In 2021, the global cryptocurrency market grew an astounding 1,200% year-to-date, reaching its highest market capitalization on record of over USD$2.4T in mid-May. At the same time, the NFT market saw comparably unprecedented growth of 2,627% in 1Q21 relative to the prior quarter-end. Given the concurrent explosions in both markets, questions naturally arise as to the degree of influence that cryptocurrency prices have on those of NFTs.
This article will explore the concept of NFT pricing and its relationship with the cryptocurrency market. In particular, the following topics will be addressed:
The NFT Boom of 2021
The NFT market experienced a renaissance in 2021, posting record figures in terms of sales volumes, active wallets, digital asset trades, and average token prices, among countless other performance metrics. Before diving into the data that exemplifies the boom in 1H21 and the subsequent bust and second boom that have gradually manifested in the first few months of 2H21, consider the following numbers which portray the recent eye-watering growth in the NFT market:
Tracing the drivers behind the sudden rise and fall in the NFT market is a challenge, not unlike the ostensibly overnight surge in interest that powers bubbles in other financial markets. In part, it can be surmised that the tremendous burst of activity in the NFT market during 1H21 – specifically through the months of February and March – is attributable to the equally historic runups in the markets for blue-chip cryptocurrencies such as bitcoin and ether. Both cryptocurrencies, among many others, achieved all-time-high prices in early 2021, with bitcoin topping out at just shy of USD$64,000 in mid-April and ether hitting its ceiling of slightly less than USD$4,200 in May, representing year-to-date price growths of roughly 800% and 2,100%, respectively. With many cryptocurrency investors’ portfolios surging in value, their tolerance for risk and willingness to allocate more to other investment opportunities naturally grew.
In much the same way that the surge in the NFT market could be attributed to a dizzying rise in cryptocurrency prices, the more recent correction in the market can in part be attributed to the subsequent plunge in cryptocurrencies. Beginning with market-wide sell-offs in mid-late May, signs of a looming ‘Crypto Winter’ emerged as bitcoin and ether fell 53% and 57%, respectively, from their recent highs. In response, the NFT market stabilized with less inflated trading volumes & average prices, and has continued to perform at a substantial discount from its peak in 1H21. Another potential explanation for the recent mean-reversion in the NFT market centers around gas prices on the Ethereum blockchain. As more speculators sold their ether to cut losses and more investors bought-in at seemingly cheaper prices, gas fees across the network rose. With transactions becoming more expensive, many NFT investors may have deferred their purchases to conserve gas fees.
Overall, while a high-level correlation can be observed from examining the interplay between the cryptocurrency and NFT markets over the course of 2021 – and this correlation will be explored in greater depth later in the article – there is reason to believe that the co-movement of the two markets will be less pronounced in the future. As the hype around NFTs gradually declines and the individuals who viewed them as merely a vehicle for wealth-accumulation exit the market, the remaining investors will be those who have a genuine interest in the underlying artworks and collectibles and consider them effective stores of value. Suffice it to say that an NFT market populated by such long-term investors will not exhibit the same spasms as the traditionally speculative cryptocurrency markets.
Examining the trends in search interest for different NFT-centric topics, it is evident that two distinct periods of peak interest have emerged in the course of the past year. Leading up to the week of March 7th, 2021, interest in NFTs broadly was on a gradual incline and ultimately spiked to reach peak interest in that same week. Notably, this week marked the watershed sale of Beeple’s USD$69M artwork as well as the record sale of the ultra-rare CryptoPunks #3100 and #7804 for USD$7.58M and USD$7.57M, respectively. Following that historic week for NFTs, search interest in the topic gradually tapered off. A similar trend was exhibited by general NFT marketplace Rarible, with a spike in interest likely also attributable to the same sales.
In contrast, search interest in leading NFT marketplace OpenSea and landmark projects in the ecosystem including CryptoPunks and Axie Infinity followed a slightly different trajectory to their peaks. All 3 of these marketplaces & projects achieved peak search interest around the period of late-July to mid-August. These lagging peaks are most likely traceable to the more recent surge in interest for Axie Infinity’s play-to-earn business model as well as the rapid ascent of the Worldwide Asset eXchange (WAX) blockchain, which offers a platform that is better optimized for NFT-hosting than Ethereum. Many had already become attuned to the general concept of NFTs during the first boom in 1H21, which explains why this subsequent NFT boom centered on specific projects and leading marketplaces.
The trends in marketplace sales volumes reveal similar insights, with most marketplaces achieving their respective apexes at the height of the first NFT boom and OpenSea almost single-handedly facilitating NFT trades thereafter. That said, while volume across non-OpenSea marketplaces saw a uniformly steep drop after March, it is evident these markets still enjoyed some volume gains on account of the second NFT boom. In the context of crypto-art marketplaces, it comes as no surprise that SuperRare has consistently led the pack in sales volumes. An observation that was less expected was the growth of Foundation, which only recently launched in February of 2021 and has impressively etched its name into the shortlist of leading NFT marketplaces. Overall, however, it is clear that interest in crypto-art amidst the NFT boom has fueled rapid growth in these marketplaces that would have otherwise been unachievable.
OpenSea’s performance has been particularly noteworthy, both from an absolute perspective given the marketplace’s 76,240% YTD volume growth in 2021, as well as in relative terms given the platform’s resilience to the initial collapse of interest in NFTs at the tail-end of 1H21. Consider that OpenSea surpassed USD$1B in lifetime gross market volume in early August. Yet what is arguably more impressive is the fact that the marketplace also achieved over USD$1B in gross market volume during the first three weeks of August 2021 alone. OpenSea has evidently become the de facto platform through which NFT investors exchange value and its parabolic growth in 2021 has set a lofty benchmark for other general marketplaces.
Pricing of Popular Projects
Finally, it would be nonsensical to speak of the NFT boom without also making mention of actual price trajectories. Focusing on the average daily prices of NFTs in the CryptoPunks, Axie Infinity, and NBA Top Shot collections – the relationships between each of which and the prices of major cryptocurrencies will be examined later – the trends largely mirror those observed in terms of search interest and marketplace volumes. With respect to CryptoPunks, their tremendous price gains from a year prior were slightly lost following the first boom but quickly rebounded to record levels. The prices of NBA Top Shot and Axie Infinity NFTs followed a similar trajectory during and immediately after the boom, however they have since failed to recover to their all-time-highs achieved in February and March.
The Value- and Price-Determinants of NFTs
Prior to taking a more granular look at the recent skyrocketing trend in prices across the NFT market, it is worthwhile to explore some of the criteria that is generally thought to confer value on a particular NFT and thereby drive its price up. As is the case with research findings on the correlation between the NFT and cryptocurrency markets, the literature on NFT value-determinants is also quite nascent. However, drawing and collating insights from several different sources allows for a fairly holistic value framework to be defined.
Importantly, it should be noted that much of the following discussion on value applies to NFTs broadly. That said, certain asset-specific features may contribute to granting certain NFTs additional value that cannot be enjoyed by NFTs of other asset classes. For instance, a moment in the NBA Top Shot collection may prove more valuable, and thus more expensive, because it tokenizes a pivotal play in the dying minutes of a Finals Game 7. Naturally, this same value-adding criterion cannot reasonably be applied in determining the value of a piece of generative art in the Ringers collection. Accordingly, the following discussion should be thought of as a general overview of NFT value-determinants and not anything attempting to be a comprehensive or authoritative list.
One oft-cited and much-maligned argument for the value of NFTs is their utility. Effectively, this value-determinant pertains to whether or not an NFT provides some added functionality. While many NFT collections were created with no express purpose other than to be collectibles, others were designed to serve a specific function by granting owners access to exclusive privileges on their corresponding platforms. Thus, NFTs which provide more consequential and rewarding levels of utility will be deemed to have more value than otherwise equivalent tokens.
The argument for NFTs having value by virtue of providing some functionality can be generalized further to also account for those aforementioned collectible NFTs which lack a stated purpose. Matt Stephenson, a behavioural economist at Columbia University, described the idea of functional value as it applies to NFTs. According to Stephenson, value can be ascribed to the tokens on the basis that they allow owners to:
“…flex with [their] NFTs, show people [their] cryptocurrency wallet, display [their] taste in art and music … [make money from] this sort of speculative mania in the resale market … [and tokenize] real-world assets by putting them on the blockchain…”
This broad definition of utility effectively captures the entirety of the NFT market and provides one potential, albeit extremely broad, explanation for the value and prices of NFTs. The length of time an NFT remains in a wallet before being traded is positively related with its level of utility, and as such can be used as a proxy for measuring the relative utilities of different tokens.
Stephenson further describes the value-determinants of NFTs by drawing a distinction between functional and hedonic value. As previously mentioned, the former considers what practical utility the NFT provides. In contrast, the latter pertains to the affective element of asset ownership. In other words, the ownership of an NFT and the knowledge that no other market participants can concurrently own the same token may arouse feelings of pride and superiority among investors. These positive emotions are most striking among owners of particularly sought-after NFTs. The hedonic element of value provides an undeniably compelling explanation for the eye-watering prices and competitive bidding wars observed among the scarcest collections in the NFT market.
Artist & Ownership History
Another popular theory of the value-determinants for NFTs surrounds the names attached to a token. In particular, it has been proposed that NFTs of works developed by renowned artists and NFTs which were previously owned by individuals of great status are more valuable than otherwise equivalent tokens. For instance, the value and USD$69M price-tag of Everydays: The First 5,000 Days could in part be attributed to the fact that Beeple was a prolific digital artist long before the NFT craze began. With respect to value derived from an NFT’s ownership history, the publicly-viewable nature of blockchains enables a level of provenance that could scarcely be achieved with physical assets. Naturally, owning an NFT that is widely-known to have formerly been in possession of someone with great celebrity can drive up its value and price. This phenomenon, known formally as biographical indexicality, was cited by Stephenson in explaining how the Mona Lisa’s value was bolstered due to the artwork’s prior ownership by French Emperor Napoléon Bonaparte.
The relative size and devotion of the community that has formed around a project can also have an effect on the price of the related NFTs. This metric can be approximated based on the volume and activity of users on a project’s Discord server, sub-Reddit, or Twitter community. Having a group of passionate NFT-evangelists to promote the aesthetic or functional benefits of the tokens on the aforementioned platforms can give rise to invaluable network effects which in turn expand the community’s size and fervor and drive the price of the underlying NFTs upwards. A prime example of these network effects can be observed in the almost cultish demeanour that has formed within the CryptoPunks community, which now touts such household names as legendary rapper & entrepreneur Jay-Z and NFL superstar Odell Beckham Jr.
Financial Determinants: Speculative Value and Liquidity
Other value-determinants exist which are more financial in nature. For one, current NFT prices can be affected greatly by expected future appreciation, which itself may be impacted by a host of other factors including the developers’ roadmap for the project as well as overall popularity of the collection. Additionally, as in traditional capital markets, NFTs may trade at a premium if they are more liquid. The ability to quickly liquidate an NFT holding de-risks the investment, thereby making it more attractive and raising the prevailing price.
Whereas the above discussion on value and the distinctive feature-list of NFTs is thought-provoking, there is little doubt that many readers – namely those that err on the side of crypto-skepticism – are still befuddled by the sheer prices that recent NFT sales have commanded. Why, such readers might ask, did a collage of 5,000 abstract and often grotesque interpolations of pop culture sell for USD$69M? Why did 24x24 pixel characters fetch prices in excess of USD$7.5M? Why did the first-ever Tweet, readily available for public viewing by anyone on the platform, go for just shy of USD$3M? In truth, these price-tags are almost certainly the products of speculative buying rather than value-based investing. As a matter of fact, the tremendous price runups exhibited across the NFT market in 2021 are a prime example of the Greater Fool Theory, insofar as the often-inexplicable increases in demand had a more pronounced impact on prices than the actual intrinsic value of the NFTs being traded.
In sum, it must be emphasized that such criteria as utility, scarcity, artist, ownership history, community size, speculative value, and liquidity are the value- and price-determinants of NFTs under normal market conditions. Thinking back to the maniacal market sentiment evident in the earlier discussion of the recent NFT hype, it goes without saying that 2021 represented anything but the norm.
A Deep-Dive on the Relationship Between NFT and Cryptocurrency Prices
In considering the relationship between cryptocurrency and NFT prices, it is worthwhile to first understand the ways in which the two assets coincide, as well as the ways in which they differ. For one, both cryptocurrencies and NFTs rely on blockchains as their underlying infrastructure, exposing them both to the data integrity benefits as well as the transaction throughput shortcomings of the technology. Additionally, the two assets are inextricably linked insofar as NFTs are typically priced on marketplaces in cryptocurrency, with ether being the default currency for denominating the tokens. Since investors seeking access to NFT markets must first purchase cryptocurrency, there is an undeniable overlap between the two assets.
That said, NFTs and cryptocurrencies differ in a few crucial ways. For one, where cryptocurrencies are inherently meant to serve as currencies, NFTs are intended only to serve as assets. The implication is that while cryptocurrencies were designed to fulfill the roles of money, including to act as media of exchange, stores of value, and units of account, NFTs are strictly to be treated as stores of value. Additionally, cryptocurrencies are fungible whereas NFTs, as their name would suggest, are not. As a result, NFT prices can enjoy a greater scarcity premium than even those cryptocurrencies with a capped supply.
Literature on the relationship between cryptocurrency and NFT prices is scarce. However, a few notable studies have been conducted from which some key insights can be drawn:
Updated Correlation and Multiple Linear Regression Analyses
Conducting simple correlation and multiple linear regression analyses to examine the relationship between cryptocurrency and NFT prices during the two most recent booms reveals similar insights to those extracted from the existing literature.
Data on NFT prices was gathered from decentralized application data aggregator CryptoSlam! Not unlike previous studies, the analyses presented here relied on the prices of both CryptoPunks and Axie Infinity to capture behaviours in both the art and gaming submarkets, in addition to the prices of NBA Top Shot moments to capture behaviours in the sports collectibles submarket. For each project, 366 observations were collected for the period beginning August 1st, 2020, and ending August 18th, 2021, a timeframe which accounts for prices pre-mania as well as both during and subsequent to the 2021 booms. Ether and bitcoin were selected as reference cryptocurrencies, the former for its close ties to the primary blockchain for NFT-minting and the latter for its status as the cryptocurrency with the highest market capitalization. Price data for ETH and BTC were sourced from CoinGecko.
The correlation analysis presents some expected results as well as some less expected revelations. For one, it is clear that the prices of each project are somewhat correlated with at least one of the reference cryptocurrencies. These correlations are strongest in the case of CryptoPunks, with the 24x24 pixel characters’ prices sharing an 80% correlation with the price of ether and a 63% correlation with the price of bitcoin. Similar – albeit weaker – correlations exist between the prices of Axie Infinity’s beloved creatures and both ETH and BTC.
Interestingly, the prices of NBA Top Shot moments appear to have only a marginal 8% correlation with the price of ETH. It should be noted that while both CryptoPunks and Axie Infinity rely on Ethereum as their layer-1 solution, NBA Top Shot runs on Dapper Labs’ proprietary Flow blockchain. The difference in infrastructure may explain the lack of correlation between the project and the Ethereum’s native token. The fact that NBA Top Shot prices still have some correlation with the price of BTC is likely a reflection of the outsize impact that the immense bitcoin market has on all other derivative technologies and assets.
Finally, running linear regressions with the daily prices of each project as the dependent variables and the prices of ETH and BTC as the independent variables, it can be observed that the prices of the reference cryptocurrencies can be quite effective in explaining the prices of the selected NFT collections. The relatively high Adjusted R2 produced by the CryptoPunks regression indicates that the model has fairly strong explanatory power and that the price of a CryptoPunk will tend to be set in response to the prices of ETH and BTC. Similar but less pronounced explanatory relationships can be observed from both the Axie Infinity and NBA Top Shot regressions.
Examining the line fit plots from each regression, it is evident that both CryptoPunks and Axie Infinity have stronger relationships with ETH than they do with BTC, whereas the reverse can be said of NBA Top Shot. This is, as previously noted, likely the result of Top Shot’s distinctive infrastructure as well as BTC’s outsize influence on offshoot markets.
In conclusion, the above correlation and multiple linear regression analyses reveal similar insights to those published in the nascent literature on NFT pricing; namely that cryptocurrency prices do tend to have an influence on the prices of NFTs, with the effect being more observable in certain NFT submarkets than others.
The primary takeaway from the findings presented in this article as well as previous studies is that, unsurprisingly, the nascent NFT market is still quite susceptible to shocks on account of cryptocurrencies. That said, as NFTs mature and use cases are established that are pointed and distinct from the speculation that has characterized the market in 2021, there is little doubt that their prices will grow untethered from those of cryptocurrencies and the asset class will take on a life of its own.
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