By Mikkel Morch, Executive Director and Risk Management at ARK36.
As the current bull market in digital assets is heating up, we are being bombarded by sensationalist stories of meme tokens recording impossibly high returns almost every other week. Many of these stories will end – or have already ended – in a predictable way: the bubble bursts, the asset crashes, and millions of dollars in value are erased in a matter of minutes.
In such a context, it may be tempting to write off non-fungible tokens, or NFTs, as just another such story. In fact, when a subset of an asset class known for its volatile and speculative nature appreciates 9000% YTD, it is only natural that a seasoned investor would like to proceed with extreme caution – if at all.
However, the exponential growth of the NFT marketplace makes it impossible to ignore this technology either. In Q3 2021, the NFT space registered a record $10.67 billion in trading volume, which represents an astonishing 704% increase QoQ. Even more importantly, large companies and well-known brands are betting on the sustained development of this technology and aggressively investing in a variety of NFT solutions and integrations. These entities come from a wide range of industries and include Google, Visa, the NBA, Nike, Twitter, and, most recently, Facebook, to name just a few.
Therefore, while the media is eager to report on the latest record-smashing NFT sale, one has to look beyond the exorbitant price tags to understand the true significance of this phenomenon. In ARK36’s view, NFTs are a highly innovative technology with great disruptive power and clear investment potential. They are already changing multiple industries at once and they will likely continue to exert this influence long after the current digital asset bull market is over.
However, in order to fully appreciate why NFTs merit serious attention from investors, it is important to understand the fundamental technical aspects of this invention that make it so unique.
For investors new to digital assets, the main point of reference in this space is likely Bitcoin. NFTs are much different from assets like Bitcoin although they share a few important similarities.
The similarities revolve around the fact that both NFTs and Bitcoin exist on a blockchain. This means that, as is the case with BTC, the ownership record of an NFT is immutable, publicly viewable, and verifiable. It can be conclusively proven without a trusted party or intermediary and with no possibility of fraud.
The main difference between Bitcoin and NFTs is fungibility. Fungibility basically means that one unit of a token is equivalent to any other unit. Bitcoin is a fungible token because you can exchange one bitcoin for another without any loss in value, functionality, or essential properties.
Non-fungible tokens, on the other hand, are different because they are not interchangeable with one another. And while one bitcoin is equivalent to another bitcoin, no two NFTs are the same.
Digital Collectibles – Or More?
When reporting on non-fungible tokens, broad audience media outlets often describe them as “digital collectibles”. This can be a useful explanation, especially that the sales of NFT artwork or sports memorabilia have so far comprised the majority of NFT trading volume.
But in reality, collectibles are just one of many potential use cases of this technology. In reality, NFTs can be used to represent almost anything – in both the digital world and the real one. This is possible because you can tie all kinds of data – like a URL, an image, a video, and more – to an NFT the moment you create it. Such metadata will then exist on the blockchain as an integral, immutable part of the NFT.
And this is precisely where the disruptive potential of NFTs lie. They make it possible to utilize the main value propositions of blockchain – trustless ownership, digital uniqueness, and digital scarcity – in a variety of domains beyond finance.
As mentioned in a report by VISA, NFTs offer “the ability to track and leverage a digital asset in multiple environments” that can give rise to new opportunities in industries such as “ticketing, gaming, music, art, and beyond”. In view of that, there is little wonder why Facebook has tied its new business identity to the development of the metaverse – a digital space that will make extensive use of NFTs and their functionalities.
The ramifications of these processes from the investment perspective are much more diverse than can be conveyed here. Most importantly, however, NFTs will likely expose whole new demographics to the world of digital assets. This is because, in order to buy and interact with the most popular NFTs, you have to have a digital wallet and use some cryptocurrency like Ethereum or Solana. Consequently, NFTs will likely become an important next step on the road to mainstream adoption and integration of digital assets.