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Tech News: The market for digital asset NFT may collapse

Photo: File

Photo: File

Published Feb 22, 2022

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Non-Fungible Tokens (NFT) expanded at an unheeded rate in 2021. This relatively new asset class became so popular that it was named the word of the year in one dictionary and was also one of the most searched for words on Google.

For those who may not totally be familiar with the term: an NFT is basically a tradeable code attached to metadata, for example an image. A secure network of computers carefully records the sale on a digital ledger (a blockchain), giving the buyer proof of both authenticity and ownership. The NFT craze is all about ownership of original and authentic digital artefacts. Since the digital world allows for the mass production of almost anything, to establish and verify ownership of any asset amid the often chaotic noise of the internet, has become extremely valuable. Interestingly, most people prefer to pay for NFTs with the Ethereum cryptocurrency.

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Two of the first areas in which NFTs were sold were collectibles and artwork, both areas in which certified authenticity is rather important. NFTs ensure certified authenticity, verifiability and careful record-keeping by keeping entire histories on a visible blockchain such as Ethereum. Numerous websites were thus created to sell the NFTs as an investment or fractionalised investment. Just like many people made copies from famous paintings or sculptures, NFTs can also be copied. However, there is always only one original.

In 2021 people made insane amounts of money by buying NFTs that made the news such as Punk, Bored Ape, Beeple and many more. In March 2021, the reputable auction house Christie’s sold an “original” digital artwork (a JPEG file), created by the artist Beeple, for a record R1.06 billion.

Some specialists believe that NFTs in 2022 will move beyond art into gaming, identity and digital real estate. The gaming industry is worth billions of rands and people are increasingly considering buying land in a game, owning a unique character, or running a virtual business within the game’s environment. It is already possible to rent land from someone in the game Vulcan Forged. Vulcan Forged even has its own coin. Certifiable ownership via NFTs will thus become really valuable.

In the real world we have a government that issues identification cards, but in the blockchain world it is much harder to prove who you are or that you are the owner of a wallet. This is where NFTs can be handy to confirm an identity. It is currently possible to own your digital identity via a company such as ENS.

Digital real estate is not only available in games. Numerous websites are selling “real estate” inside the metaverse (a created universe) such as Decentraland and Sandbox. In December 2021 Sandbox was in the news by selling a plot to PWC Hong Kong, following the example by the American rapper Snoop Dogg and the company Atari. Plots next or close to Snoop Dogg’s majestic virtual mansion sold for R6.85 million each. Sandbox eventually sold 4 433 plots worth R1.07 billion in seven days.

This begs the question, why anybody would buy virtual or “fake” land in another reality like the metaverse and at such inflated prices. According to William Gee from PWC Hong Kong it is worthwhile because “the metaverse offers new possibilities for an organisation to create value through innovative business models, as well as introducing new ways to engage with their customers and communities”. Apparently people see inherent value in virtual land and property due to the commercial options within the alternative reality.

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The problem is that any person with the specialist knowledge and financial means can develop a different alternative reality and map. Many of these will die, while some will create value. To make the right investment choice is the challenge - just like investments in real life.

Millions were made in 2021 on simple pictures of digital avatars, animals and abstract art. The market is red hot. However, prices are not logical and often cannot be justified. Prices of NFTs and digital real estate will probably remain high and may continue to increase in the future, but it is highly possible that a crash or correction is waiting. All over the world central banks are tightening monetary policy due to inflation, while interest rates are rising limiting the flow of money. New and unproven asset classes are likely to be punished much harder.

Just like any other market driven by enthusiasm, impulsive purchases, and hype, the fast-moving and speculative NFT market could cause many investors to lose significant amounts of money. The current frenzy reminds one of the ostrich feather boom in South Africa from 1890 until 1914 and the Dutch tulip mania from 1634 until 1637. In both cases products fetched extremely high prices before the craze dissipated and the bubble collapsed.

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One of the biggest concerns is that there is an infinite supply of NFTs. NFTs provide ownership of an original digital asset, but not the right to prevent others from using its digital copies. Investors will pay hundreds of millions of rands for traditional artworks such as Rembrandt, Monet, Van Gogh because the number of masterpieces are finite and the artists are dead. NFT copies, however, could easily become a commodity. In fact, typically digital, there is no difference between an original JPEG image costing millions of rands, and a copy that is downloaded from the internet for free. The supply of legal copies of NFTs is thus infinite and may even become more than the demand and cause the prices to collapse.

Another concern is that blockchain does not store the actual digital asset. If investors buy NFTs, they are merely buying links to the digital artwork and not the artwork itself. Although buyers have copyright to the link, the monitoring of the vast internet for illegitimate displaying of NFTs and the prosecution of any infringement is nearly impossible to enforce. This severely limits the monetisation of the asset.

Since blockchains and cryptocurrencies are still relatively new, there are currently several competing standards to generate, safeguard, distribute and certify NFTs. This uncertainty as to how ownership certification will be guaranteed in perpetuity is an important risk and endangers the value of the assets and also their ownership.

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Cryptocurrencies, that underpin the NFT market, are further known for their price volatility. NFT prices tend to closely follow cryptocurrency prices and are thus just as volatile. This creates uncertainty in the market and may severely influence the value of an asset.

Changing macroeconomic conditions could also have a significant impact on the prices of alternative assets such as NFTs. In the last few years the number of billionaires in the world increased tremendously resulting in huge amounts of money invested in a variety of asset classes. Covid-19 reinforced this trend because of the many stimulus and support packages injected by central banks or governments. Much of this money has been invested in the financial markets.

The risk in the above is that after the 2008 global financial crisis, sales of art and luxury products declined by almost 40%. With central banks starting to raise interest rates and tightening monetary policy in an effort to rein in inflation, new and untested asset classes are most likely to be punished much harder than the more reliable and traditional asset classes. The highly volatile NFT market, based on cryptocurrencies with nothing to back them up, will become even more volatile and risky and will eventually decline. It would be wise to tread carefully with digital assets.

Professor Louis CH Fourie is an extraordinary professor at the University of the Western Cape

*The views expressed here are not necessarily those of IOL or of title sites.

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