What gives NFTs their value?

Punk #7523 sold for $11.75 million in June 2021, becoming one of the most visible examples of the NFT boom. The sale raised a question that remains useful beyond that period: what gives a digital collectible value, and what exactly does its buyer own?

What is an NFT?

An NFT is a uniquely identifiable token recorded on a blockchain. Ownership of the token does not automatically convey copyright, a commercial licence or legal title to an associated physical object; those rights depend on separate terms.

The NFT contains a record of when the item was created, or “minted” in NFT terminology, and how much was paid for it. Additionally, it includes information on previous sales, as NFTs can be exchanged or traded on NFT marketplaces.

You might be wondering, what’s the difference between the Punk Alien and any other digital image that can be traced to a server location somewhere on the internet?

What sets NFTs apart is the way they are created and the unique qualities they possess. Minting an NFT involves creating a new record on a decentralized blockchain, such as Ethereum for Crypto Punks, although NFTs can be minted on other blockchains as well.

The token’s on-chain history and its associated media are different things. NFT metadata can point to externally hosted files, and some contracts allow metadata URLs to change. An image can therefore change or become unavailable even while the token remains in the wallet.

Non-fungibility distinguishes one token from another; it does not stop someone copying the artwork or minting another token that refers to it. Check the issuing contract and the creator’s provenance, not just the displayed image.

On Ethereum and other blockchains, there is a programming standard called ERC-721 that sets out parameters to ensure a record is non-fungible.

An NFT represents where an item exists, like a URL for digital art or the location of a physical asset. It’s like a receipt or certificate of authenticity for physical collectibles.

Scarcity & Intrinsic Value

Though this might sound interesting from the perspective of technical innovation, on its own, it doesn’t explain why a tiny pixelated image of an alien is worth almost $12million. To understand that you have to understand the two elements that give collectible items value - scarcity and intrinsic value.

If something is scarce, it has a limited supply. Most famous pieces of art, for example, are one-offs, but being scarce doesn’t, on its own, make something valuable. I could do a one-off doodle on a notepad, put it in a frame and auction it, I’m pretty sure no one would be willing to pay anything for it, because it has no intrinsic value.

Intrinsic value is hard to define as it is subjective appreciation of something’s value, but boils down to being unique, irreplaceable and significant or sacred. My doodle might be unique, but it is easily replaceable and certainly has no special significance, because I have no standing as an artist and haven’t generated any other fame.

Scarcity of an NFT does not only derive from the way it is minted, but also from the composition of the image itself. Punk #7523 is one of a limited collection of 10,000 algorithmically generated images, each of which is unique. Though the collection shares certain common traits, there is relative scarcity within it. This is one of nine aliens in the collection, but it is the only one wearing a mask.

A copy of the artwork can look identical, but a token’s network, contract and identifier distinguish it from other tokens. Market value depends on demand for that particular provenance and any associated rights.

CryptoPunks became an influential early NFT collection. Collectors may value its history and aesthetic, but neither establishes an objective price.

Punk #7523’s history and rarity may help explain buyer interest. They do not establish that its 2021 sale price can be recovered in a later sale.

The Power of Hype

There is no equation for calculating the value of a piece of art, such as the Mona Lisa, since intrinsic value is subjective. Artists and artistic movements can fall in and out of fashion, and the reasons for this are complex and generally reflect changes in society.

Interest in NFTs is tied to the interest in speculative cryptocurrency. The future value or adoption of cryptocurrency is uncertain and must be understood in a macroeconomic context.

Low interest rates were part of the backdrop to the 2021 NFT boom. That historical setting should not be treated as a description of current rates or as proof of any individual buyer’s motives.

The $11.75 million sale records what one buyer paid at that time. A past sale does not establish lasting value, liquidity or a future resale price.

However, the future value of Crypto Punks is uncertain, as is the value of the many NFTs based on them. The argument about intrinsic value doesn’t hold for all of them.

The hype surrounding NFTs may be inflating their value as they become more commonplace. However, early examples are now becoming a form of digital conspicuous consumption, which is known in economic terms as the Veblen effect.

A Veblen good is one for which demand increases as price increases. This seems to contradict the normal rules of supply and demand, but it explains how branded goods, which look identical to cheaper versions, command such high prices.

However, collectible art is not the sole use case for NFTs. Even within that genre, there is a great deal of innovation.

Innovation & The Future of NFT

NFTs are tradable on exchanges such as Opensea. If you’re considering buying your first NFT, the decision of which one to buy can be overwhelming, given the large number of options available. The NFT market is becoming saturated as artists attempt to carve out their own niches.

Minting a token does not itself create demand. Assess the creator, rights, provenance and market activity before treating an NFT as valuable.

There is also plenty of anecdotal evidence of price manipulation of NFTs, as well as their use in money laundering and as part of complex tax mitigation schemes.

New NFT uses can develop while individual collections lose demand. Assess the rights, storage and practical benefit of the particular token.

Pak’s The Merge sale in December 2021 used an unusual model in which purchased units affected the resulting collectible. The example illustrates how an NFT’s rules and artistic context can shape demand; it does not provide a general valuation formula.

The Merge illustrates how artists experimented with NFT ownership and participation. The number of buyers and the sale total do not prove that the valuation was justified or sustainable.

NFTs also appear in games and virtual worlds. Facebook’s 2021 rebrand to Meta reflected interest in that broader theme; it did not guarantee demand for any NFT collection.

NFTs have the potential to disrupt other common records of ownership, such as property or shares, which are both enormous markets. Anyone who has ever purchased a house can attest to the need for innovation in the face of archaic processes.

NFTs can represent access or transferable digital rights where the issuer’s terms and technical design permit it. Encoding a token in a smart contract does not by itself create enforceable rights over property, shares or third-party services.

A collectible’s code can remain unchanged while demand for it falls. NFT prices depend on buyers’ interest, the rights and benefits attached to the token, and the ability to find a buyer when selling.

An NFT can gain cultural importance without becoming liquid, and it can remain technically available after collectors lose interest. Artistic significance and a realizable sale price are different questions.

Remember: Unitywallet does not offer legal or financial advice. This blog piece should be used to help you form and shape opinions but cannot replace individual financial due diligence.

Sources: ERC-721 specification