If you’ve been on Twitter any time in the last few weeks, you’ve probably seen the term NFT somewhere between 2–3 million times. We’ll dive deeper into the various applications, but at their core, NFTs are a digital representation of ownership for a unique asset.
In this article I’m going to discuss:
- WTF an NFT is
- Do assets need to exist in the real world to have value?
- How NFTs reduce friction
- How TopShot capitalized on the opportunity
- NFT Ecosystem and the rise of Flow
- Applications outside of digital art and collectibles
In an interview with the Bankless podcast, Andrew Steinwold describes NFTs as a Trojan Horse for crypto.
NFTs are like a Trojan Horse for crypto. Simple use cases like art and gaming appeal to a broader audience outside of crypto natives, which is crucial for onboarding newcomers to the space.
This is what’s so exciting about NFTs compared to other crypto applications. They offer an onramp to the crypto ecosystem for people outside of technology and finance enthusiasts.
WTF is NFT
Fungible is the operative term in a Non-Fungible Token, so it’s crucial to know what fungibility means to truly understand NFTs. For those who don’t carry around a dictionary, fungibility refers to goods that are interchangeable. A currency is fungible. Every dollar is valued at the same amount, and all bitcoins are created equal. With an NFT, each token is unique or NOT fungible.
NFTs are designed to prove ownership, so let’s use an example to understand what that means. Beeple is a digital artist and an each piece of his work is paired with a unique NFT, a token confirming that owner’s version is the real one. An NFT of his work just sold for $69 million. Below is a copy of the image.
The common question for those new to the space is something like “why can’t I just download the image from Google search?”. Because the NFT is not the digital asset, it is the unique token attached to the asset which verifies the original copy. NFTs are like certificates of authenticity for digital assets.
There is a great analogy in this primer of NFTs: “An NFT is like a deed to a house. A deed is not the house itself, but a record of ownership of the house… An NFT is not the digital asset itself, but an electronic record representing ownership of the asset.”
Do these assets need to exist in the real world?
Anyone who is reading this article likely has some exposure to crypto, so I will save the elevator pitch on investing in digital assets. Instead, I want to focus on one application of NFTs that explains how they reduce friction compared to existing methods.
Two great resources that formed my opinions:
- NonFunGerbils podcast interview with Jeremy Levine
- Jonathan Bales article on NFTs and Investing in Digital Assets (this article lit the initial fire and subsequent demand took TopShot down for 3 days)
Investing in trading cards is a highly fragmented process. After purchasing, you likely need an intermediary to verify the card’s worth and scarcity, and then you’ll need to store the card in a vault for safekeeping. All the while, there are time gaps between these steps since you need to ship the physical card to each step of the process. Jeremy Levine, a legendary fantasy sports entrepreneur and recent investor in trading cards, broke down the investment process in an interview on the NonFunGerbils podcast. In most cases, he doesn’t ever see the physical card he purchased before it is stored away.
The physical card does not have any “intrinsic value”, it’s valuable because there is demand for it on a marketplace. Said differently, it’s valuable because people agree that it has value…which leads me to my next point. In order for a marketplace to be efficient, there must be transparency and liquidity. Transparency means you can quickly get an answer to how much something is worth, typically by assessing recent transactions. Liquidity is not only a measure of the supply and demand, but also a measure of the efficiency of transacting on that market. If it takes weeks to transfer the assets purchased on the market, the asset can’t be traded while in transit, thus limiting transaction volume and liquidity. Trading card markets like Dibbs.io have made strides to improve transparency and liquidity, but fundamentally the physical nature of the assets are a limiting factor.
Now back to what drives value. In the world of collectibles, whether it’s art or trading cards, proving authenticity is of paramount importance. There are countless copies of the Mona Lisa, but no matter how good the replica, only one is priceless. Verifying the authenticity of a collectible typically requires relying on the opinion of an expert. Anyone familiar with crypto need not be schooled on the dangers of relying on a trusted 3rd party.
So to summarize:
If the physical asset is not used for anything (ie no intrinsic value) and the existence of the physical asset creates friction, why does the asset need to exist in the real world?
How NFTs reduce friction
NFTs verify ownership and authenticity through the blockchain, thus removing the friction associated with relying on third party verification.
Transparency: With open blockchains, all information about the state of things is equally accessible by the whole world. In legacy investment markets, the challenge was about getting access to the best information. Now that all information is open and accessible, the challenge is about how you digest and interpret information. If you go to buy a physical collectible, you need to rely on a third party to provide you with a list of previous transactions. With an NFT, everyone has access to the same decentralized and immutable (can’t be tampered with) list of transactions.
Since the asset is digital and not physical, you don’t have to wait for the card to be ship and you don’t have to worry about storing it in a vault. This improves the ease of transacting compared to physical assets, thus improving liquidity.
Scarcity is a key value driver when referring to any collectible item, but it is a fundamental feature of crypto applications. Each time the government prints a new dollar, it diminishes the value of existing dollars. There will never be more than 21 million bitcoin and the fixed supply creates finite scarcity.
The CryptoPunks, one of the first NFT applications, are 10,000 unique characters. There are a finite amount of CryptoPunks, and this scarcity has created massive demand to the point where they are now viewed as a status symbol. The new Rolex is having a CryptoPunk as your avatar.
TopShot Capitalized on the Opportunity
TopShot is what got everyone (in my Twitter feed) talking about NFTs in the first place, so I want to discuss how they stormed onto the scene. There have been enough general overviews of the platform so I’m going to highlight two reasons I think contributed to TopShot’s rapid adoption that I haven’t seen mentioned as much.
To provide some visual context, here is the first moment I bought from TopShot:
NBA Top Shot: Donte DiVincenzo - Owned by fixed_tetra8702
Milwaukee Bucks (125) vs Cleveland Cavaliers (108) | Dec 14 2019 - Dunk | Serial No. 254
TopShot has done two things incredibly well:
- They have created demand by highlighting scarcity
- They have seamlessly integrated legacy payment methods
Let’s dive into each one individually.
They have created demand by highlighting scarcity
TopShot has designed a scalable business model by using tiers of scarcity. There can hundreds of copies of the “same” moment, but each TopShot moment has a serial number to differentiate it from the others in the edition. The moment pictured below is #254/299, meaning there are 298 other copies of this “same” moment, that are identical in everything except serial number. This can make a big difference as people place a higher value on specific serial numbers (#1 in the pack is typically best, etc).
Moments with a Common or CC designation are not capped, meaning they will continue to make more copies as others sell out. Moments with the Limited Edition “LE” designation have a finite amount, meaning no more can be printed in the future.
Despite the unrelenting demand for new packs, TopShot has kept supply low which has further fueled the demand. Every time a new pack drops, hundreds of thousands of people (including ones who don’t care about Basketball but want in on the hype) wait in line for one of their packs. I’m still not entirely sure if the lack of availability was strategic or a result of the technical immaturity of the site, but let’s assume it was by design.
Building a bridge to legacy payment methods
Brief tangent to fundamentals of market development because it’s crucial to explain why certain crypto applications are experiencing such rapid adoption.
The technology adoption lifecycle breaks down the stages in which societies accept a new product. The Early Market is comprised of Innovators and Early Adopters, or technology enthusiasts and those always in search of the next big thing. Beyond those groups is the Mainstream Market, starting with the Early Majority, and between the markets is what’s known as “The Chasm”. This is where many once promising startups and technologies see their end.
“Crossing the Chasm” (great book for anyone interested in learning more) refers to making the jump from the Early Market to the Mainstream Market. The Early Market is comprised of individuals who see potential in everything they use. They look at an early MP3 player and are willing to suffer through bugs and UX issues because they see the future of music as digital. The Mainstream Market is much more practical. If they’re going to pay for something, they want a fully baked solution that seamlessly integrates into their daily life.
As a technology, crypto is currently making that jump across the chasm. As a newcomer to crypto, “sending money” is a completely foreign concept. Questions start to run, “Wait, so I have to send to another wallet? What’s a wallet? It’s been 10 minutes, where’s my money?”. This dynamic presents a hurdle for onboarding newcomers, especially when it comes to the use of applications outside simply investing.
One of the things TopShot has done so well is integrate legacy payment methods. You don’t need to transfer ETH from a Metamask wallet to get a pack, you just use your debit card. This is a main reason why you have people using TopShot who also probably argue that Bitcoin is a scam. It is designed and built for mainstream adoption. Payment integration thus becomes a tool for onboarding and activation, an onramp to crypto.
TopShot uses a platform called Dapper for payment. To explain the value of this, let’s review some problems with the existing options.
NFT Ecosystem and the Rise of Flow
Most NFTs and supporting marketplaces run on the ETH blockchain.
Any time a transaction is made on the ETH blockchain there is a cost, and this is known as the gas fee. ETH gas fees are variable and they increase with the usage of Ethereum itself. One transaction can cost hundreds of dollars which makes it unsuitable for small purchases. I went to purchase an NFT on OpenSea, one of the largest NFT marketplaces, and the gas fees were >$100.
Flow is a new kind of blockchain, built for NFTs
Aside from the gas fees, projects on the ETH blockchain can suffer from congestion on the network. In 2017, CryptoKitties, one of the first NFT projects, brought the ETH blockchain to a halt from overwhelming congestion.
This was a catalyst for Dapper Labs to built a new blockchain called Flow, that supports fast / low-cost transactions and was designed to handle the demand of things like NFT and crypto games. Decrypt has a great overview on Flow and Dapper Labs.
Currently TopShot is the only application using Flow, but others such as CryptoKitties and OpenSea are currently implementing it. TopShot currently has a custodial wallet but it will be interesting to see if TopShot decentralizes and offers a non-custodial option. Eventually you may be able to see trade TopShot moments on a third party marketplace.
Applications outside of digital art and collectibles
We’re in the early stages with NFTs in general, but the possibilities of creating truly unique digital assets are endless.
The value of rights and licenses 10x with NFTs. Art was the first application to take off, but music may be next. Imagine an interface that feels like Spotify but is truly an NFT player with token economics attached, and whenever we listen to a song a token is sent to musician
Check out the use cases listed by Messari in the tweet below. TopShot got the name out there, but NFTs could end up being one of the most promising blockchain innovations. This goes way beyond digital art.