How does an NFT have value?

On June 10, 2021, a 24 x 24 pixel digital image of a punk space sold for $11.75 million, which is more than $20,000 per pixel. Simply described as Punk #7523, it is an early and rare example of an NFT, an uncorrectable token created on the Ethereum blockchain. The sale of Punk #7523 was not a one-off, but a rock NFT that sold for just under $4 million. There is now huge interest in NFTs given the huge sums involved, but many newcomers to the cryptocurrency world are wondering how is NFT worth it?

What is an NFT?

An NFT is a digital document, such as a receipt, that proves ownership of something (physical or digital), such as a collectible such as a pixelated drawing of a Punk Alien.

It is a record of when the item was made – or minted in NFT’s unique terminology – and how much was paid for it, including past sales, as NFTs can be traded/traded on NFT markets.

At this point you might be thinking, so what? What is the difference between the Punk Alien and a digital image like the one at the top of this article that can be traced to a server location somewhere on the internet?

What is different about NFTs is the way they are made and the properties it gives them.

Hitting an NFT means creating a new record on a decentralized blockchain, in the case of Crypto Punks it is Ethereum, but NFTs can be hit on other blockchains.

One of the key features of a decentralized blockchain is that the information they contain is immutable; in other words, it cannot be changed. No one can change the information associated with an NFT, it is a unique and immutable record.

Of course, this doesn’t stop anyone from copying and then minting the same image, but NFTs are not fungible tokens. They are designed in such a way that they cannot simply be copied and exchanged for an identical product, but reflect the ownership of a unique object registered by the blockchain that has no interchangeable counterpart.

Ethereum has an agreed upon programming standard called ERC-721 – and it is shared by other blockchains – which defines parameters to ensure that a record is non-replaceable.

It is important to separate the plate from the image as the NFT does not necessarily represent the product itself. Images can be stored on a blockchain, but an NFT can simply point to where an object exists, such as the URL of a digital artwork, a photo, or the location of a physical asset. The same goes for analog receipts or certificates of authenticity proving ownership and provenance of physical collectibles, such as a signed album.

Scarcity and intrinsic value

While this may sound interesting from a technical innovation standpoint, it simply doesn’t explain why a tiny, pixelated image of an alien is worth nearly $12 million.

To understand this, you need to understand the two elements that give value to collectibles: scarcity and intrinsic value.

If something is scarce, it is limited. For example,

• the most famous works of art are unique, but scarcity by itself doesn’t make something valuable.
• I could do a one off scribble on a notepad, frame it and auction it off, I’m pretty sure no one would pay anything for it as it has no intrinsic value.
• Intrinsic value is difficult to define because it is a subjective assessment of some value, but it is unique, irreplaceable, and meaningful or sacred.
• My doodle may be unique, but it’s easily interchangeable and certainly doesn’t have any special meaning as I don’t have artist status or have built another reputation.

Compare my scribbles with the world’s most famous painting, the Mona Lisa, painted by Leonardo Da Vinco around 1503. While some historians argue that Da Vinci actually painted two versions of the Mona Lisa, only one has been found, making it unique. since he died in 1519, he is certainly irreplaceable.

The same can still be said of many paintings by long-dead artists. What distinguishes da Vinci, and the Mona Lisa in particular, is not just the work itself – the enigmatic smile, composition and form – but the fact that da Vinci was the first to use these techniques, making the painting a archetype of Renaissance art.

So if we jump from 1503 to 2021 and go back to Crypto Punks and Eth Rocks, we can use the idea of ​​intrinsic value to try to understand why they paid so much.

NFTs are meant to be unique, this quality is debatable as the same image can be slapped on separate blockchains or simply downloaded and copied, but isn’t that the case with the Mona Lisa?

I can buy a poster of La Gioconda and hang it in my room, but it’s not the same as the original that hangs in the Louvre. The blockchain proves the origin of the NFT – which was the first version – so its immutability really depends on how much we can trust the record to remain decentralized and therefore free from change.

The scarcity is due not only to the way the NFT is minted, but also to the composition of the image itself. Punk #7523 is part of a limited collection of 10,000 algorithmically generated images, no two alike. The collection has some similarities within which there is a relative scarcity.

He’s an alien, one of nine in the collection, but the only one with a mask. 175 characters use a mask. He has an earring (2459 punks have) and a knitted hat (419 punks have).

NFTs are not prohibitively expensive in the sense that an identical untraceable version can be made, but their value does not necessarily come from the technical skill of the artist.

Innovation and future of NFT

NFTs are traded on exchanges such as Opensea. If you are considering buying your first NFT, the decision to buy can be overwhelming as there are so many out there now. The NFT market is saturated as artists try to create their own niche. Most are opportunists who put little effort into creating any intrinsic value and simply think that creating the NFT itself is enough to secure the value.

There is also plenty of anecdotal evidence of NFT price manipulation and its use for money laundering or as part of complex tax avoidance schemes. That’s not to say it’s all downhill with making NFTs these days, as long as meaningful innovation continues and signs indicate it’s just getting started.

An NFT collection called Merge sold for $91.8 million in December 2021 and was created by NFT artist Pakin. It was hacked because buyers did not receive Ethereum cash, but instead paid to own “bulk” tokens that are merged into a dynamic NFT collectible after token sales, hence the name The Merge.

This concept is unique and marks another special moment in the history of NFTs, justifying its astronomical value in the eyes of 28,984 token buyers. This follows the rules of scarcity and intrinsic value and takes advantage of the current crypto hype.

In addition to collectible art, NFTs play an important role in Metaverse-type games which are currently built on a game-for-money model. This could disrupt the entire game economy and you should take a moment to consider why Facebook has become Meta.

NFTs can disrupt other real estate registries such as real estate or stocks, both of which are huge markets. Anyone who has ever bought a home will attest to the need for innovation in archaic processes.

NFTs can also be used to add a new dimension to the business models that power most of our digital lives by enabling secondary markets for on-demand and on-demand services. The possibilities are endless, as long as ownership or rights to something can be defined in a smart contract, it can probably be traded as an NFT. Most data is owned by trusted third parties, but when people are granted the right to own it, things get really interesting.