What is a Non-Fungible Token (NFT)?
Within the Ethereum ecosystem, the reserve smart contract platform today, the ERC-20 token standard defines tokens that are identical in their properties, making them fungible in nature. In other words, you don’t care which DAI token you receive (for the most part) since all of them are identical in form and function. Tokens built on this standard dominate the market, and power the entire suite of Decentralised Finance applications that have blossomed since their seeds were sowed in the DeFi Summer of 2020.
NFTs, as the name suggests, cannot exist on the ERC-20 standard. Thus, via an Ethereum Improvement Proposal in 2017, Dapper Labs (the company behind CryptoKitties), introduced ERC-721 — a new token standard that inherits all the major benefits from ERC-20, but, critically, allows each token to be unique. Now, every ERC-721 token is fundamentally different from one another. It matters if you get NFT A vs NFT B.
With that background out of the way, in practice, NFTs are nothing but digital files; they could be MP3, MP4, JPEGs, etc. However, it allows us to identify the original copy. For example, if you send me an image over email, we can’t post facto determine which is the original copy. There is no master database that keeps a record. However, with NFTs, you can, thus unlocking a paradigm of digital scarcity.
There is a common misconception that posits that the inherent value of NFTs is nought due to the fact that anyone can simply create a duplicate copy of the JPEG (or whatever the file type may be). Amongst the uninitiated, the misunderstanding is understandable. However, a critical component to grasp is how said scarcity is verified. You see, “minting” (aka, creating) an NFT is simply the act of putting timestamped metadata on the blockchain, which says “Hey, this is the first instance of this file, and it belongs to address xyz”. This entry will forever remain on the blockchain. Thus, simply making a duplicate copy of the NFT won’t allow you to alter this metadata. It can only change once a fair transaction (purchase, transfer, burn, etc.) takes place as per the blockchain’s parameters. This is analogous to why making a fraudulent version of, say, a luxury watch, does not dilute the value of the original watch. If anything, it adds to it.
This analogy to luxury goods is helpful in understanding why people are paying such large sums for mere monkey JPEGs. The reason why luxury goods tend to be sought after is because their value is derived from price and scarcity. In other words, 1) the higher something is priced, the higher the demand, and 2) the less something is available, the higher the demand. While this seems irrational, the reason this phenomenon is observed in human behaviour is because we are social animals who love to signal our social status. The limited availability and high price-tag are not attributes of the product, they are the product. And they’re both extremely visible — just Google it. More so, due to the digital nature of NFTs, they allow for signalling at a much larger scale than physical luxury goods. The only people that can see you wearing designer clothes are the people who are in close proximity to you, but anyone in the world with an internet connection can see that you own a particular NFT.
In sum, an NFT is just a digital file (JPEGs, MP3s, MP4s) that is reliably scarce as it can be verified for originality. There are other features NFTs allow for (such as programmable royalties), but what this digital scarcity essentially does is unlock a game of bragging rights — it is starting to become part of culture. Over the course of 2021, thanks to NFTs, we have seen waves of new entrants onboarding themselves into the crypto world. DeFi could never do this; it could never appeal to the masses, since the financial world is a far more esoteric and convoluted field. On the other hand, profile picture (PFP) projects — NFTs that are often a collection of simple images (with a common aesthetic theme but varying visual elements), which signal that you are part of a specific community — are something everyone instinctively understands, and can participate in.
How to Analyse PFP Projects
As PFP projects are one of the trailblazers in leading mass NFT adoption, today, we will take a look at how exactly one can approach valuing them. To caveat, this is no exact science. Valuation never is, but this is all the more true when it comes to PFPs or other digital art. Thus, use this as a guideline when approaching your research, and over time, you will develop an eye for it.
- The Team
- The Roadmap
- The Community
- The Art
- The Numbers