NFT as a New Virtual Asset Class: A First Look
Virtual goods come for virtual currencies
Do you know which digital asset is mentioned in the first report of the ECB "Virtual currency schemes" as a currency belonging to the same category as bitcoin? Linden Dollars is the currency of the Second Life virtual world. Bitcoin and Linden dollars have been classified by the ECB as a third type of virtual currency, which differs in that it is freely exchangeable for national currencies.
Eight years have passed since then. While the authorities were thinking about how to regulate virtual currencies, which can be exchanged not only for virtual goods, but also for real currencies, the market went further. We are witnessing the emergence of a new class of assets - virtual goods that can be exchanged not only for virtual currencies, but also for real national currencies.
Why is it important?
Previously, it was impossible to talk about the ownership of digital objects like game items and characters in the full sense of the word. Control remained in the hands of developers, they could change the properties of these objects, "print" and confiscate them at their discretion, censor and discriminate against users, forbidding them to freely transfer these objects and trade them. The production and circulation of digital objects was opaque, such data was not publicly available. Public blockchains have corrected this and made it possible to transfer control over digital objects from developers to owners of private keys. This is how NFT was born.
What is NFT?
NFT is an abbreviation of the English "non-fungible token" - a non-fungible token. If, for example, the native Ethereum token or the ERC-20 standard tokens are fungible, then NFTs are not fungible, each token is unique. The Ethereum network uses three ERC standards for NFT: ERC-721, ERC-1155, and ERC-998.
Regardless of the technical details, NFT is the title of ownership of a digital object. This object can be text, image, audio, any digital artwork, game item or character, land and real estate in the virtual world, domain name, financial instrument, fan paraphernalia, club card or regular ticket to an event. In addition to this, the ERC-988 standard allows the creation of tokens that own various combinations of the listed entities and ERC-20 tokens. The NFT story is just beginning.
A brief history of NFT
Pepe the Frog
Experiments with NFT began with the emergence of solutions such as Colored Coins and Counterparty, which made it possible to tokenize assets on the bitcoin blockchain. The star of those times and one of the oldest NFT projects is Rare Pepe Directory, memes with Pepe the frog.
In January 2017, the HOMERPEPE meme tokenized on Counterparty was bought for $500 from XCP. In January 2018, at the first Rare Pepes live auction, this meme was bought for $38,500 in PepeCash tokens.
Source: Larva Labs
Ethereum blockchain NFTs trace their ancestry to the pixelated portraits of CryptoPunks, a project of the Larva Labs team. There are only 10,000 crypto-punks, initially they were distributed free of charge, but now they are already valuable blockchain antiques. In May 2020, crypto-bank #6487 was bought for 100 ETH, the average daily selling price of crypto-punks in mid-October 2020 increased to 7 ETH.
The first hype in NFT history is CryptoKitties. A breakthrough novelty is the ability to breed cats: you take two NFT cats and produce NFT offspring of varying degrees of rarity from them, which you keep or sell. In early September 2018, a two-week-old cat named Dragon was purchased for 600 ETH.
Many projects began experimenting with the NFT breeding mechanics, adding other game elements to it. Today Axie Infinity is the leader in this category.
Another novelty is L2 games built by third-party developers on top of CryptoKitties. The idea is that NFTs are not created for the game, but games are created for existing NFTs. This idea is being developed by the Enjin project, which raised 75,000 ETH in an ICO at the end of 2017, and Eminence from André Cronier.
One of the L2 crypto cat apps, Wrapped Kitties, allows you to wrap NFT cats in ERC-20 tokens. You didn't think tokenize tokens. If you can't afford an expensive NFT, you can buy a part of it, one thousandth, for example. In early October 2020, the market capitalization of wrapped NFTs reached $500,000.
Toy Speculative Bubbles
Bubble games, or, to put it simply, games in the style of "Hot Potato", have become ambiguously famous. Their rules are simple: each next NFT buyer pays more than the previous one. After someone has bought an NFT from the developers, with each next resale, the price of this NFT is automatically increased according to a given algorithm.
In January 2018, bubble game CryptoCelebrities appeared and at its peak NFT with this Donald Trump photo was sold for a record $137,000 in ETH. A bubble cannot inflate indefinitely, and someone has to pay for it to burst. We'll come back to the bubbles in the cryptocurrency market when we talk about the prospects for NFT.
A new wave of tokenization
Further, the tokenization of non-fungible digital objects quickly spread to card games (Gods Unchained), RPG (MyCryptoHeroes, Neon District), sports games (F1 Delta Time, Sorare), virtual worlds (Decentraland, Cryptovoxels), Ethereum domain names (ENS), traditional financial instruments (yinsure). The tokenization of digital art has received a new impetus: it has become even easier to create, trade and receive royalties from NFTs.
All these classes of digital objects are already traded on NFT marketplaces, the NFT production and circulation ecosystem includes dozens of projects. The volume of this market is still relatively modest, but its brief history suggests that interest in NFT is growing. We will talk about the NFT market, the most successful NFT marketplaces and NFT traders, as well as the most “whale” NFT category based on the results of 2018-2020 in the second part of this article.
NFT Market 2019
According to Nonfungible, in 2019, compared to 2018, NFT turnover in dollar terms fell by 4% ($152.8 million versus $159.3 million). At the same time, the number of active addresses increased by 1% (113,287 versus 111,640), the capitalization of the NFT market increased by 16.81% ($210.5 million versus $180.2 million), and the share of NFTs participating in the turnover remained practically unchanged (12.39% versus 12.30%).
Interestingly, a large turnover or capitalization is not necessarily accompanied by a large and strong user community. The leaders in terms of turnover were the card game Gods Unchained, the role-playing game MуCryptoHeroes, the virtual world of Decentraland and the Ethereum Name Service domain names. More than 50% of users came from three projects: CryptoKitties, 0xUniverse and MyCryptoHeroes. In general, in 2019, tokenized art and games, card and role-playing, showed themselves best.
The top 5 most expensive NFTs sold in 2019 topped the F1 Delta Time '1-1-1' race car, which sold for 415.9 ETH.
NFT Market 2020
In 2020, the NFT market has revived. In the first half of the year, the cumulative turnover of NFT in dollar terms was $232.5 million, showing an increase of 294.29% compared to the first half of 2019. The tokenized art segment captured 31% of total NFT turnover, coming closest to the leader, the land in virtual worlds, which accounted for 40% of turnover.
In the fall, amid a growing wave of publications about NFT as a new element of DeFi, the market continued to grow. One of the largest NFT collections, which is backed by the WHALE token, has risen in price by 40% in September. A symbolic moment was the appearance of the tokenized painting "Block 21" at Christie’s auction and its sale at a price 10 times higher than the estimate.
Despite the growth, the total turnover of the NFT market, as well as the turnover of individual NFT marketplaces, is still very far from the cryptocurrency market. Although, as the experience of the Rarible marketplace has shown, almighty farming (profitable farming) can do something about it.
On July 15, 2020, the NFT Rarible creation and trading platform began rewarding its sellers and buyers with the RARE token, which controls the Rarible DAO token. Thanks to this, the trading volume on Rarible in two months has grown from thousands to millions of dollars.
The explosive growth turned out to be ambiguous: in order to maximize their reward in RARI, traders began to buy NFT from themselves, increasing volumes. However, RARE's pharming helped Rarible outperform OpenSea, the oldest and largest NFT marketplace, in trading volume in two months.
So far, RARI is the only case for the pharming of the NFT marketplace management tokens. Whether OpenSea will respond, similar to how Uniswap responded to the liquidity vampires, remains to be seen. Farming NFT management tokens is not the only way to combine NFT and farming. In the article on the prospects for NFT, we will take a closer look at the question of what can happen if you combine farming and NFT.
These were the largest NFT marketplaces, and now the largest NFT sellers and buyers and their main asset.
According to Nonfungible, in 2019, the top 10 NFT buyers spent $1.4 million, of which almost 50% was spent on LAND - NFT tokens, which control plots of digital land in the virtual world of Decentraland. The top 10 sellers sold NFTs for $1.56 million - the share of Decentraland land in these sales was 60%. The top 10 addresses that bought and sold NFT made a profit of $0.53 million. 65% of this profit came from the sale of Decentraland land.
NFTbank data on the 10 most successful NFT traders for the period from January 2018 to August 2020 suggests the same: large traders made money on virtual land. Their total profit from NFT resale was 2,540.6 ETH and 91% of this profit was generated from NFTs in the Real Estate category.
Source: Zima Red
Created in 2003, 6 years before Bitcoin, the virtual world of Second Life, already had a virtual land market and land use fees, but there was no NFT. Today, the market for tokenized virtual land exists not only in "traditional" virtual worlds like Decentraland, Cryptovoxels, The Sandbox and Somnium Space, but also, for example, in Axie Infinity.
Although competitors have become more visible in 2020, Decentraland remains the leader in this segment. It is no coincidence that there is only one token in the DAI collateral portfolio that is related to NFT in general and virtual worlds in particular - this is MANA, the currency of the Decentraland virtual world.
The sale of LAND on the primary market takes place through an auction and only for MANA, which are then burned. Decentraland DAO decides on new land auctions and LAND parameters. All MANA and LAND holders have a vote in this DAO: the more these assets you have, the more weight your vote.
Why do we need land in virtual worlds? Then, why and in the real world: our entire existence takes place on the earth, which belongs to someone, with all that it implies. However, unlike real land, the area of virtual land can be increased. For example, Decentraland DAO can vote to increase the area of the Decentraland virtual world and print a new portion of LAND for these new lands.
Have you ever dreamed of becoming a cyberlandlord: owning digital land and living on the income from this land? With the development of the virtual land lease market, this may become a reality. If the virtual land begins to bring real income, then it ceases to be a toy and becomes a real asset. The transformation of seemingly useless collectibles into real assets, like the transformation of real assets into collectibles, has a long history. Today, this story gets a very unexpected continuation, which is devoted to the second article of this series, "Bitcoin and Collectibles."