What makes so many people interested in buying digital assets like NFTs – and why are they willing to pay millions for them?
You probably have heard the term non-fungible token (NFT) in the news recently. This term refers to unique digital assets that exists in a given blockchain—a decentralized and distributed database shared by a network of computer systems (such as Ethereum or Cardano). In other words, a NFT is digital record, a signature, of an image, a video, or any other electronic format.
A reason why NFTs have received so much attention from the media and the public is the large amounts of money people have paid for some of them.
For example, the CEO of Twitter sold his first tweet as a NFT for over 2.9 million USD. CryptoPunks, a well-known NFT project that consists of 10,000 collectible characters, has also drawn much attention. Today, the lowest price you can pay for one of them is about 85 ETH. That is about 360,000 USD for a collectible picture on the internet, which can be downloaded by anyone.
Figure 1. A crypto punk example. Crypto Punk #8857 has a value worth 6.63M USD as of the 24th of November 2021.
Reasonably enough, many people look at NFTs with excitement but also with deep scepticism: What is the value of NFTs? Why would people buy them? And why for so much money?
What is value?
Let us first look at what value refers to, which, by no means, is an easy task. In marketing, value is often defined as a general evaluation of the utility of an offering based on what is received and given. Value is multifaceted.
Different types of value may include functional value (task-related), psychological value (intrinsic), monetary value (compensation), and social value (relational). However, broadly speaking, value refers to the perception of the cost/benefit trade-off associated with an offering.
And the key word here is perception. As the German philosopher Friedrich Nietzsche suggested, “We have created the world that possesses values!”. We typically value things we agree are valuable.
Understanding NFT value through art
Frequently, NFTs are compared with art by drawing a parallel between the two markets. Selling and buying NFTs for large sums is compared to selling and buying artwork through transactions of similar magnitudes.
Why buy an original artwork if you can have a poster of it? It does not feel the same. Therefore, the way in which we assign value to offline artwork serves as a reference point to the way in which we assign value to NFTs. Indeed, the challenges with identifying the authenticity art, are solved in the context of NFTs, given that they are digital signatures.
For decades, researchers in the field of empirical aesthetics have been interested in understanding the perception of art and characterizing aesthetic value. Aesthetic value, a type of psychological value, seems to stem from a combination of objective properties of the stimulus as well as subjective or learned factors.
For example, one may find a painting of a dog beautiful because of its symmetry and colour palette (objective) and/or because of the value one has ascribed to dogs (subjective).
With technology inundating our daily lives more and more, digital art has piqued the interest of empirical aesthetics researchers. Ranging from digitally reproduced artworks to AI-generated art, technological developments have opened new avenues to define what aesthetic value means. NFTs open yet another avenue.
What then, gives value to NFTs?
According to William Woodwall, the artist behind EntheosAI, an NFT project of AI Generated Art in the Cardano blockchain, in the context of art, an NFT “…at its core, it’s just a way to authenticate a signature by an artist. It’s a digital authentication (…) an NFT is a way of using modern technology, the blockchain, this cryptography, this math that we have to authenticate a piece. It’s a digital way of signing and saying yes, for sure, EntheosAI made this work and there is no other way to fake this piece”.
Figure 2. Entheos 231658 (left) and Entheos 245535 (right), AI Generated Art in the, from the NFT project https://www.entheosart.com/
As mentioned earlier, NFTs also gain value through social agreement. Andreas Nicolas Fischer, founder of Studio A N F in Germany, and the artist behind the NFT project Infinite Halo says that what gives value to NFTs is “…artificial scarcity bundled with the fact that they are still available to be viewed online by everyone. The community behind them is a great motivator - they often serve as entry to an online club that is exclusive to holders of certain works. They are/will become like digital business cards/art collections that form your digital identity”.
Figure 3. Two rare algorithmically generated art, Halo 7109 (left) and Halo 04040 (right), from the NFT project Infinite Halo https://www.infinitehalo.io/
Creating value through NFTs
NFTs represent a new way firms can capitalize on to create value for the companies themselves and their customers.
Given the importance and power of communities for the value of NFTs, firms may use the latter to market brand-related digital assets that strengthen existing communities and create new ones around these assets. For instance, firms like DC Comics and McDonalds, have developed limited series of collectible tokens that bring attention to and engagement with their brands.
Think of extending cult-following brands such as Supreme into the digital world. Moreover, companies may exploit NFTs’ digital rights management features to provide owners with exclusive offline experiences and benefits, such as events with artists, dinners, and the delivery of one-of-a-kind products to owners of NFT across time. Brands may also use NFTs as an entryway into the virtual economy.
NFTs may be used as blockchain-based tickets to grant owners access to virtual events and make them be part of virtual alternate realities through virtual properties, games, art, and trading of digital assets. Furthermore, NFTs may serve as novel alternative investments with potential for high returns—but high volatility.
Importantly, NFTs pricing seems to depend on scarcity and aesthetics, so traditional asset pricing models may not be effective in explaining their returns.
Conclusions
Value is multifaced. As such, we find much diversity in the sort of objects we value.
As our experiences move from offline to mixed reality, that is, involving offline and digital elements, as well as to fully virtual, we will find more objects of value in digital environments. Whilst the way in which we create value in said environments needs to be looked at critically, here also lies a value creation opportunity for brands, artists, and other communities alike.
Resources:
Chamberlain, R., Mullin, C., Scheerlinck, B., & Wagemans, J. (2018). Putting the art in artificial: Aesthetic responses to computer-generated art. Psychology of Aesthetics, Creativity, and the Arts, 12(2), 177–192.
Grace, D., & Iacono, J. L. (2015). Value creation: An internal customers’ perspective. Journal of Services Marketing, 29, 560-570.
Kaczynski, S., & Kominers, S. D. (2021). How NFTs create value. Harvard Business Review. Available at https://hbr.org/2021/11/how-nfts-create-value
Wall Street Journal. (2021, March 11). NFTs are fueling a boom in digital art. here’s how they work. The Wall Street Journal. Available at https://www.youtube.com/watch?v=zpROwouRo_M