Why are some nonfungible tokens so expensive? | Business | Economy and finance news from a German perspective | DW
Non-functioning tokens (NFTs) came on the scene earlier this year when some of them started raking in millions of dollars at auctions. A confusing and controversial new digital asset is emerging. DW’s own experiment with selling an NFT made a smaller splash. Which made us all the more curious: why are some so expensive?
Guardians of the arts?
First of all, a reminder: NFTs prove ownership of digital files. They can represent digital artwork, but can also be associated with video game accessories, collectibles, and more. Anything that can be stored as data on a blockchain can be an NFT. NFT transactions are publicly recorded on a blockchain and often purchased with cryptocurrencies.
Investment bank JPMorgan Chase recently estimated the global NFT market at $7 billion (€6.3 billion).
In October, an experiment by The Economist raised $420,000 when the weekly news magazine auctioned off an NFT of one of their front pages. An issue about decentralized finance, the cover image depicted cryptocurrencies alongside images from the children’s book Alice’s Adventures in Wonderland. Buyer @9x9x9 told The Economist it was the appropriate title – “Down the Rabbit Hole” – that forced them to buy the cover data file.
But buyers of breathtakingly expensive NFTs point to a whole host of reasons for spending a lot of money for the rights to a data file that anyone can view or copy. Cryptocurrency entrepreneur Vignesh Sundaresan spent a record $69 million on an NFT earlier this year. The NFT enthusiast, who has invested in the technology, denied that he was trying to push prices up. He said he wanted to support the artist and show the technology.
For other buyers, it’s about scarcity. “The buyer knows how many will be made and has blockchain proof of ownership,” US billionaire and NFT collector Mark Cuban told online news portal Business Insider.
What the data says
Researchers at the Alan Turing Institute (ATI) wanted to know what the data say about this phenomenon.
“What we’ve observed is that there’s massive heterogeneity in the success of NFTs,” Andrea Baronchelli, an associate professor of mathematics at the University of London and ATI’s token economy theme leader, told DW. “Some – very few – do very well, some do quite well, and the majority are worthless.”
Earlier this year, ATI’s team of experts completed a study that looked at the role certain factors play in the price of NFTs. They looked at three components: the visual characteristics of the NFT, past sales of related NFTs, and the buyer’s and seller’s social network.
Researchers used a machine learning model to consider a data set of 4.7 million NFTs exchanged by more than 500,000 buyers and sellers. The result? Past sales of related NFTs were the most important of these three factors, accounting for more than 50% of the price difference.
For example, past sales of NFTs from the CryptoPunks collection, a prominent set of 10,000 tokens with pixelated images of punks, would be a good indicator of future sales of tokens from the same collection.
Visual features were the second most important aspect. Including this data increased the performance of the machine learning model by as much as 20%. Data showing the popularity of the traders boosted performance by 10%.
Together, they concluded that these three factors can explain up to 70% of the variability in NFT prices. They plan to look at more factors in the future, including the platform where the NFT is sold and the creator’s activity on social media.
An old market reconsidered
In the market for NFTs of digital artworks, one can recognize something of the traditional art market, where scarcity, social networks and, often to a lesser extent, content of the artwork help determine the value of an object. But NFTs have some characteristics that set them apart from their real-life counterparts, said Mauro Martino, director of the Visual Artificial Intelligence Lab at IBM Research and co-author of the ATI study.
“A very big difference between the art market and NFTs is that the artists take 10% to 20% of the secondary sales,” he told DW. “So when the piece is re-sold, a portion of the sale always goes to the artist. This is really a novelty in the idea of art and could be a major breakthrough for artists.”
This is possible because future sales of NFTs are recorded on blockchain, allowing artists to receive their cut automatically.
A JPEG of a rock
That’s good news for anyone whose NFT has generated some money. But what about the majority who are not worth much at all?
“There are 10,000 new pieces ready to go every day…I don’t know where,” Martino said. “There are not 10,000 new buyers every day to support this incredible production.”
Stability in the NFT market would require more public attention to attract traditional investors, as well as greater comfort with cryptocurrencies, the experts said. This development is probably years away and surprises may crop up in the meantime.
“If we find that the enthusiasm for NFTs today is very similar to the enthusiasm for cryptocurrencies at the beginning, then we can expect a big correction,” said Baronchelli. This would have unclear implications for this non-fungible asset.
“If I have bitcoin and it drops 40%, I still have 60%,” he said. “If I have a JPEG of a rock? What happens to the value of that JPEG? We don’t know because there is nothing comparable.”
Edited by: Hardy Graupner