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Why the NFT market is heading for a sharp drop

Updated: Mar 18, 2022

In March 2021, auction house Christie's sold a JPEG file for $69.3 million , a record for a digital work of art. Ownership of the "original" JPEG called "Everydays: The First 5000 Days" was secured in the form of a non-fungible token (NFT).

In 2021, investors invested $27 billion in this market . Meta will allow users to create and sell NFTs. There is only one problem: the NFT market will eventually collapse for any of a variety of reasons .

NFT is a special trading code attached to the image. A secure network of computers registers the sale on a digital ledger (blockchain). The buyer receives proof of authenticity and ownership.

NFTs are usually paid for with the Ethereum cryptocurrency. And they are stored using the Ethereum blockchain. NFT combines the desire to own art with modern technology. An ideal asset for the new wealthy members of Silicon Valley and their henchmen in finance, entertainment and retail investment. The booming and speculative NFT market will bankrupt many investors - like all hype markets driven by impulsive buying and hype.

The price volatility of the cryptocurrencies underlying the NFT market must also be taken into account. The prices of non-fungible tokens usually move in tandem with the prices of cryptocurrencies. When cryptocurrencies fell in 2018, the nascent NFT market was also affected.

Environmental issues and climate impacts are not as important for the NFT market, although a significant amount of energy is consumed to “mine” cryptocurrencies using computer networks. And the big carbon footprint grows with every transaction. But the real problem is that the current NFT boom is built on sandy foundations.

The Infinite Supply Problem

NFT gives ownership of a digital asset, but not the right to prevent others from using its digital copies. Wealthy investors are willing to pay tens of millions of dollars for traditional physical art (such as Rembrandt, Van Gogh or Monet) because of:

  • a limited number of masterpieces - the artists died long ago and do not create new works of art;

  • the ability to sell copies of NFTs as a commodity.

However, there is no difference in appearance between the original $69.3 million JPEG file and the copy downloaded for free from the Internet. Theoretically, the supply of legally usable copies of NFTs is infinite and could potentially exceed the demand for them and lead to a collapse in prices.

The blockchain does not store the actual underlying digital asset - an NFT purchaser acquires a link to a digital work of art, not the work itself. Transaction costs:

  • monitoring an infinite number of online platforms for NFT demonstration,

  • detection of illegal use,

  • prosecution of violations

make it virtually impossible to respect copyright and prevent misuse. This greatly limits the monetization of the asset.

The problem of "young" technologies

Non-Fungible Tokens are produced and traded using new technologies: blockchain and cryptocurrencies. There are many competing standards on how to create, secure, distribute and certify NFTs: ERC-721, ERC-998, ERC-1155, streaming and non-streaming standards, FA2 by Tezos . The resulting uncertainty does not guarantee the certification of property rights on an eternal basis, jeopardizes the value of assets and even their ownership.

The value of NFTs will evaporate if the next wave of better technology is found to be incompatible with secure NFT ownership. Companies that work with NFTs today may disappear tomorrow. And ownership claims will be unclear.

The Psychology of Buying Luxury Goods

Will put downward pressure on NFT prices. Most luxury goods are the so-called Veblen goods (the purchase is driven by the desire to demonstrate the exclusivity of the individual). The usefulness of such goods is limited and does not allow the owners to advertise their wealth. For this reason, they are often highly profitable for sellers.

NFTs allow buyers to broadcast their wealth mainly through the high price they paid, but only if they receive a positive response from their peers. If such spending doesn't resonate with that audience, the investor might as well burn the cash to light a cigarette.

Because holding NFTs does not prevent other people from displaying the same assets and signaling their ownership, these tokens are unlikely to serve as effective indicators of unique purchasing power. And many NFT buyers remain anonymous anyway, as the blockchain provides limited knowledge of ownership.

Changing macroeconomic conditions

Will negatively affect the prices of alternative assets and traditional works of art. Over the past two decades, the number of billionaires around the world has more than quintupled as returns to invest in alternative asset classes have skyrocketed. The COVID-19 pandemic continues to reinforce this trend. Much of the economic stimulus of central banks has gone to financial markets and further increased the fortunes of the super-rich.

Since the global financial crisis in 2008, sales of art and other luxury goods have fallen by almost 40%. Central banks are beginning to tighten monetary policy in an attempt to contain inflation. New and untested asset classes will be hit harder than more reliable ones. The volatile NFT market based on digital currencies is hardly a safe haven.

Prices for non-fungible tokens will constantly decrease. So far they remain high and will continue to grow for some time, but the fall will come. The optimism of investors trying to guess the time to exit the market will turn out to be unfounded.

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