The acronym 'NFT' has become increasingly common over the last six months. NFTs have been featuring heavily in mainstream media as awareness of them continues to explode. I’m going to talk about NFTs from an economists’ perspective and discuss what they teach us about how value functions in our societies and economies. NFTs have undergone a crazy price increase recently and sceptics are certain this will come crashing down as they call into question the real value of NFTs. I am going to investigate the NFT phenomenon and what value really is in our economies.
What are NFTs?
Non-fungible tokens. They are digital items (most commonly images) stored on the blockchain; they can be art, screenshots, characters etc (some examples are below). The blockchain is a database of recorded transactions that utilizes technology that is far too complex for this article. All you need to know is that it proves ownership over digital items like cryptocurrencies and NFTs. People can create digital things and use the blockchain to make them scarce, this process is known as minting in the NFT space. Minting makes NFTs impossible to duplicate or replace in any way, this is what non-fungible means. The best way to visualize this, if you haven’t come across it before, is to imagine that the blockchain is giving digital items a unique identifier, like an artists’ signature on a one-of-a-kind painting or hallmarks on precious metals like gold.
Collections from left to right: Bored Ape Yacht Club, Beeple, XCOPY.
As economists, we know that scarcity and demand create value. We can see why NFTs are scarce, but why are they in demand?
Items in the economy are demanded due to the utility people get from buying them. Utility in the economic sense refers to anything desirable people can extract from a good like happiness or usefulness. Those in the NFT space, on the other hand, use the term utility to describe the different uses of NFTs. Uses for NFTs are, for example: use in videogames or other virtual spaces (like the metaverse), as a kind of funding for future projects, as a profile picture (Twitter recently added this feature), even as a membership to a collectors’ club with parties and other benefits.
Many economists and commentators take issue with the idea that NFTs have their value because of their usefulness. The videogames and metaverses that NFTs are marketed with typically do not exist, the NFT creators claim they will exist some day and then the NFT will be useful. Similarly, projects funded through NFT sales are non-existent, you are buying a right or membership to something that will exist in the future. The two aforementioned uses for NFTs appear almost indistinguishable from online crowdfunding (like Kickstarter) that has been extremely popular since the early 2010s.
If online crowdfunding works so well, why can’t this?
In terms of funding projects, NFTs won’t work as well as crowdfunding for two reasons. First, we already have crowdfunding. Second, crowdfunding companies like Kickstarter have Terms of Use that legally bind creators to fulfil promises and to refund backers if promises are not upheld, there is no such legal underpinning in the NFT space. Ryan Korner, an agent of the IRS (Internal Revenue Service), stated that the IRS is “seeing mountains and mountains of fraud in this area [the NFT market].” No one has any idea how much fraud has occurred in NFTs, but a quick Google search will tell you it’s a very real issue for this market, see below.
Courtesy of: Vice (top left), Reuters (top right), The Verge (middle), Rolling Stone (bottom left), The Wall Street Journal (bottom right).
NFTs acting as memberships to elite clubs and societies also seems like a far-fetched justification for their value. If people want to join collectors’ clubs for their art pieces that’s great, this concept exists for all sorts of goods, but does it justify an NFT’s price? No. The same way the existence of a Porsche owners’ club does not make up much if any of a Porsche’s price tag.
So, if project funding and club memberships are likely not driving the price increase, what is?
Twitter just implemented a feature that enables people to use their NFT as a profile picture and Twitter will change the border around your profile picture to a hexagon so people know that it is your NFT. Here is an NFT profile picture (below and left) versus a non-NFT profile picture (below and right).
The profile pictures may seem insignificant, but I think otherwise. Before this feature, the joke was often made that if somebody screenshotted your £500,000 NFT, they would be able to get the same utility out of it as you do for free. This new feature allows NFT owners to outwardly show off their NFTs by showing the world who owns it. The idea of showing off expensive things is not new, and neither are items that are only valuable because people want to show them off.
As previously mentioned, utility in economics is any satisfaction or pleasure that a person can extract from a good. People extract a great deal of satisfaction or utility from showing off something that other people want or are impressed by. In the past, goods that have captured this concept include; designer clothes, cars, décor and watches like Rolexes.
Let’s move away from NFTs for second. When thinking about why NFTs are valuable we need think about value more generally, we should ask why certain things have more value others.
Why is a Rolex valuable? Probably not because it can tell the time. The quality will absolutely contribute but the main reason people want Rolexes is, in my experience, because other people want Rolexes. A Rolex is an item to flaunt, show off, talk about, collect and admire - the utility (that is, the satisfaction extracted from the good) simply comes from owning the item. There are all sorts of reasons why Rolexes have become that name above other brands and the same applies to NFTs, not all of them become valuable, most never will.
So, the answer to the question “why are NFTs valuable?” may have a similar answer to the Rolex question. Like a Rolex, An NFT gives the owner some social value as they own something that others desire, NFT owners get utility just from owning them, and from having others know they own it. It is easy to be critical and say that “a market that is propped up by vanity or bragging as opposed to usefulness or quality is a market that is doomed to fail” but many legitimate markets operate on the premise of giving buyers something to show off, and it may be about time for this concept to reach the digital world.
Value is a complex idea. A habit of economists and those who study the markets is to look for intrinsic value or real value, but value is whatever we make it. When criticizing the NFT market, critics will obsess over the “lack of real value for the economy” that NFTs offer, but all something needs for it to be valuable is for it to be scarce and for people to want it – NFTs tick both of those boxes.
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