The year NFT died and came back to life

When McCoy and his partner, entrepreneur Anil Dash, pitched the idea of ​​a unique crypto-like token that demonstrated ownership of digital goods back in 2014, they had a certain sense that it was an “important idea.” The purpose was to create a mechanism to trace the origin of digital works and give small artists a new way to make money. But McCoy says he never imagined NFTs would become a conduit for financial speculation.

During 2021, which kicked off in earnest with the landmark Beeple sale, a frenzy of buying and selling drove the prices of NFTs sky high. By the end of the year, the average price of an NFT had risen above $3,000, despite a tsunami of new tokens flooding the market, while the cheapest NFTs from the most acclaimed collections sold for $200,000 apiece.

But all economic bubbles must eventually burst, and the NFT bubble has done so in spectacular fashion. In January 2022, $17 billion worth of NFTs changed hands, but by November the figure had fallen to $400 million, a 97 percent collapse. Exactly what triggered the crash is unclear, but the drop in demand – catalyzed by a downturn in the cryptocurrency market – has removed nearly $9 billion from the combined value of all NFTs in circulation.

Members of the NFT industry, tasked with picking through the wreckage, are treating the collapse as something of a cleansing event. “I’m a firm believer that you don’t need the hype,” says Shiva Rajaraman, VP of Product at OpenSea, the world’s largest NFT marketplace. While the publicity was good for business, he says it brought people to NFTs for the wrong reasons – to make money – and distracted from the usefulness of the technology.

With regulators now circling, and skeptics basking in schadenfreude, the NFT is at a crossroads. The consensus among industry insiders is that for the technology to achieve widespread use and continued cultural relevance, it must be recast in a different light.

Rajaraman says a new type of use case is emerging that takes advantage of the special properties of NFTs: the ease with which they can be traded and the ability to move them freely between applications. Although some predate the NFT craze, they have been “covered up” until now by the trading frenzy, he says.

Among the itch of helpbags, NFT games are the most battle-tested, with some games attracting hundreds of thousands of players every day. Although the details vary from title to title, the general idea is to allow players to own their in-game assets (characters, cosmetic items, and so on) and exchange them for cryptocurrency.

In a game called SplinterlandsLaunched in May 2018, NFTs are linked to digital cards that each grant a special ability that can be used in battle against another player – similar to titles like Hearthstone or Magic the Gathering. The tokens associated with the cards can be traded on the secondary market, meaning people can get back money they put into Splinterlands if they decide they no longer want to play, says Jesse Reich, the creator. And far from fostering an unhealthy fixation with profiting from play, such a setup encourages “entrepreneurship” in players, Reich argues.

The price of a single card ranges from 1 cent for the most common to hundreds of thousands of dollars for the rarest; the median is around $5 to $6. To ensure that no one is priced out of the game, players are usually matched for battle only with others whose card quality and skill level are similar to their own. Although the number of players has fallen somewhat since the market downturn, Splinterlands still attracts 150,000 to 250,000 people per day, and approximately 90,000 cards change hands in the same period.

An Australian studio called ImmutableX distributes NFTs in a similar way in titles such as Gods Unchained, released in 2019. Co-founder Alex Connolly argues that NFTs prevent scam-ridden “grey markets” from forming, where players resort to unofficial avenues to trade in-game assets for real money. Gods Unchained NFTs sold directly by ImmutableX range from $2 to $150, but as with Splinterlandstrade on the market for prices ranging from a few cents to many thousands of dollars depending on their scarcity and perceived in-game value.

Individually, NFTs are increasingly being used as a form of membership. Some restaurants in New York sell tokens that entitle owners to a table whenever they want it, while Starbucks has launched an extension to its loyalty program where customers can earn NFTs for trying drinks and completing other activities. Celebrities like DJ Steve Aoki do something similar, using NFTs to give fans special access to events and merchandise.

It’s fair to ask how this sort of thing is different from other membership or rewards schemes. According to Ryan Wyatt, CEO of the business arm of Polygon, the Ethereum extension on which many NFTs now sit, it’s all about tradability.

In all of these examples, membership tokens can be traded on the open market, because they sit on top of public blockchain infrastructure that is not owned by a single company. So in a scenario where loyalty to a brand gives someone a special benefit (eg a lifetime discount), that person can choose to convert their stake into cash by trading away their NFT. With a traditional non-NFT membership, which is not freely transferable from one person to another, this value cannot be redeemed.

The same premise could also extend into virtual worlds, says Alex Salnikov, co-founder of NFT marketplace Rarible, who predicts that NFTs will serve as a “basis of commerce” in the metaverse. Not only can an NFT provide exclusive access to a particular digital experience, but it can act as an ownership agreement for a virtual property or clothing for an avatar. To some ears this may sound confused, but the billions in annual revenue generated by Fortnite shows that people are willing to pay to improve their social status in virtual spaces.

The thread that connects most of these applications is the use of NFTs and financial incentive as the basis for community building. Even creators who were originally attracted to NFTs for the monetization opportunity enjoyed themselves.

“It’s bigger than the money,” says King Saladeen, a prominent Philadelphia-born artist who turned to NFTs when the lockdown stopped him from working on physical projects. Around his NFT projects, King Saladeen fostered a community on the messaging platform Discord, where fans can chat directly with him. “It’s about the connection you get with someone you’ve followed for a long time.”

There is a shadow of uncertainty hanging over all these endeavors as a result of a lack of regulatory clarity. There are no NFT-specific regulations anywhere in the world, creating a level of risk for any business that might consider investing in the technology. Likewise, this means that there is no recourse for people who have lost significant sums of money on failed or abandoned NFT projects that are no longer supported by their creators.

Some countries are starting to follow suit: In November, the UK government launched an inquiry designed to assess whether NFTs pose a threat to “vulnerable speculators.”

Julian Knight, the MP who chairs the committee overseeing the inquiry, says “NFTs swept through the digital world so quickly that we didn’t have time to stop and assess.” While the committee intends to keep an open mind about the potential of NFTs to “democratize how assets are bought and sold,” the inquiry will focus on consumer protection as a priority.

Meanwhile, the EU is preparing to vote on a new set of laws, Markets in Crypto Assets, which will determine how crypto-centric organizations can operate. MiCA is described by Caroline Malcolm, head of public policy at blockchain analytics firm Chainalysis, as a “benchmark” on which other countries will base their own rules.

Although NFTs will not be covered by the first set of MiCA rules, an investigation over the next 18 months will determine whether additional NFT-specific provisions are necessary to reduce financial risk to users.

There is also the question of whether NFTs will really work the way people think. The rules of supply and demand, says economist Peter Schiff, dictate that NFTs will not and cannot hold their value over time.

He says that the “code of honor” is the only thing that prevents NFT issuers from diluting the value of tokens by flooding the market with new goods, meaning that scarcity cannot be relied upon as an anchor of value. “Anyone can have beachfront property in the metaverse,” he says, “because I can create an infinite number of beaches.”

While Schiff admits that there are potential use cases for NFTs, such as transferable memberships, he sees these as only marginal improvements on systems that already exist, not the “game changers” they are made out to be.

He also claims that the majority of people using NFTs are uninterested in use cases that are separate from speculation – they are only in it for financial gain. And there is plenty of evidence to support this theory.

Even after the crash, high-profile companies have continued to flood the market with NFTs, in an attempt to cash in on brand equity. Crypto exchange Binance, for example, recently released a set of NFTs in collaboration with Cristiano Ronaldo (on which $445,000 has been spent), while Warner Bros. Discovery published an NFT version of The Lord of the Rings: The Fellowship of the Ring.

“The important thing is that the typical person who bought an NFT is going to lose their money,” says Schiff. “If you bought an NFT because you think it’s going to be worth more in the future, you’re wrong. It probably won’t be worth anything.”

McCoy, who started all this in the first place, is more philosophical about the future of his creation. He also predicts that the renewed focus on utility will create a measure of price stability, breaking NFTs free from the exhausting boom-and-bust cycle that has characterized the cryptocurrency market to date and led to the loss of funds by so many.

“Unique digital property is too important a concept to go away now,” says McCoy, “[it’s just that] the final form and function of these symbols remains to be seen.”

Updated 01/03/2023 11:00 AM ET: This piece has been updated to correctly attribute quotes to Alex Salnikov, co-founder of NFT marketplace Rarible.