Is Value of NFT Fake or Real? An Economic Interpretation

It has been so long for Non-Fungible Tokens (NFTs) to be the centre of attention again since the CryptoKitties’ craze. Its Google Trends index has exploded from a single digit in February 2021 to a maximum of 100 by less than 1 month, thanks to the record breaking $69M NFT sale by the artist Beeple auctioned at Christie’s.

In August, Visa also jumped into the market, buying the CryptoPunk 7610, which is one of the NFT-based digital avatars for $150,000. Visa’s head of crypto, Cuy Sheffield, thinks NFTs will play an important role in the future of retail, social media, entertainment, and commerce.

It seems everyone in the space is thrilled about the “latest industry development”, anticipating NFT will be the next killer application in Ethereum as well as the whole crypto sphere. However, does NFT actually represent something with genuine value, or it is just another castle in the air? In this article, I will try to connect the concept of NFT with traditional economics and explain. Beforehand, let me make a really quick introduction of NFT, in case some of you may require.

What is NFT?

Literally speaking, an NFT is a token that is heterogeneous in nature, in which every single token is unique and not interchangeable, as opposed to cryptocurrencies which we have been already familiar with such as Bitcoin and Ethereum. A Bitcoin can be substituted by another Bitcoin perfectly while an NFT cannot be substituted by another NFT. Therefore, applying this characteristic, an NFT can be used to represent the digital ownership of an artwork, a photo, a video, a collectible, a virtual avatar, a player skin in a video game, a piece of music, or a tweet, etc., which heterogeneity matters.

Digital Ownership Means Something or Nothing

Digital ownership is exclusive, only the NFT holder has the right to own the underlying asset (usually in digital format, although it can relate to physical assets too). At a first glance, the right to own an NFT is solid, as the token ownership is recorded in a distributed ledger that is immutable and irreversible.

However, owning the NFT does not perfectly equal owning the underlying asset itself, especially in digital formats. Blockchain can only govern the ownership of NFT, but the underlying asset has to be managed by an agent. The NFT creator can be the agent at the same time who has to promise the buyer, not to mint another NFT (or duplicated copies) for the same or bringing down the digital asset offline if the asset is hosted by the creator or agent. This has to be done by written contracts or trust.

Another problem that is even more upset is, how to prevent others from downloading the same asset online. The original file for the $69M jpeg has been on Christie’s and Beeple’s site, not to mention a lot of high-value NFTs are actually mapping videos, music, pictures, or even tweets displayed on the web freely or at a low cost.

The buyer of an NFT has a blockchain digital certificate specified the exclusive ownership of the underlying asset, but the general public will not pay attention to it, because the certificate itself cannot enforce the display, usage, and ownership of the underlying asset in essence. Who will care about who is the actual owner, if everyone can duplicate an identical copy of the original? Probably only the actual owner herself.

Nevertheless, the NFT market is still booming as if the above problem never exists. Skeptics will say it is an illusion, or another emperor’s new clothes, while I believe irrationality usually originated in satisfaction and pride.

Utility, Luxury Goods and Store of Value

In neoclassical economics, utility represents a single consumer’s preference. Different consumers have different preferences and utility is a subjective measurement, varies across individuals. One may treasure a lot the rights and exclusive ownership of an NFT, however, the general public does not believe the same.

Moreover, as NFTs are heterogeneous in nature, when an NFT is minted, there is no precise market price to follow, in contrast to other fungible cryptocurrencies with (fairly) liquid markets. Therefore, the buyer of NFTs will largely depend on their own utility to place the bid.

Here we can also bring the idea of luxury goods into consideration. When people become wealthier, they will demand more luxury goods proportionately. Although we cannot confirm if the NFT fad is caused by the most recent bull run in the cryptocurrency market, we can observe the close relationships between the two and assert most of the current NFTs are luxury goods.

Luxury goods are usually associated with a high price tag, such as the NFTs of those rare artworks and collectibles. Some wealthy people will treat NFT as a store of value vehicle apart from mere satisfaction and personal desire. The only arguable concern is, does NFT serves the store of value function well given the market of the asset underlying is illiquid and the price is often dependent on personal utilities.

Is Digital Artwork a Right Use Case of NFT?

Counterfeit artworks appear in the physical world, not because of the people who counterfeit, but the people who are aware of the counterfeits. The cost of distinguishing the authenticity of a physical artwork is high, but still a lot lower than that of a digital artwork, which can easily be forged with a few clicks.

The opposition suggests patents and copyrights will offer enough protection to the digital artworks, and blockchain integration further enhance this process by NFT and digital certificates issuance. However, it only deals with the issue of how digital ownership can be seen, but the issue of how digital ownership can be done remains unaddressed.

Still, NFT is an exciting topic in blockchain with potentially good prospects applying in a lot of real-world usages. Though not all assets are suitable to be tokenized, some new business ideas and markets are going to be expanded with the usage of NFT. This will be covered in the next article.