Non-Fungible Tokens (NFTs), the hottest topic in the crypto space has trickled down to popular culture. A lot of people don’t understand them yet. Ububele thought as a bonus to the newsletter about Bitcoin, Ethereum & Decentralized Finance, he should share my thoughts on NFTs. Some (most) people don’t care about the underlying infrastructure of the financial economy of the internet, but a lot of people care about how property rights & how ownership of items makes them feel, if not explicitly then implicitly.
Property rights are constructs in economics for determining how a resource or economic good is used and owned. Resources can be owned by (and hence be the property of) individuals, associations, collectives, or governments. Property rights can be viewed as an attribute of an economic good. This attribute has three broad components and is often referred to as a bundle of rights.
the right to use the good
the right to earn income from the good
the right to transfer the good to others, alter it, abandon it, or destroy it (the right to ownership cessation). – Wikipedia
The biggest change or disruption NFTs bring is what it means to own something on the internet. When the world opened up to this new world-wide-web in the early 1990s everything was about how we could move stuff from the physical world into the digital one. With that, the media industry lost its grip on property rights. In 1999, the music industry was the first to lose its property rights, all of a sudden music became a commodity that was freely replicable & shareable with anyone through Napster. In 2001, The Network TV & Movie industries lost their property rights with the introduction of BitTorrent. Then, the Newspaper industry lost its property rights in 2009 to Google & social media sites, Facebook & Twitter.
For creators & their industries to get a grip on the loss of property rights they had to cede their power of attorney to agent-aggregators. Again, the music industry went first – they ceded their power of attorney to Steve Jobs with the launch of iTunes & the iPod, Steve was able to at least help bridge the gap in falling income from record sales for the music corporations until Spotify arrived. Spotify not only saved the music corporations but fundamentally changed how music is consumed. But not everyone was saved, Universal Music Group thrived at the expense of the creator, the artist who had to find other avenues to subsidise the revenue loss from album sales with more live performances & adjunct revenue streams like merchandise & brand deals.
The Network TV industry ceded its power of attorney to streaming sites like Netflix & Hulu. As fewer people watched TV-by-appointment & started illegally downloading shows, ratings declined & to supplement that decline, rights were sold to Netflix & Hulu. Network TV faced another conundrum; cord-cutting, Millennials no longer opted into bundled broadcast TV but rather subscribed to internet streaming sites, viewership further declined for fridge networks. Again, the losers, in this case were the creators’ who used to sign huge Sitcom & Talkshow deals.
The Movie industry survived the peer-to-peer sharing era of BitTorrent due to how the business model works, where movies first appear in Movie Theaters for the first 90 days, that pre-sale had been a buffer. But now there has been a fundamental shift in consumer behaviour due to COVID, where Mass-media & Entertainment giants no longer cede distribution rights to Movie Theatres, opting to go direct to the consumer. In the short-term what does that look like? & what are the long-term implications of that on Hollywood? What does the vertical integration of Disney mean for the creators?
Then the last industry to lose its property rights was the Newspaper industry. They were absolutely demolished by the internet to the point of ceding their property rights to Google, Facebook & Twitter – for free. Local papers were no longer viable businesses & large outlets like The New York Times & Washington Post moved to subscription model. Newspaper outlets became places to read long-form opinionated pieces for those who could afford them.
Property rights in media has changed hands many-a-times over hundreds of years – almost always to the entity that controls the distribution. In that period the creator has never had full ownership of the contents or their creation, in fact, there is no creator class that has ever had unencumbered ownership of their creation except for one area, the artist – in art.
The Unbundled Creator: The Artist
Art is a form of communication. As an abstract, art is a way to communicate emotion, & value accruals based not on fundamentals but rather a scarcity in ownership of that emotion. For centuries, art has been viewed as a scarce commodity that accruals as a store of value & that scarce commodity had a signature tag of the creator based on forms, era, style etc. The artist has always been attached to the art itself;
The Mona Lisa by Leonard da Vinci
The Creation of Adam by Michelangelo
Number 17A by Jackson Pollock
The artist – in art has always been unbundled from the field itself. Not by any making of themselves, but by design.
In contrast to every other creator, the perception of value in the artist – in art is assigned by the consumer and not an intermediary, regardless of how auctions go. For instance, the value of a song is determined by Spotify, Apple Music & the record labels, the value of a book is determined by Penguin, MacMillan & other publishers. Christies & Sotheby may be the auction houses that start the bids but the value is always determined by the bidder. The closest to the artist – in art, is the photographer but the value of a picture has never been close to the value of a piece of art. The most expensive picture ever sold was Andreas Gursky’s Rhein II, sold in 2011 for $4,338,500. In contrast, the most expensive art piece ever sold, the Salvator Mundi by Leonard da Vinci, was sold for $450.3 million to the crown prince of Saudi Arabia, Mohammed Bin Salman in 2017.
What makes art – art. What makes it valuable? I don’t want to get philosophical or anything. In my opinion, the 2 things that make a piece of art so much more valuable than any other media form, if I can call it that, are:
Scarcity – music, books, pictures, movies are infinitely & easily replicable – art is not.
Consensus; the aristocrats for centuries have agreed to place value in the artist – in art & their art. That consensus got carried down for generations where the rich still have consensus on the value of ownership of a scarce item.
This is not to say that value is placed on all artists – in art. Like most things in life, this too faces Pareto’s principle, where value accruals to a select few, often the dead that can never produce another piece of art, which means scarcity forever for the owners of their art. The problem for the unbundled creator is that in most cases they needed to die for value to accrual to their work.
A lot of this ties into the emotional aspect we as humans place on ownership of scarce items, we will touch on this on the market size of NFTs, but first, we need to know what NFTs are now that we have tackled property rights & the value of the artist – in art.
What are Non-Fungible Tokens?
A Non-Fungible Token or NFT is a unique digital identifier that lives on a blockchain. This unique identifier is a representation of ownership of a virtual good. Virtual goods can span a variety of assets such as gifs, images, digital art, virtual trading cards, in-game assets, music, videos etc. Physical goods can also be represented by a Non-Fungible Token, a good example of this are Unisocks.
It is important to understand how Non-Fungible Tokens differ from Fungible Tokens. Fungible Tokens are essentially items that are interchangeable & indistinguishable from each other, like-for-like items. Bitcoin is a Fungible Token, 1 Bitcoin is equivalent in representation & value to another Bitcoin, like a 10 rand note is of equivalent representation & value to another 10 rand note. Non-Fungible Tokens (NFTs) represent items (virtual goods) that are distinguishable from each other & not interchangeable in representation. For instance, the unique identifier that points to ownership of a digital art piece, that digital art piece is not interchangeable for another like item, it’s unique, therefore Non-Fungible. But ownership of the token itself can change hands.
NFTs were born out of an Ethereum blockchain standard called ERC-721. You can think of it as a set of rules or better a set of principles that are prerequisites of properties that govern the classification of a token. This is in contrast to ERC-20 standards for fungible tokens. These two standards govern the types of tokens that exist on the blockchain, they have the following properties:
Non-Fungible Tokens sit side-by-side to fungible tokens on the asset layer of the Ethereum blockchain:
The fascination people have with NFTs are not really about the standard or even how they work. The fascination is what they represent, the virtual goods, the visual element & the value people place on images of cats on the internet or a video of Lebron dunking that can be easily viewed on YouTube or the art of a guy who calls himself Beeple. It goes back to our discussion on the value placed on the artist — in art. If you go through the properties of what makes art valuable it is not that big of a mental leap to understand why people place value on NFTs.
Scarcity; are NFTs scarce? Yes, even if what the token represents i.e. an image that is infinitely replicable is not scarce, for the first time in the digital age, ownership of that particular image can be attributable to a person & people now pay large sums in dollar terms to own the property rights to that image.
Consensus; thanks to Bitcoin & the introduction of a consensus mechanism, in the form of the blockchain, people now understand that value can be created & moved on the internet. This has unlocked other things outside of currency that people value & ownership of virtual goods is one of them.
It also goes back to what property rights mean for the person who owns that virtual good:
the right to use the good
the right to earn income from the good
the right to transfer the good to others, alter it, abandon it, or destroy it
He created a hash that uniquely, and unhackably, identified that file
He created a metadata file that included the hash to the artwork
He created a hash to the metadata file
He uploaded both files (metadata and artwork) to the IPFS darknet decentralized file sharing service
He created, or minted a token governed by the MakersTokenV2 smart contract on the Ethereum blockchain
Christies created an auction for this token
The auction was concluded with a payment of $69 million worth of Ether cryptocurrency. However, nobody has been able to find this payment on the Ethereum blockchain, the money was probably transferred through some private means.
Now that we have a fundamental understanding of what NFTs are, what they represent & what it means to own one, we can now think about the market for them. This may sound obscure and a bit weird but bear with me.
The Market Size for ‘Emotion’
The market size for NFTs is the market size for emotion itself, things that make us humans feel good. The biggest purchase driver of art is emotion, yes it is one part emotion & one part tax evasion for the rich but the thought of buying assets with no use case besides maybe social status & self-exuberance does not make sense except for emotion being the driver of the purchase. Then, what are other purchases that are driven by emotion? luxury collectible cars? rookie cards? rare artefacts? What is the market size for emotion? I think art & collectibles is a good inference.
Another way to think about the market size for NFTs is to look at the long tail of other things sold as NFTs that are not Beeple artworks, these might be songs by your favourite musician, access points to celebrities, the rights to movies, books, blogs posts etc. Anything that relates to internet culture can now be tokenized & sold as an NFT. There are only a few items mentioned above, but it begs to ask, how do we think about culture? What’s the mental model for it? American entrepreneur Tristan Walker once said:
“All global culture is lead by American culture which is lead by black culture in the US”
Though not entirely true, a lot of cultural elements in the world are driven by black & brown people, music being the major one, sport being another. The market for culture is nuanced, at the top level it constitutes all of media & entertainment.
Market size for ‘Culture’ = $2 Trillion
Every time a new industry or technology is born we tend to use an analogue of an existing market to make an inference on the value it can create. This is always wrong because new technologies fundamentally change the existing analogue market.
Everything in this space is moving so fast that it is very difficult to pay attention to the important parts. It is so early to even tell if this is real or a spur of the moment thing. NFTs are clearly in a bubble stage, there is no real price discovery happening, you get what you pay for & then you may not sell it for what you bought it for. That’s how power law goes, a lot of NFTs will be worthless. Then again art itself is a bubble that’s been running for centuries. What is clear is that NFTs have altered the course of property rights on the internet, they have established scarcity, we will have to wait & see if consensus holds – that might only happen a couple of centuries from now. Fascinating, isn’t technology exciting?!
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Ububele hodls some Bitcoin & Ethereum in his personal capacity. This content is for informational purposes only, you should not construe any such information or other material as investment or financial advice. Nothing contained on our site constitutes a solicitation, recommendation, or offer by Ububele to buy or sell any Bitcoin, Ethereum, NFTs or any other financial instruments.