99% Of Nfts Will Devalue – How To Pick A Good One

Through the ages, royalty and elites were spending huge amounts of whatever currency had been circulating at the time on paintings and other rare items. Sometimes the art of collecting took rather strange turns as in The Collector by John Fowles where a psychotic youth kidnaps a female and holds her captive in his cellar. The cinema industry wasn’t alien to the subject either, which is confirmed by the sheer number of movies with the same or similar name.

The onset of the digital age and the advent of blockchain tech didn’t change much in this respect.
Non-fungible tokens (NFTs) that leverage the technology are tapping into this curious quirk of human nature (bad habits die hard), and there’s no limit as to what an NFT can represent – from cat memes and music tracks all the way up to medical records and human genomes.

But does it mean that everything dressed up as an NFT will have or acquire value over time beyond its basic utility? And if not, what will then? Let’s set the facts straight and find out.

What are NFTs?

It is hard to pinpoint the exact date when the idea of what later came to be known as a non-fungible token emerged for the first time. Probably, it all started in May 2014 when a GIF image was sold as a proof of concept at Rhizome’s Seven on Seven conference for $4 on the Namecoin blockchain. The process of transferring ownership with the help of cryptography was christened monetized graphics.

However, the name didn’t stick because at the time the market wasn’t quite ready to embrace this technology. You won’t find a lot of links for the term in a Google search nowadays, and most date back to 2014 anyway or reference that experiment in some other way.

CryptoKitties

So it wasn’t until the wild success of CryptoKitties launched in November 2017 that the modern history of NFTs as we know them began. CryptoKitties was quickly followed by a bunch of other blockchain-based games featuring NFTs as in-game assets that could be bought and exchanged outside the game environment and often even across different games.

That, in itself, was a huge improvement over such games as World of Warcraft where the fate of an in-game item is fully controlled by the company behind the game, not the gamer.

Then came digital art and all that fancy stuff which is offered for sale as NFTs like a digital collectible of a column authored by The New York Times technology writer Kevin Roose (actually sold for $560,000 in a charity auction), X-ray images of Canadian actor William Shatner’s tooth from 1953 (likely just for kicks), and even the entire genome of Harvard geneticist George Church (which is available for free).

The original idea proposed by Kevin McCoy and Anil Dash, the guys who were the counterparties to that May 2014 trade, was to offer artists an alternative way to support and protect their work so that they could earn some dough and maintain control over their creations.

The NFT Market and the Future

However, it didn’t pan out too well considering that people started creating NFTs from the works of artists without asking for permission or paying any royalties. Then how come that the NFT market is booming right now and why should it necessarily deflate at some point in the future?

The sad truth is that cryptocurrencies exist in a rather lonely, isolated environment, and there is no light at the end of the tunnel. You can’t buy much with them directly (and still less after Elon Musk decried Bitcoin). Money bags invested billions of dollars in crypto, but they can’t disinvest now without crashing the prices, which would mean going back to square one.

Basically, you can easily sell a dozen Bitcoin without significantly impacting the price, but if you are going to sell a few thousand, that alone might trigger a panic sell-off. As the irony would have it, these days we have a numerous packs of nouveaux riches who can’t meaningfully spend their newfound wealth.

And NFTs come to the rescue as they offer an illusion of purposeful economic behavior, just like the DeFi frenzy of 2020 that came before the recent mania and was preceded by the altcoin madness of 2017. In this manner, NFTs are a passing fad that will eventually be superseded by something else.

Misconceptions About NFTs

There are some nuances that add undertones to this picture and thus are worthy of mention. In purely technical terms, an NFT is not digital art itself because it is just a pointer to a piece of art stored as a file somewhere on the Internet, not on the blockchain as many erroneously assume (if anything, a human genome is about 725 megabytes of raw data).

And if this file is gone tomorrow or becomes inaccessible for whatever reason, the NFT representing it instantly becomes worthless. In fact, such an outcome is only a matter of time as most of these files are stored on the servers of start-ups selling the NFTs. Then one day they just go belly up (though not necessarily all of them on the same day). C’est la vie.

Further, real-life artworks are physically unique while digital collectibles can be effortlessly copied and reproduced – down to their last bits and as much as needed. Indeed, there’s an issue of fakes and imitations, but it actually proves the point with the real stuff. All things considered, an NFT is simply an entry in an auction catalog that only adds value to the thing it symbolizes (for example, by being registered in a high-profile auction), but can’t have a value of its own.

In other words, it is a proxy for value (aka token, yeah), not the value itself.

Skimming Off the Top

Understandably, the previous part draws a rather gloomy picture. That’s because “better safe than sorry”. With that established, let’s see what we can make out of it and how it can facilitate better investment decisions.

Most people are banking at random on the future growth of an asset they only think they are investing in. However, this is not investing but rather a form of gambling, and the total majority of gamblers are set to lose in the end due to house edge.

The “house edge” here refers to the advantage that other investors have by knowing exactly what they are doing and why they are doing that. Long story short, they will buy from a gambling-type investor when the asset is undervalued and sell it to him when it gets overpriced. Otherwise, they will just sit patiently on the fence biding their time.

Seriously, you don’t really expect a man on the street to be able to assess the market value of a painting or even distinguish the original artwork from its exquisite replica, do you? Every year fakes and forgeries are discovered in both public galleries and private collections. But how is a digital collectible different?
How do you know it is a real deal in the first place?

Pick Your NFTs Like You Would Your Cryptos

Therefore, it truly comes to understanding your field of pursuit. It is fundamentally the same idea of value investing promoted by Warren Buffett (even if he strongly dislikes crypto) and applied to crypto space (in this case, NFTs) – understanding the strengths and weaknesses of an asset, then buying it at a discount and selling it at a premium.

At the same time, the NFT market is very diverse and you don’t exactly need to be an expert as common sense and personal interest in a certain area will help you avoid the majority of pitfalls that you would otherwise inevitably fall into.

In this manner, if you don’t want to be left with a worthless token for the reasons explained above, you should stay away from what is essentially buying a link to a file and which doesn’t imply the transfer of certain ownership privileges regarding the contents of the file (for example, a song or a video), the privileges that can be defended or enforced in the court of law if it comes to that.

The NBA NFTs

For example, the National Basketball Association (NBA), a professional basketball league in North America, sells so-called Moments, NFTs of the NBA highlights (think trading cards here), which are licensed by the NBA. As a purchaser of these NFTs, you can do only a small number of things with them, namely, buy, hold and sell the highlight for personal, non-commercial purposes.

Essentially, the NBA is selling a license to the game highlight that is portrayed in the NFT but not the underlying copyright itself. As a result, you can’t modify or commercialize it. However, if someone makes a perfect copy of the highlight, it will be instantly recognized as a fake and thus will have no perceived value that the NFT ownership bestows.

Consequently, you are legally protected from someone making bootleg copies of the digital content that the NFT links to. This is one of the reasons why the NBA highlights are in high demand by basketball fans, with the most expensive Moment featuring a LeBron James dunk sold for nearly $100k. These crypto-collectibles can be a legit investment, especially if you are deeply in love with the sport.

Blockchain Video Games

Blockchain-based video games are another niche of the NFT market where personal involvement on some level can help you greatly. Case in point, the new kid on the block, well, on the racetrack, Zed Run, a horse racing game using NFTs, rides as far as to claim that it will eventually enable players to “work in professions such as stable owner, race track owner, breeder, accessory designer and more”.

Well, this is a pretty bold statement in itself, but its logic can be reversed. If you are anything in any of these occupations, you can safely trust your judgment as to how well the game mimics real-life horse racing, and, by extension, make an educated guess regarding how popular it can potentially become. But this is the heart and soul of value investing.

More broadly, if something is your cup of tea, and has been for years, you can pretty much rely on your appraisal of it. Then the subtle art of picking the right NFT as a digital collectible or investment vehicle boils down to determining your area of expertise or interest (for example, gaming, arts, music, sports, etc) and choosing the market where you feel most at home, understand how much you pay for something and what you get in return.

The Bottom Line

NFTs are not a get-rich-quick scheme, even though you may be led to believe otherwise. Indeed, if you were lucky to get in early, you may have struck it rich and done extremely well – as with virtually anything else out there. But this ship has already sailed. Further, it is not unreasonable to expect that most NFTs will turn into trash when the music finally stops.

The good news, though, is that not all NFTs are born to die equal, and after the dust eventually settles while the hype subsides, what’s left of them will be the real deal. Finding these rare pearls in a bed of oysters is a daunting task that requires hard work along with insights into the essence of market forces and human motivation.

But that has always been the case with investing anyway.

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