Insights

Vol.4: Beyond Digital Art: Long-Term Use Cases for NFTs

November 05, 2021
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Beyond Digital Art: Long-Term Use Cases for NFTs

If you’ve been following crypto news at all in 2021, it’s been impossible to miss stories about NFTs: Jack Dorsey selling an NFT of his first tweet for almost $3m, the woman from the “Disaster Girl” meme selling the original image for $0.5m, and various pixel art images selling for tens of millions of dollars. Now every major brand seems to be jumping on the NFT bandwagon, from McDonalds to the NBA.

But are NFTs here to stay? Or is this a return to the hype madness of the ICO era? Is there a use for this technology beyond the art world? As usual in crypto, the answer is nuanced. In this edition of the CkSum Insights series, we’ll look at the current state of the NFT market and explain what we see as the long-term utility of this new technology.

What are NFTs?

NFT stands for “non-fungible token”, and it’s important to understand what this means to grasp the potential of this technology.

Non-fungible assets are unique and not interchangeable. There is only one Mona Lisa, for example. Compare this to a banknote, perhaps the ultimate example of a fungible asset, where any ten-dollar bill can be exchanged for any other with no relative transfer in value.

NFTs can be transferred via the blockchain like any other cryptoasset, and with that transaction ownership rights are transferred in a way which is transparent, auditable, and cost-effective.

It should be noted that many fungible assets have non-fungible properties which are rarely used. While banknotes are used in a fungible way, they also have serial numbers which make each one unique. However, this non-fungibility is rarely used except in an auditing capacity.

This mix of fungibility and non-fungibility holds the key to what we at CkSum consider some of the most promising long-term use cases for NFTs, but let’s begin by looking at the market which put NFTs on the map: digital art.

Exhibit 1: NFT Image: EVERYDAYS: THE FIRST 5000 DAYS by Beeple

Source: EVERYDAYS: THE FIRST 5000 DAYS by Beeple (b. 1981)

NFT Art: An Investment in Culture

The most visible use of NFT technology at present is NFT art. Supporters see NFTs as providing a new freedom for artists to reach an audience and profit from their work, while detractors often point to the sheer strangeness of paying life-changing sums for a “unique” version of an image which can be endlessly duplicated and distributed.

And the sums involved are certainly life-changing. In just a few months, NFT marketplaces such as OpenSea have exploded to become a multi-billion-dollar industry.

In March 2021, the artist Mike Winklemann — known as Beeple — sold the NFT of his artwork Everydays: the First 5000 Days for $69m via the auction house Christie’s. This sale makes the NFT the third most expensive work from a living artist ever.

While this might seem to confer legitimacy to the medium, some have speculated that the purchase was a stunt to boost the profile of NFTs. If it was, then it worked: According to Forbes, the Beeple sale was a direct catalyst for the explosion in NFT sales, which hit $10.7b in Q3 2021.

This isn’t all good news for creators and buyers. As might be expected, the high-profile stories are significantly outnumbered by disappointing sales, with the average NFT sale being reported at less than $200. There have also been multiple reports of scammers using the  pseudonymous  nature of the blockchain to create an artificial sales history and trick unsuspecting buyers. If Person A sells an NFT to B for $1000, who sells it to C for $100,000, who sells it to D for $10,000, then D might think they’ve got a great deal, until it turns out that A, B and C were all the same person, using different accounts.

Exhibit 2: NFT Sales on Open Sea

Source: Reuters: NFT sales surge to $10.7 bln in Q3 as crypto asset frenzy hits new highs

While this should certainly cause some reflection on the long term value of the NFT art space, it should be noted that this kind of hype isn’t unique to crypto. Most artists and artworks never turn a profit. Even the Beeple story is hardly new: in 2007, Damien Hirst’s piece For the Love of God was sold for $100 million, at the time the highest price paid for an artwork by a living artist. But the consortium which bought the piece included Hirst himself, leading many to likewise speculate that it was merely a stunt to increase the value of Hirst’s brand.

There are also many reports of NFTs being used to facilitate money laundering, but of course this is also true of traditional art and indeed most asset classes. If anything, the blockchain-based nature of NFTs should help to reduce this kind of fraud as enforcement agencies get up to speed with the higher levels of traceability the technology confers.

Enabling New Business Models for Gaming

One of the most exciting uses of NFTs is their potential for gamification and impact on gaming business models. Although many of the biggest NFT purchases relate to one-off artworks, most NFT drops are variations on the trading-card business model (a market which, not coincidentally, also sky-rocketed during the pandemic). Participants in a sale will pay to guarantee themselves an NFT from a set, but the precise parameters will be randomised. The artwork itself is often procedurally generated. Some lucky people will win the rarest NFTs, while most will receive less valuable “common” types.

Many industries have been quick to capitalize on the potential here. Well-known examples include the digital collectible trading service NBA Top Shot, where participants collect and trade video clips of basketball “moments”, which had amassed $230m in trades by February 2021 and $744m in secondary trades between July 2020 and Oct 2021.

But if gamification is making waves in the NFT art world, it makes even more sense for the gaming industry itself. Indeed, NFTs feel like a natural extension of existing gaming trends. In recent years, gaming has increasingly switched from selling one-off games to multiplayer experiences with a huge level of customization and add-ons for purchase. These games often add a gambling layer in the form of loot boxes and randomized item drops which have become a multi-billion dollar industry and drawn negative attention from regulators who view it as a gateway to gambing.

Ethics aside, it seems inevitable that NFTs are poised to be the evolution of the loot box trend. Gamers are already familiar with the concept of tradable items whose value varies based on rarity. It has been a simple matter to enhance this trend with NFTs, which enable more efficient and secure marketplaces and open up new revenue and governance models for game developers and players alike.

The biggest success story in this new space has been the “play-to-earn” trading and battle game Axie Infinity from Vietnamese developers Sky Mavis. In addition to being the most expensive NFT collection at time of writing, the underlying AXS cryptocurrency has grown over 100,000% in value since November 2020 and developer Sky Mavis raised $150m at a $3b valuation from a16z in October 2021.

Exhibit 3: Axie Infinity (AXS) Price Chart

Source: CoinGecko: Axie Infinity (AXS) Price Chart

Axie Infinity players earn AXS by playing the game, staking AXS, and participating in key governance votes. The AXS they earn can then be sold on cryptocurrency exchanges such as Binance for local currency. The game has been profitable enough for players in the Philippines to support themselves playing the game as a full-time job. Additionally, in acting as a governance token, AXS enables players to direct game development and decide how Axie Community Treasury funds will be spent.

Exhibit 4: Axie Infinity Marketplace Dashboard - Oct 2021

Source: Axie Infinity Marketplace Dashboard showing $640m trading volume for October 2021

Solving Problems in Ticketing

Although most news around NFTs relates to astronomic prices, NFTs can also be used to dampen price inflation. Ticketing for events is a clear example of a market which would benefit from an added layer of programmability and restrictions. Popular events are often plagued by scalpers, who use bots to buy up tickets for no other reason than to resell at a higher price. By one estimate, around 12% of people who rebuy tickets are scammed. Using NFTs, it’s a simple matter for the ticket issuer to add a price ceiling or other controls to the secondary market. This allows legitimate secondary markets to exist, while reducing the incentive to scalp.

Improved Provenance and Rights Transfer

NFTs can be used to reduce fraud and improve auditability across a whole range of global asset markets, from wine to real estate. The blockchain makes it simple to track ownership history and can help standardize processes across disparate jurisdictions.

Utility here isn’t limited to high-value assets. In many parts of the world, ownership is hard to prove and institutions are unreliable or outright corrupt. Despite the caveats associated with blockchain ownership mentioned earlier, for billions of people NFT-based ownership on a blockchain would be a major step up in terms of auditability, reliability, and cost.

The programmability of NFTs can also bring benefits to other asset classes. For example, it’s a simple matter to automate dividend payments by issuing stock as NFTs. Not only would this be more efficient, but it would increase transparency.

Joint Ownership and New Funding Models

Most of the examples so far have focused on using NFTs as proof of unique, total ownership of an asset. But the technology is equally useful as a way to track and control shared ownership among a consortium of owners.

This has innovative applications in crowdfunding. Stoner Cats is an adult animated series from Orchard Farm Productions, directly funded by sales of procedurally generated NFTs. By participating in the sale, people not only get to directly fund a project, they also receive a unique piece of NFT artwork as proof of their participation. NFT ownership will be required to watch the series, so they also provide a way to gate access to episodes. It’s unclear how this will work in  reality  (it  is  notoriously difficult to prevent piracy of video content), but the idea of a show with limited ticketed access is interesting and unique. This combination of features highlights the power of harnessing the programmability and non-fungible nature of NFTs.

The Problem of Trustless Ownership

NFT detractors are most concerned about the long-term reliability of the technology itself, due to the slippery concept of what an NFT actually is. When you purchase an NFT, the token is transferred to your crypto wallet, and the transaction will be recorded permanently on the blockchain. The token only represents your ownership of the asset, however: the asset itself is stored on a server, and the NFT serves as a pointer to that storage location.

So in addition to the conceptual issues mentioned earlier in relation to NFT art — why pay millions to own an NFT of an image which you can generally view and duplicate for free? — many NFT owners are finding that their NFT ownership is less secure and permanent than they imagined. If the server owner changes or deletes what’s at that location, the NFT can become worthless. There are decentralized solutions which preclude this kind of manipulation, but this still relies on the service remaining online.

This might seem like it makes NFTs a technological dead end, but it’s important to remember that this isn’t different from other proofs of ownership. The deed to a house isn’t the same as a house, for example. Nonetheless, it’s important to note that most registries of ownership have utility only because they’re part of a broader system of cultural norms, trusted authorities and arbitration and enforcement entities. Without these, trustless systems such as blockchain still have many unsolved problems left to resolve.

Where Next?

At CkSum we’re confident these problems can be resolved, and actually it may be high-value unique assets like art where these issues are most keenly felt. There are many other applications for NFT technology which are well-suited and more sustainable, including gaming, ticketing, shared ownership, and using NFTs as an addition to existing provenance and rights transfer systems.

Although the NFT art movement is going through a period of intense hype which is likely to cool, the underlying value of NFT technology shouldn’t be underestimated. NFTs will spread to other assets and markets, and using the blockchain as a low-cost, transparent and auditable way to track ownership and rights transferral will become common.

This will be increasingly important as people become more comfortable with the notion that digital assets can be just as valuable as physical ones. As virtual reality technologies become more and more powerful, the concept of the “metaverse” — digital spaces where participants can interact virtually with other users and buy and sell space and other virtual assets — is gaining more and more traction.

Facebook has made the biggest splash here with its rebrand to Meta, but there are a number of crypto projects in the process of building metaverse experiences, including The Sandbox and Decentraland. As metaverse projects blur the boundaries between our offline and digital lives, NFTs will play an essential role in tracking ownership of the new assets which can be bought and sold there. These virtual economies may only exist digitally, but the value they generate will be very real.

AUTHOR HIGHLIGHTS

Richard Sparrow - CIO/ Director

In addition to being the Chief  Investment  Officer  for  CkSum  Capital,  Ltd,  Richard  is  a Vice President of Attribution at CipherTrace, Richard has spent the past 4 years building on Bitcoin and blockchain helping law enforcement, regulators, and the financial industry understand how crypto is transforming industries. For the prior 20 years, Richard worked in the Silicon Valley providing mobile and fintech infrastructure solutions for Amdocs, Deutsche Bank and Lending Tree, among others

Paul Wehner - Director

Since graduating from MIT with a Bachelors in Finance, Paul has been a serial entrepreneur specializing in financial technology. He is the Co-Founder and Chief Product Officer of SFB Technologies, a venture-backed company selected to lead the development of the world’s first decentralized legal tender, the SOV, for the Republic of the Marshall Islands. He also won the $100K First Place Prize at 2018 EOS Global Hackathon in Hong Kong for a decentralized identification solution. Previously, Paul led Product Management for the eCommerce vertical of Endeca Technologies which was purchased by Oracle for $1.1 billion, and led development efforts at MyLife, growing it from 0 to 250,000 monthly active users and an eventual acquisition by Meredith.

INVESTMENT STRATEGY

CkSum invests in a well-researched, diversified portfolio of cryptocurrencies and decentralized finance (DeFi) projects. CkSum follows a multi-stage investment process which includes identifying key, long-term industry trends, picking the best currencies, protocols and companies within those trends, and leveraging our holdings to generate increased returns through low-risk, high-yield staking and lending opportunities. We strive to provide an easy, safe, and reliable entry point into this revolutionary industry.

DISCLAIMER                                                                                                                                                                              

This material does not constitute an offer or solicitation to purchase an interest in CkSum Select Fund I, LLC or any related vehicle; such an offer will only be made via a confidential offering memorandum. An investment in the fund is speculative and subject to a risk of loss, including a risk of principal. There is no secondary market for interests in the fund and none is expected to develop. No assurance can be given that the fund will achieve its objective or that an investor will receive a return of all or part of its investment. This material contains certain forward-looking statements and projections regarding the future performance and asset allocation of the fund. These projections are included for illustrative purposes only and are inherently speculative, as they relate to future events, and may not be realized as described. These forward-looking statements will not be updated in the future. Returns for each investor and investment series will differ based on the timing of capital contributions. Please note, information above is subject to change; this is for general, illustrative purposes only.