Cryptocurrencies and the related purchase, custody or even investment of these assets have already arrived at the centre of the financially and technologically interested society since several years now. These assets, which initially could be described as completely unregulated and which to this day do not meet the official definition of the term currency, went through various peaks and lows. But Germany, as a member of the European Monetary Union, would not live up to its own stereotype if it had not already dared to make its own attempt to regulate these currencies before the official publication of MiCa regulation (Markets in Crypto-Assets) at the European level. Thus, a new class for the crypto value business was already defined with the fifth Anti-Money Laundering Directive, which is also reflected in the Electronic Securities Act (German eWpG). This development makes it clear that crypto assets of various kinds have found their way into the mainstream. The reproduction of already established financial products, such as the classic loan business or various (exchange-traded) funds, are emblematic for this development as well as the ingenuity of the institutional providers of the aforementioned products. The consequence of this entry into the mainstream and the accompanying “dumb money” can be identified as an explanation for the strong price fluctuations. Rising interest rates on bonds, government restrictions, pandemic and currently especially geopolitical impulses can also move investors towards classic investment options and drive the decentralised assets into a “crypto winter”.
Despite the declining prices of various cryptocurrencies, the increased interest in another initiative from the blockchain sector can be observed. This observation is called Non-Fungible Token (NFT) and promises nothing less than the digitalisation of valuable items as well as their democratisation on the blockchain. In contrast to this mission, the general public often hears about incidents of fraud (so-called scams) or astronomic prices for the certificate of authenticity of a monkey image. In this blog article, we therefore want to look beyond the supposed primary functions of a cryptocurrency, i.e. investment or payment, in order to take a look at the NFT trend.
However, before we get into the “lazy ape club” or the “minting” of a so-called non-fungible token (NFT), we would like to provide clarification on what is meant by a NFT in the first place.
What is a NFT?
Non-Fungible Token, or NFT for short, describes a digital proof of authenticity and ownership. Behind each of the abstruse-looking artworks is a unique and non-exchangeable data unit that is stored on a digital (decentralised) ledger. Proof of ownership is made possible by storing the data unit on the blockchain. Specifically, the proof of ownership is attached to the digitised value on the blockchain (mostly on Ethereum). In this way, objects receive distinctive signatures that make them unique. Essentially, a comparable technology is used as with cryptocurrencies. The difference, however, is that cryptocurrencies are “like-for-like” interchangeable, which in turn does not apply to NFTs. Even if a NFT is copied, the authenticity of the original can always be proven. Unlike a Bitcoin unit, each NFT is unique, so it cannot be exchanged for each other. There is additional information stored in the file that goes beyond just a currency and brings it into the realm of, well, anything previously known. As a result, NFTs have become collectible digital assets that hold value – just like physical art has value.
A special feature in this context is that a NFT issuer can create several NFTs of the same content (an edition like a comic book) or split a value into countless parts and sell them. The former was most recently implemented by the “Bored Ape Yacht Club“, which created and sold 10.000 NFTs with different “Bored Ape” images. The latter was demonstrated in the sale of “The Merge“. In this NFT project, 29.983 collectors bought a total of 312.686 parts of a work of art, which was sold for a total of 91,8 million US dollars and thus displaced Jeff Koon’s “Rabbit” from 2019 (91,1 million US dollars) from first place in terms of the highest proceeds.
What does Minting mean?
This term is understood to mean that a digital source file is converted into a blockchain-based token that proves ownership of an object, such as an image, video or physical object.
In this process, digital objects are stored in a decentralised database. Once added to the aforementioned database, they cannot be edited, changed or deleted. The term minting is derived from the minting of a coin, as the digital file also receives an individual and unchangeable imprint. This process is similar to the creation of fiat currency when a physical coin is minted.
An example from practice
Since the concept of NFT or the creation of such an asset may sound very theoretical at first glance, we would like to use a practical example to explain the concept behind it in more detail. As a Frankfurt-based digital agency, “Online:Digital X GmbH & Co. KG” is in contact with a wide variety of clients in order to improve the client’s digital visibility and online marketing. The “Löwen Frankfurt” ice hockey team had a similar experience. They were trying to strengthen their digital profile and set up a marketing campaign for the club and its players. To make this possible, they wanted to put players and special pictures and snapshots on the blockchain. The material for this was sought from the club’s archives and shows 30 years of history about the club. Once a sufficient amount of information could be generated, this content was digitised and stored on the Blockchain. After the digital player cards were created, they were given away to fans who left a corresponding comment on social networks. Even though this form of marketing was new territory for the time being (the “Löwen Frankfurt” were the first ice hockey club in Germany with such a campaign) and the fans first had to be educated, the campaign was ultimately a complete success, as it not only strengthened the digital marketing profile of the club, but also created real value in the form of a NFT. Currently, the first NFT of this project amounts to about one coin of the currency Ethereum. Particularly with the promotion of the “Löwen Frankfurt” from the second to the first German ice hockey league, both the club and its players hope to be able to launch further marketing campaigns and to use the “Löwen NFT” to retain fans of the club for as long as possible.
Where does the enthusiasm for NFT come from?
Despite the fact that digital assets such as cryptocurrencies or NFTs are enjoying enormous success, no fundamental analytical value, apart from the proof of authenticity of each NFT, is recognisable at first glance. The question automatically arises as to which criteria are fueling the trend. On the one hand, it may be the hope of an asset that will only materialise after widespread use of “Web 3.0” and the associated environment controlled by user decisions. Ambitions generated by the virtual worlds created by “META” can give further impetus to such a movement. Certainly, the unregulated nature of the NFT industry may also attract early-stage investors and the very ones with the “Fear of missing out” (FoMo), before the “Dumb Money” enters the market to become the eventual recipients of these trend perceptions.
Certainly, one explanation, albeit a romanticised one, is that artists want to remove the intermediary, as is already the case with cryptocurrencies, in order to receive a fair remuneration. On the other hand, there is the possibility that, analogue to exchange-traded funds, a possibility should be created to enable less financially strong (private) investors to access an emerging trend that would otherwise remain closed to them. This would to a large extent include the concept of democratisation of “decentralised finance“. Despite the fact that various positive currents seem to emerge from NFT, these must also always be viewed critically.
All that glitters is not gold
In addition to the undoubtedly positive effects of such an innovation, negative aspects should not be ignored. Both the technology and the financial products in an unregulated market have downsides, which can involve various dangers and risks. On the one hand, there is the possibility that users with little experience in the cryptocurrency sector will become victims of a “scam”. In particular, this still very young topic and the associated lack of experience increases the associated risk. Due to the promise of high returns with low stakes, inexperienced private investors in particular can easily fall for a scam. In addition, there is the problem of expiry: even if a NFT does not threaten to decay with the same half-life period as a classic work of art in a museum, there is always the possibility that the ledger or the corresponding storage location (server) is taken offline or the password for a “wallet” is lost. Processes for recovering the valuable objects are rarely established. In conclusion, there is the possibility that the hope in the future value of a NFT acquired today, will not materialise in the sense of a gold-rush atmosphere.
What is the final assessment of the movement?
In conclusion, it can be said that NFT technology holds both opportunities and risks. If one sees the application in appropriately remunerating artists for their work or ensuring the authenticity of a work of art, NFT can be seen as a positive trend. This would make forgery scandals, such as that of Wolfgang Beltracchi, and the associated immaterial damage to various auction houses a thing of the past. It also seems conclusive that the artworks purchased today represent the state of the art of the next generation, regardless of whether this generation is called “Metaverse” or not. But at the same time, it must be critically assessed that, in addition to the great areas of application, negative manifestations are also becoming visible. For example, the creation and distribution of NFT projects with questionable value and sense of purpose can be mentioned. These are advertised by more or less serious providers to a less experienced audience with the hope of capitalising on their “fear of missing out”. Especially the price increases or “bull runs” that can be explained with the phenomenon of artificial scarcity are reminiscent of the dynamics of bitcoin after a halving of the proof of work yield. All interested readers can look forward to this phenomenon in 2024 (halving from 6.25 BTC to 3.125 BTC). Although there is a different rationale behind the Wirecard case, there is at least the danger that small investors will also “bet on red” in this trend and lose everything without reinsurance. In conclusion, in my opinion, it is necessary to assess whether the crypto- winter longed for by Vitalik Buterin (co-founder of Ethereum) and the accompanying sifting out of fraudulently motivated crypto enthusiasts will also arrive in the NFT space. If risk-seeking investors and providers taking advantage of the trend disappear, the objective of the NFT mentioned at the beginning, the digitalisation and democratisation of values on the blockchain, including its guarantee of authenticity, can find a meaningful long-term application. Historically, cryptocurrencies needed about 5 years in the mainstream before they gained respectability and appeal to both institutional and non-institutional investors.
It therefore remains to be seen whether the seriousness gained so far with regard to blockchain technology will also reach the NFT market or whether it is merely a short-lived trend.