresses of the owner and previous owners, no identifying personal information about anyone will be documented in an NFT.)
Furthermore, the data file (NFT) will record every transaction (including the amounts) that the piece of art went through during its lifetime.
Finally, NFTs may also contain “smart contracts“. Smart contracts may enforce a rule related to the NFT. The most common type of smart contract is one that governs that every time that the piece of art is sold, the original creator will get a percentage of the sale.
As an example of a smart contract of this type, let’s say the creator of an NFT includes a smart contract rule in this NFT that states that the creator will make 10% off of every sale that this NFT ever goes through. The creator then sells this NFT for $1 in 2021. The new owner sits on this NFT for 4 years and then sells it for $1 million in 2025; the creator will then automatically receive $100,000 worth of cryptocurrency (most likely Ethereum) into their crypto wallet.
Obviously, the data of an NFT is very important. Millions of dollars could be lost if this data disappeared or were altered in any way. So how can we know this data is safe? Where are NFTs stored?
NFTs Are Stored on a Blockchain
NFTs are stored in blocks on a blockchain (most commonly, the Ethereum blockchain).
A blockchain is unable to be changed or tampered with. As well, almost every major blockchain is publically available for anyone in the world to take a look at any piece of data on the blockchain at any time. Blockchains are distributed, public and immutable.
For these reasons, an NFT can never be stolen off of a blockchain. Furthermore, an NFT can’t ever be duplicated; it will always be completely unique. This is where the name NFT comes from. NFT stands for “Non-Fungible Token” which basically means “Non-Replicable Token” or “Non-Replaceable Token”. An NFT is one of a kind.
Therefore, people can copy an image as much as they want and use an image as much as they want, but they’ll never be able to convince the world that they own that image. Anyone can refer to the blockchain to see who the true sole owner of the original image is. (Well, they can see the anonymous wallet address of the owner anyway; it’s up to the owner whether they want to publicly reveal themself or not.)
Even though everybody else in the world can have possession of the image, the owner is the only person in the world who has undisputed ownership of that image, because the owner is the only person in the world who owns the NFT pointing to the image.
The implementation of this technology has generated rapid economic and societal changes across the globe over the past couple of years.
What Makes NFTs Special?
Why have NFTs become such a big deal so quickly? What characteristics of the concept have caused so much hype?
NFTs Are Sources of Recognition & Pride
Acquiring NFTs is often used as a way to gain social capital in the crypto (and art) community, essentially expensive bragging rights.
Then there are many collectors who choose to remain publicly anonymous; they may reveal their NFTs only to a close circle of family and friends, or nobody at all. These people may buy NFTs simply to feel the pride of ownership.
NFTs Are Completely Unique (Non-Fungible)
In an age where everything can easily and freely be copied and shared on the internet, NFTs are a way for somebody to actually truly own a one-of-a-kind digital asset. The fact that there is one and only one of each NFT in existence is what makes collecting NFTs different from collecting most other traditionally collected items (trading cards, coins, jewelry, antiques, stamps, alcohol, comic books etc).
Of course, traditional art is also usually one of a kind.
The Public Has Complete Access to the Art Associated with NFTs
There is a big difference between collecting NFTs and collecting traditional art though. When somebody buys an NFT, they are not hoarding it away like an art collector. The digital art that the NFT collector has bought can still be freely enjoyed and admired by everyone else in the world; perhaps that fact even makes owning an NFT more appealing to some collectors.
In fact, Vignesh Sundaresan actually stated that he “believes the beauty of an NFT is when everyone gets to enjoy it.” He actually encourages everyone to download a free copy of his Everydays: the First 5000 Days.
In a way, buying NFTs is more selfless than collecting traditional art. The rest of the world can get as equally up-close and personal to appreciate the art’s beauty as the owner can.
NFTs Give Power to Artists
In an era where artists are often exploited by large corporations acting as 3rd parties (Youtube and Spotify for example), NFTs can help give artists their power back. Like cryptocurrencies, NFTs render the middlemen redundant.
People may be more motivated to buy NFT as they can be assured that they are directly supporting the artist of the NFT; nobody else will be taking a cut of the proceeds.
Perhaps most significantly, as mentioned earlier, artists can utilize smart contracts where they will indefinitely receive a percentage of revenue off of every single sale of their piece of art. Thus artists can receive passive income for the rest of their lives if their art continues to gain value and change hands.
NFTs Can Potentially Make People a Lot of Money in a Short Period of Time
Finally, perhaps the most common reason why most people buy (and create) NFTs is for a short-term or long-term investment. They’ve seen the lightspeed massive increase in value of NFTs and so thus are trying to “get in early“, believing that most NFTs will only increase in value. In this way, buying an NFT can be slightly akin to buying a particular cryptocurrency.
Of course, there’s always the possibility of the bubble completely bursting and everyone losing everything.
However, keep in mind that although Amazon shares plummeted from $100 to just $7 when the dot-com bubble burst, they have since gone up to $3731.41 (although it took about 20 years for that).
There are quite a few appeals to NFTs that have allowed them to become popular so quickly, but are there any problems with NFTs?
Problems with NFTs
There are 2 very major problems with NFTs as of now. Both of these problems primarily originate from the fact that most NFTs are stored and transacted on the Ethereum blockchain.
The Environmental Impact of NFTs
Like most cryptocurrencies, or anything that requires frequent creation of data on a blockchain, NFTs consume a ton of energy. Most major blockchains need gargantuan amounts of computational power in order to function, and the majority of that power comes from dirty energy as of now. The more people that use a blockchain, the more energy that blockchain consumes.
However, that’s not to say that this can’t be fixed. Most NFTs are stored on the Ethereum blockchain. In 2022, there are plans for the Ethereum blockchain to undergo a major shift from a Proof of Work (POW) blockchain to a Proof of Stake (POS) blockchain. This new “Ethereum 2.0” blockchain will dramatically reduce the amount of energy required in order for it to function.
Furthermore, recently there has been increasing pressure (spurred partially by Elon Musk) for blockchain miners to move toward mining using sustainable energy sources.
Excessive “Gas Fees” on the Ethereum Blockchain
Similar to the energy issue, the more people that use the Ethereum blockchain, the more expensive “gas fees” are becoming.
“Gas fees” are fees set by the miners; it’s basically the minimum amount of compensation a miner will accept in order to spend time and energy processing a transaction on the Ethereum blockchain. For NFTs especially, these fees are extra high. It’s to the point now where most NFTs sold for under $100-$200 are actually going to put the artists out of pocket.
It’s really not a good look as cryptocurrencies and blockchains are supposed to be a way to eliminate the unnecessary fees imposed by middlemen such as banks and other institutions. Calling it something novel and innocent-sounding like “gas fees” doesn’t change the fact that it’s still other people taking your hard-earned money.
A potential solution to this problem is to simply use other blockchains besides Ethereum’s to create and transact NFTs; this option has become increasingly popular with artists over the past few months. Alternate blockchains are less popular and thus have fewer transactions occurring on them. As a result, the fees required for each transaction on smaller blockchains are a tiny fraction of the fees set on the Ethereum blockchain. Opting to use an alternate blockchain that uses Proof of Stake (POS) would also solve the environmental impact problem as well.
Along with solving the energy problem, “upgrading” the Ethereum blockchain is supposed to also fix the high “gas fee” issue. When Ethereum (a Proof of Work blockchain) switches to Ethereum 2.0 (a Proof of Stake blockchain) next year, it should bring these “gas fees” down to almost nothing.
NFTs have some issues, but they are not problems that can’t be solved.
So what do you think?
Are NFTs a passing fad? Or are they the beginnings of a technological, societal, cultural and economic revolution? They’ve certainly made a massive impact in an extremely short period of time.
The most expensive piece of art ever sold was Leonardo da Vinci’s Salvator Mundi painting for $450 million.
How long before an NFT tops that?