Non-volatile token prices are still high for now and may continue to rise for some time, but a collapse will follow. With central banks ready to tighten monetary policy in an effort to curb inflation, new and untested asset classes are likely to be hit harder than more reliable ones.
LAUSANNE – In March 2021, Christie’s auction house sold a $ 69.3 million JPEG file created by artist Beeple, a record for digital artwork. Ownership of the “original” JPEG – entitled “Every Day: The First 5,000 Days” – is secured as a non-swingable sign, or NFT.
The sale has made headlines and NFTs have been red-hot ever since. Investors poured $ 27 billion into the market in 2021, and Meta, Facebook’s renamed parent company, says today it has plans to allow users to create and sell NFTs. There is only one problem: the NFT market will eventually collapse, for one of many reasons.
In essence, an NFT tradable code attached to metadata is like an image. A secure network of computers records the sale in a digital ledger (a blockchain), giving the buyer proof of both authenticity and ownership.
NFTs are typically paid for with the Ethereum cryptocurrency and – perhaps more importantly – stored with the Ethereum blockchain. By combining the desire for art with modern technology, NFTs are the perfect asset for Silicon Valley’s newly rich composition and its train of acolytes in the world of finance and entertainment, as well as in the wider community of retail investors.
But, like other markets fueled by exuberance, impulse buying and hype, the fast-moving and speculative NFT market can hurt many investors. The current fad invites comparisons with the Dutch tulip mania from 1634 to 1637, when some bulbs fetched extremely high prices before the exuberance subsided to make way for the bubble to collapse.
The NFT market is likely to suffer a similar fate – but not, as some may think, for environmental reasons. To be sure, NFTs consume significant amounts of energy, as cryptocurrencies such as Ethereum and Bitcoin are “exploited” using computer networks with a significant carbon footprint – which grows with each transaction. But when it comes to understanding what will cause the NFT market to collapse, the climate impact is a red herring. The real problem is that the current NFT tree was built on a foundation of sand.
Let’s start with the problem of infinite supply. NFTs offer ownership of a digital asset, but not the right to prevent others from using your digital copies. Part of the reason wealthy investors are willing to pay tens of millions of dollars (or more) for traditional physical artwork by artists like Rembrandt, Van Gogh or Monet is that the number of masterpieces is finite; the artists are long dead and can not produce new works of art. NFT copies, on the other hand, can become a commodity.
Also, as with anything digital, there is no difference in appearance between an original JPEG that sold for $ 69.3 million and a copy that can be downloaded online for free. In theory, the supply of legally usable copies of NFTs is infinite, potentially saturating the demand for these pieces and causing prices to plummet.
Since the blockchain cannot store the actual underlying digital asset, someone who buys an NFT buys a link to the digital artwork, not the artwork itself. While buyers acquire copyright from the link, the transaction costs associated with monitoring the myriad online platforms where NFTs are exposed, identifying illegal use, and enforcing and punishing any infringement make it nearly impossible to enforce copyright or misconduct again. This severely limits the monetization of the asset.
Another risk is that NFTs are made and sold with emerging technologies – blockchains and cryptocurrencies. Today, there are several competing standards on how to generate, protect, distribute, and certify NFTs, including ERC-721, ERC-998, ERC-1155, flow and non-flow standards, and Tezos’ FA2. The resulting uncertainty about how certification of ownership will be guaranteed forever jeopardizes the value of the assets and even their ownership.
In fact, the value of NFTs may evaporate if the next wave of more advanced technologies to replace cryptocurrencies or the blockchain are incompatible with secure NFT ownership. Companies operating in the NFT market today may not exist tomorrow, generating waves of ownership claims.
The price volatility of the cryptocurrencies that support the NFT market is also a central issue. NFT prices tend to move in tandem with cryptocurrency prices. When cryptocurrencies fell apart in 2018, the emerging NFT market also fell.
The psychology of buying luxury goods is also likely to put downward pressure on NFT prices. Most luxury goods are often referred to as Veblen goods, with limited usability than allowing owners to advertise their wealth. For this reason, they often generate huge profits for sellers.
NFTs allow buyers to promote their wealth primarily through the high price they pay, but only if they receive a positive response from their peers. If those expenses do not resonate with their audience, the investor might as well use cash to light a cigarette.
Since owning an NFT does not prevent others from displaying the same assets and naming an ownership, these signs do not serve as effective indicators of unique spending power. And many NFT buyers remain anonymous anyway, because the blockchain ensures ownership knowledge is limited.
Finally, changing macroeconomic conditions could adversely affect the prices of alternative assets such as NFTs and traditional works of art. In the last two decades, the number of billionaires in the world has increased more than fivefold, and disposable income to invest in alternative asset classes has skyrocketed as a result. The Covid-19 pandemic has intensified this trend so far. Much of the great economic stimulus injected by central banks went to financial markets, which further increased the net worth of the super-rich.
But investors’ attention may be fleeting. Following the global financial crisis of 2008, sales of arts and other luxury goods fell by almost 40%. As central banks begin to tighten monetary policy in an effort to curb inflation, new and unproven asset classes are likely to be hit even harder than more reliable ones. And the extremely volatile NFT market, based on digital currencies with nothing to back it up, can not be a safe haven.
In short, the prices of NFTs will suffer a significant and permanent decline. They are still high for the time being and may continue to rise for some time, but the decline will take place. Investors who think they can snatch the market have every right to try, but their optimism is likely to be misled.
Patrick Reinmoeller
He is Professor of Strategy and Innovation at the Institute for Management Development.
Karl Schmedders
He is Professor of Finance at the Institute of Management Development.
Reference-www.eleconomista.com.mx