Investing in non-fungible tokens and the DeFi market
By Prof Louis C H Fourie
The year 2020 brought many surprises. The incredible fast spreading of the Covid-19 virus across the world, the economically disruptive lockdowns, the large government stimulus packages, and the unequalled fast recovery of the stock market since the crash that started on 20 February 2020.
In March 2020, the lockdown of almost half the world's population thrusted the global economy into an unprecedented recession, and global stock markets shed 34% in thirty days.
Although they bounced back strongly after the announcement of government measures (gradual exit from lockdown, economic stimulus policies, extended unemployment assistance, and the development of vaccines), the short-term environment remains uncertain.
Recently, scientists have been warning of a third and even a fourth wave of the virus while countries are racing with their vaccination programmes. Add to this the current high levels of unemployment, significant slack in the economy and the labour market, the possibility of harmful inflation, a possible asset price bubble, and the perfect storm of uncertainty has been created.
As a result, current markets are characterised by an increased volatility and nervousness, partly due to the ongoing pandemic and the resultant structural uncertainties. A real possibility therefore exists that equity markets may retest previous lows. Many investors are warning of a possible correction in the near future.
Simultaneously, real personal disposable income has increased since the start of the pandemic – often due to fiscal stimulus packages and fiat money. As a result of the current uncertainty in the equity market and also the expensiveness of global equities, investors are looking elsewhere to invest their surplus money. One such a place is non-fungible tokens or NFTs - the newest crypto phenomenon worth billions of rand that attracted the interest of people all over the world.
Non-fungible tokens (NFTs)
Fungibility refers to something that is easily interchangeable such as the exchanging of a R100 for ten R10 bills. Non-fungible tokens are, however, unique or scarce digital objects represented as tokens that cannot be replicated. They can consist of literally anything that can be digitalised to form a collectible item just as in the case of paintings, cards and stamps. Digital content is tokenised through a process called “minting,” which assigns a coin on a blockchain to any given work, authenticating as many copies as the creator would like. But instead of a physical certificate of authentication, NFTs use blockchain technology (typically Ethereum), as a verifiable digital ledger. Since the NFTs are created on Ethereum’s blockchain, which is immutable, it cannot be altered, and no one can undo a person’s ownership of the NFT.
NFTs have been around since the coloured coins of 2012, but only really took off in 2017 when CryptoKitties (a blockchain game allowing players to adopt, raise, and trade virtual cats) were bought and sold on Ethereum blockchain to such an extent that it congested the Ethereum network. Although R2.6 million for a CryptoKitty may seem like madness, it is nothing when compared to what is being paid for NFTs today. The NFT market has quadrupled in 2020 since investors (traders, gamblers and collectors) saw the value of investing in a verified item of art no one else possesses and as a result many new NFT marketplaces such as OpenSea and SuperRare were established.
A variety of collectibles
Although it was dominated by art, NFTs now consist of many new types of collectibles such cards or videos of major sports icons, expensive and rare beanie babies, songs, virtual clothing, virtual land, event entrance tickets, recipes, and many more. What makes NFTs interesting is that an NFT video of the famous basketball player, LeBron James, sold for R3.14 million in January 2021 even though anyone can watch the video on the Internet. An artist by the name of Beeple recently sold a ten second video clip for R99.5 million. Major sums were also paid for an X-ray of the teeth of William Shatner (the famous Captain James T Kirk from Star Trek). One of the reasons for the astronomical prices is that investors expect the original, verified and rare piece to rise in value over the years to come.
The rise in popularity of NFTs
The major reason for the rising popularity of NFTs and blockchain-driven decentralised finance (De-Fi) in 2020, is the constant migration of people from the traditional financial system due to a distrust of institutions and governments, which is quite common during periods of crisis.
NFTs may be an answer for artists as it gives them control over their content and ensure that they receive a percentage of every sale. Musicians could also leverage the platform to increase the current minute amount per stream paid to them by companies such as Spotify.
Investing in NFTs
But investing in NFTs purely as an investment is another matter. Digital tokens in the crypto market have been issued before by start-ups to raise money, especially in 2017. Unfortunately, many of these companies failed and the NFTs became valueless. Tweets of famous people selling for R16 000 or videos of them unpacking cards for millions of rand point to an uncontrolled market that just does not make financial sense and defies all logic. The majority of buyers are certainly not collectors and are probably investing to speculate. The current huge demand is highly reminiscent of the 2017 Initial Coin Offering (ICO) boom that caused the market to crash.
At the moment, NFTs are the Wild West. Crypto wallets are often used to circumnavigate government controls and many fake accounts and false copyrights at auctions are a serious concern making the trading in NFT treacherous. But NFT’s does have value such as exclusive new releases from artists who can directly negotiate their fees. It can also help ensure the authenticity of clothes and other products and thus prevent fake imitations.
Prudent investing during market volatility is always about cool-headed decision making – also in the case of investing in the new asset class of NFTs. NFTs and blockchain are revolutionary concepts and will continue to shape our world — whether we buy into the craze or not. With Bitcoin and Ethereum at extremely high prices and consumers - with surplus money in a market with low interest rates – constantly looking for new places to allocate capital, will continue to invest in NFTs, thus growing the NFT ecosystem.
Prof Louis C H Fourie is a Technology Strategist