Dhairyah C. Shroff is a second-year law student at Jindal Global Law School with interests in public policy, cryptocurrency, intersectional economics and intersections of law & economics. They are a member of the editorial department of the Arthaniti Society.
Credit: OpenSea
On 2nd December 2021, The Merge, a piece of digital art by the anonymous artist Pak, officially became the most expensive NFT ever sold, breaking the previous record held by Beeple’s “Everyday: The First 5000 Days”, selling for a whopping $98.1 million, also becoming the largest ever art sale by a living creator. Non-Fungible Tokens, aka NFTs have, in the recent past, gained gargantuan traction. To illustrate, the net value of NFT transactions in the first half of 2020 stood at around $13.7 million, while that in the same period in 2021 had touched the $2.5 billion mark[1]. This piece attempts to answer the various questions the mind of an economist asks; what an NFT after all is and where it is placed in the conventional consumer market model, the impact of trading techniques, real-time price determination, nature and determinants of the NFT market, and of course, the question of whether it is, in fact, a big fat fad.
From a traditional perspective in an attempt to breakdown the nature of NFTs, they can be seen as goods in a market where crypto is the only currency. We can see this simple market structure working even in novel markets like, for instance, that of the metaverse, which plans to sell consumer goods like branded clothing in the metaverse through crypto as NFTs. These ‘clothes’ will be produced and sold by the companies themselves, and will come with a brand authenticity tag, much like actual physical merchandise. When it comes to the nature of NFTs as commodities, collectors tend to view them from two primary perspectives. The first is that of non-asset commodities, as items having an intrinsic value, being purchased like ordinary goods at market price to be kept with them in the long run, without intention of reselling. Meanwhile the other school of thought treats NFTs like investments, where the collectors expect an increase in price. This is beautifully illustrated in the popular concept of the rule of three among NFT collectors. The rule follows buying three NFTs, followed by selling the first one at the initial investment, or the cost price of all the three NFTs combined, such that it recovers the cost of the whole operation, steering off a loss. This is then followed by selling the second NFT at the highest possible market price, generating profit. The third NFT, treated as a long-term investment, isn’t sold until it reaches its highest market value at which, it is in fact, sold.
This model, being used by both new and veteran collectors alike, offers a great economic insight into the playing field of NFTs. One naturally wonders why something as mundane as screenshots or digital art would sell for such high prices and have resale value, imitating pieces of physical art, the value of which increases with each set of hands exchanged. And that is also exactly what drives the value of NFTs. NFTs possess monetary worth following the principles of scarcity; Jack Dorsey was able to sell his first-ever tweet as an NFT at $2.9 million as he was himself selling the tweet, and that too just one copy, giving the commodity, in this case, Jack’s NFT, scarcity and authenticity, driving up its price. The genesis of NFT value lies in them being, as the name suggests, non-fungible, which is also the source of the digital scarcity. Terry Nguyen describes this value of authenticity additionally as biographical indexicality, which follows that NFTs possess economic value as they are characterised by biographical elements that index noteworthy events in relation to an individual’s life history. This essentially means you cannot exchange one NFT for another and still have the same thing, even if they are valued the same. Say I, as an NFT collector, buy an NFT at the same price as of Jack Dorsey’s NFT, that is $2.9 million. Despite the same selling price, the two NFTs cannot be said to possess synonymity since these are two distinct NFTs with different blockchain value codes, they are non-fungible. This makes each NFT unique and its ownership irrefutable and irreplicable. This is the very feature of NFTs which has given artists the freedom to sell their pieces of art at a stable and copious price without the possibility of plagiarism or duplication coming into the picture. This, combined with the perceived brand value in cases of NFT Collections gives rise to price determination. For instance, in the case of the Bored Ape Yacht Club, one of the most expensive and widely known NFT Collections, collectors are willing to pay the high prices because of the brand value, membership to an elite club and status attached to the NFTs, and not necessarily the value derived from the ownership as such.
This brings us to the natural question of whether the NFT craze is, in fact, a fad, and if the bubble is about to burst. Any phenomena that have a meteoric rise, especially one as vigorously upcoming as that of NFTs, also witnesses a sudden jolt before eventually stabilising for the long run. Sceptics say this jolt is the end of the NFT economic apparatus, while enthusiasts insist on this being a minor setback soon to be recovered from. The very principles that govern the traditional market, are observed to be structuring the NFT market as well. After a sharp rise in 2020, 2021 proved to be the year of NFTs. As NFTs started selling for values higher and higher and institutionally became a thing, buyers rushed into the market anticipating profit. As buyers increased, they drove up demand, thereby increasing NFT prices. This meant that the collectors who got in early cashed in into the NFT craze and made big bucks; while those who entered much after encountered inflated NFTs with lower resale values, thus lower margins. As demand grew, so did supply, as digital artists, who were now able to sell their art for over twice or thrice the amount they were earlier selling at, tried to capitalize on the craze. This flooded the market with NFTs, now driving down the prices. To illustrate, the average price of an NFT this month is less than $2000, a downfall of around $5000 from the previous month’s $6800[2]. This tussle between the push and pull effects ended with the latter prevailing with characteristics of the former; low prices and even lower resale values. This turned the markets morbidly deceitful, where buyers were attracted by low prices but could not even cover the costs of their transactions and reaped huge losses while reselling. This is more so evident by the recent panic selling of NFTs, where two thirds of all NFT owners had to indulge in panic selling in a bid to minimise losses in the face of a rapidly falling market, according to a recent report by PrivacyHQ[3].
The result? The ‘bubble’ is now clearly shrinking, if not bursting, at this stage at least. During the afore mentioned period of January, while gross sales stood at $160 million, the same came down to $26 million in February[4], a steep fall. The sceptics seem to have got this part right- a fall in the demand as well as supply of NFTs is resulting in a deadlock in the market and the hype seems to have retarded a bit. Despite a fall in sales, the NFT market has witnessed stabilization never seen before, with NFTs becoming more affordable notwithstanding the resale quotient. Akin to the crypto market, NFTs too will have too bear the brunt of initial scepticism and lack of trust, but given its measure of utility and varied applicability, the market will in the long run stabilize and ossify, which is to say that the ‘bubble’, instead of bursting, will shrink and harden up, guaranteeing lower yet stable margins for both the collectors and the sellers. Despite the downturn though, NFTs remain one of the internet’s greatest economic innovations and a digital device changing our perception of the traditional market model yet justifying the very principles of conventional economics in neo variance.
[1] Howcroft, Elizabeth. “NFT sales volume surges to $2.5 billion in 2021 first half”. REUTERS [2] Market Tracker & Data Visualiser. San Francisco: NonFungible, 2022 [3] NFT Wallet & Security. New York City: PrivacyHQ, 2022. [4] Morris, Chris. ‘The NFT Bubble is Showing Clear Signs of Bursting’ FORBES
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