It appears recently, perhaps due to media coverage or perhaps due to me never shutting up about them, my friends have started becoming interested in NFTs. People who I previously annoyed with my talks of NBA gifs and digital race horses are starting to ask serious questions such as sustainability of investments and how they can get involved. This seemed like a good time to provide a general background on NFTs, their value, and a beginners guide to how to get involved. This will be a multiple part series, so I suggest you start with Pt. 1 and continue along in order.
WHAT IS AN NFT?
For the unaware, NFT stands for Non-Fungible Token. Think anything which you can buy in physical form, but existing in digital form instead. There are a few different categories of NFTs which are distinct in many ways both in how they provide value to their owners and the type of investor who tends to own them. Below I will provide the most popular current categories of NFTs. Note that not all NFTs fit neatly into a single category and many can be categorized as multiple things.
Perhaps the most familiar cross-over from traditional investments and NFTs I would categorize as Collectables/Art. These include my beloved aforementioned basketball gifs (NBA Top Shot) and art pieces such as those created by my current favorite NFT artist Ghxsts. These derive value the same way any collectable does- from ownership of a limited item.
Take, for example, NBA Top Shot. These are essentially digital basketball trading cards. They have the player’s season/game stats for that year, an indication on if this is the player’s rookie card or a year they won an MVP/NBA Title, and is licensed by the NBA. The only difference is instead of a static image, Top Shots give a video gif of a special play from that player. Similar to physical cards, these are bought in “packs” and each pack has a randomized assortment of possible cards. Also similar to physical cards, the value of any particular card is a mixture of the card’s rarity and popularity of the player. A 1-of-100 LeBron will be worth more than a 1-of-10,000 LeBron or a 1-of-100 [generic scrub player].
These derive value the same way physical cards derive value. Any physical collector’s cards will likely be organized in binders or haphazardly thrown in shoe boxes. While collectors may frame and display their most prized collection, the most valuable cards are stored in climate controlled vaults and only taken out to be authenticated and sold. NFT cards can also be displayed (both physically and on social media). However, when you want to sell a physical card, it must first be sent to a grading company, which authenticates the card and can take 6+ months. With NFT cards, the authentication is done on the blockchain, which removes both the time and expense required before selling.
Art NFT collectables are the same basic idea. You can likely find a high resolution image of the Mona Lisa and have it printed, framed, and hung on your wall. Or you can commission an artist to physically paint you a copy which would be imperceivably different from the real thing for 99.99% of the population. But the fake is virtually worthless while the real copy is valuable because of its authenticity. NFT art can be displayed just like physical art, but again the authenticity is established on the blockchain. NFT art also gives you direct access to the artist. Often, artists will “airdrop” art to existing owners. For example, anybody who owns a Ghxsts “Zxdiac” piece also gets 1 additional piece of art a month automatically delivered to their digital wallet. These airdropped pieces can then be sold individually by the collector or as a bundle. Artists also often have discords (think AOL chatrooms on steroids) where they can interact with collectors and explain meanings behind pieces/announce upcoming releases.
Another category of NFT is called play-to-earn. Popular examples of these include Zed.run and Axie Infinity. With these NFTs, there are two aspects: both the actual NFT and the game which you can play with the NFT. I will use Zed as an example because it is the one I am most familiar with, but the general concept is the same across the genre. In Zed, you can buy digital horses which can then be raced against other digital horses for real money. These horses have varying skills. Some are overall great, some are great at certain distances, and some are donkeys. The only way to tell if a horse is a good racer is to actually race it, but just like in real racing, certain horses will be more likely to be good than others depending on lineage.
The racing aspect alone is super fun. After I watched Jonathan Bales race his first horse Spicy Mayo, I knew I had to get a horse of my own. With these play-to-earns, there are three general ways to make money. First, you can buy the underlying NFT and just treat that alone as an investment. As more and more people get into Zed, the demand for the horses go up. The more rare the horse the more potentially valuable the investment. In Zed, there will only ever be 36,000 “genesis” horses created. Just as virtually all real race horses are decedents from the same 28 parents so too all Zed horses will be decedents from those 36,000 original horses. This makes even the worst performing genesis horse extremely valuable.
Second, you can earn through the game aspect such as racing horses in Zed. To enter a race, you pay a fee ($2-$500+ depending on the race). The first 3 placing horses get a share of that prize pool. Racing takes skill, learning both what distances your particular horse is good at, and also knowing the other horses in the race to determine how strong the competition is. Some horses are great racers which are very profitable to race, while others are bad-to-mediocre which can still be fun to race but which will likely not be profitable over an extended period of time.
Finally, you can use your NFT to create additional NFTs to sell. In Zed, similar to real horses, female horse can mate with males to create offspring. The owner of the female horse keeps the offspring, and pays a “stud fee” to the owner of the male horse. While better horses are more likely to create better offspring, there is also a random aspect like in real horse racing where even bad horses can create good or even great offspring.
Some play-to-earn NFTs, such as Zed and Axie, already have a game developed in which you can buy an NFT and start playing immediately. Others, such as Chicken Derby and Rumble Kong are still selling their initial NFTs which are used to fund the game development (think a kick-starter with ownership perks for early investing). Getting involved in established games are generally more expensive, but have the reward of instantly being able to play/earn in the game. Newer games generally provide a cheaper barrier of entry, but also are not immediately playable.
The final genre of NFTs are what I will refer to as avatar NFTs. These are NFTs which similar to art NFTs have various artistic features, but their primary utility is membership into a digital networking group. The most famous of these is CryptoPunks, but other projects include BAYC, Cool Cats, and countless others.
These avatar projects are often a group of ~3,000-10,000 unique NFTs which share some common characteristics. Each have varying levels of rarity or value based on their characteristics. For example, Ape and Zombie CryptoPunks are worth millions, while more common human Punks are worth tens of thousands.
These are called avatar projects because people set these as social media profile pictures as a part digital flex and part group identifier. The cost to mint (i.e., be original purchaser) are what many people would consider expensive for a .jpg, but are relatively cheap compared to cost to join established projects/communities. A BAYC could be purchased for .08 ETH (~$184) on May 1st, 2021. The current minimum price for one is 52 ETH (~$182,000).
Similar to the art projects discussed above, these have value based on the art aspect, but also these provide value as a sort of online country club. People will automatically follow people on Twitter based on their avatar. These projects have active discord communities where members share investment ideas, discuss NFTs, and otherwise socialize. They organize meet ups, and online events such as poker tournaments or raffles. Especially in areas such as digital marketing or web engineer, these profile pictures can even lead to coveted job opportunities.
For every NFT avatar project which succeeds, there are 10 that fail. This is largely due to a combination of the strength of the community, the marketing/organizational skills of the founders, and luck or being at the right place at the right time. So being an original owner of an avatar NFT is like buying a lottery ticket, which you can help increase the chance of payout of by being an active or valuable community member.
You can also think of avatar projects as digital clothing. What makes a Ralph Lauren t-shirt more valuable than a plain Gildan t-shirt? The quality can be largely the same if not identical. The value is in the brand and what wearing that brand says to people before you ever talk.
Hopefully if you got this far you at least understand what NFTs are and generally how they are valuable in different ways depending on the type of NFT. If you enjoyed this and think one or more of these types of NFTs are appealing to you or would just generally like to learn more, I will be releasing a Part 2 next week which describes the best way to research potential NFTs and how to purchase your first NFT.
If you have any questions or would like me to write about anything else, let me know on either of my twitter pages! As always, I am an attorney, I am not your attorney. For legal advice, you should always consult (and pay for) an attorney.