The failure of NFTs in 2022

Over the last two weeks, cryptocurrency prices have fallen dramatically, but some sectors of the economy have been hurt worse than others. Stablecoins, in particular, appear to be extremely volatile.

Are NFT markets on the horizon? After trade volume and NFT prices fell dramatically on average since their high last year, people are starting to wonder. Many new purchasers entered the crypto economy last year via NFTs, which insiders touted as a fun way to experience with crypto. If the NFT market fails, the ramifications might be massive. It may take a long time to get them back into the fold if they have been burned by a major decrease.

Non-fungible tokens are so named because, unlike related technologies like bitcoin and ethereum, each one is distinct in some sense. That implies they can be used for more than just simple monetary transactions; in recent years, users have used NFTs to convert art, music, games, and trading cards into digital assets.

NFTs keep track of who owns them and allow them to be traded or updated via a blockchain, a decentralized ledger first used by bitcoin to monitor ownership of the cryptocurrency. However, the majority are based on the Ethereum blockchain, which is maintained using a carbon-intensive technique known as proof of work.

A report published this week by Chainalysis, a blockchain data firm, said collectors have spent $37bn this year up to 1 May, putting them on track to beat the $40bn spent in 2021. However, it said that the “explosive” growth of the NFT market last year had “levelled off”, with a sharp dip in transactions since February. In other words, the monthly spend on NFTs is no longer rising in leaps and bounds, when it started to take off in the middle of last year.

The NFT market will likely suffer a similar fate – but not, as some might think, because of environmental concerns. To be sure, NFTs consume considerable amounts of energy, because cryptocurrencies like Ethereum and Bitcoin are “mined” using networks of computers with a large carbon footprint – one that grows with every transaction. But when it comes to understanding what will bring down the NFT market, climate impact is a red herring. The real problem is that the current NFT boom is built on a foundation of sand.

Begin with the issue of limitless supply. NFTs give you ownership of a digital asset but not the right to stop others from copying it. The quantity of masterpieces is finite; the artists are long gone and cannot make new artworks, which is one of the reasons why affluent investors are willing to pay tens of millions of dollars (or more) for traditional physical artworks by the likes of Rembrandt, van Gogh, or Monet. On the other hand, NFT copies may become a commodity.

Furthermore, as with all things digital, the appearance of an original JPEG file sold for $69.3 million and a copy acquired for free online is identical. The number of legally useable copies of NFTs is theoretically endless, potentially overwhelming demand and driving costs down.

Because the blockchain cannot contain the underlying digital asset, anyone purchasing an NFT is purchasing a link to the digital artwork rather than the artwork itself. Although buyers obtain copyright to the link, the transaction costs associated with monitoring the limitless internet venues for displaying NFTs, identifying illicit usage, and investigating and punishing infringement make enforcing the copyright and deterring misuse practically difficult. This severely restricts the asset's monetization.

Another issue is that NFTs are being manufactured and sold using unproven technologies such as blockchains and cryptocurrencies. The resulting uncertainty about how ownership certification would be assured in perpetuity puts the assets' value and even ownership at risk.

In fact, if the next wave of advanced technologies that surpasses crypto or blockchain is incompatible with safe NFT ownership, the value of NFTs may vanish. Firms that deal in NFTs now may not exist tomorrow, causing ownership claims to become unclear.

Price volatility of the cryptocurrencies that support the NFT market is also a major concern. The price of NFT tends to move in lockstep with the price of cryptocurrencies. The nascent market for NFTs crashed along with bitcoin in 2018.

The mentality of purchasing high-end goods will likewise put downward pressure on NFT prices. Most luxury items are so-called Veblen objects, which have little function other than allowing owners to flaunt their money. As a result, they frequently earn substantial returns for sellers.

NFTs allow buyers to publicize their riches, mostly through the high price they paid, but only if their peers respond positively. If the investment does not resonate with this audience, the investor may as well burn money to light a cigarette.

And because the blockchain assures that information of ownership is limited, many NFT buyers stay anonymous.

Finally, shifting macroeconomic conditions may have a negative impact on the pricing of alternative assets like NFTs and traditional artworks. The number of billionaires in the world has more than fivefold increased in the last two decades, resulting in a surge in available money to invest in alternative asset classes. This trend has so far been reinforced by the COVID-19 pandemic. Much of the massive monetary stimulus injected by central banks poured into financial markets, enhancing the super-net rich's worth even more.

However, investor interest can be fickle. Sales of art and other luxury goods fell by over 40% after the global financial crisis of 2008. With central banks tightening monetary policy to combat inflation, new and untested asset classes are likely to be punished more severely than more trustworthy ones. And the extremely volatile NFT market, which is based on digital currencies with no backing, is far from a safe haven.

NFT prices will eventually fall dramatically and permanently. They are still high and may continue to rise for a while, but the crash is coming. Those who believe they can timing the market are entitled to try, but their optimism will almost certainly be unfounded.