The following represents the second of three parts which together comprise the NFT Technologies manifesto. Make sure to read through Parts I and III to understand the full scope of the problems we aim to solve.
While the so-called ‘NFT Summer’ has been a time of incredible creativity and wealth-creation for many, there is little doubt that a large segment of investors have been forced to forgo the market opportunity entirely. Several potential deterrents to entry have existed for the crypto-curious, all of which are to be anticipated in an as yet unregulated market. However, investors who fear they have missed the NFT train need not worry, as many of the risks that have prevented them from entering the market can be mitigated by routing their capital through institutional-scale investment vehicles.
In Part II of our Manifesto, we define some of the pervasive challenges to investing in NFTs and outline how we plan to advance solutions through our second core vertical. In particular, we will cover the following subjects:
Whales in NFT Markets
In traditional economics literature, the Gini coefficient is used as a measure of wealth distribution in a nation; where more of the wealth is concentrated among a smaller faction of citizens, the nation is said to have a Gini coefficient closer to 1, and vice versa. A similar, albeit less formalized metric exists in the world of cryptocurrencies when discussing the distribution of different tokens among addresses. In crypto-market jargon, addresses which command disproportionately large fractions of a digital asset’s circulating supply are referred to as ‘whales’. The existence of these so-called whales has formed the bedrock of a common criticism pointed at the world of digital assets, namely that market dynamics have forced many tokens to deviate from the spirit of decentralized ownership.
The profile of a digital asset whale tends to be fairly homogenous. Whales may be early adopters of popular cryptocurrencies such as ether, accumulating sizable positions in such tokens well before they catapult into mainstream consciousness and achieve prices in the thousands of dollars and market capitalizations in the multi-billions. Alternatively, whales may come from institutional backgrounds, leveraging their scale advantages rather than their speculative foresight to gain significant footholds in digital asset markets. Irrespective of their profiles, the existence of whales poses some noteworthy implications for NFT and digital asset markets writ large:
Overall, the existence of whales can make NFT markets more difficult to enter and riskier to remain in. Two ad-hoc metrics that can be used to quantify the presence of whales and the overall concentration of an NFT project’s owner-base are the unique holders’ ratio and the Whale Concentration Index (WCI). The former is computed as the proportion of unique tokenholders to the collection’s size, while the latter is simply the collective ownership stake of the top 10 holders. Naturally, higher holders’ ratios and lower WCIs would imply less concentration in an NFT collection. Computing these measures for a selection of high-value projects reveals unfavourable levels of concentration among their respective communities.
Lofty, Speculation-Driven Pricing
Where the existence of whales presents challenges on the sell-side of NFT markets, including limiting the supply of actively-traded tokens as well as putting downward pressure on prices in periods of capitulation, there also exist significant challenges on the buy-side. Not least of these demand problems is the fact that speculative buying has driven NFT markets – and to a lesser extent cryptocurrency markets – to multiple booms in only the first 8 months of 2021. This is exemplified by the quarter-over-quarter growth in the cumulative size of NFT markets as at 1Q21, which came to an eye-watering 2,627% rate. This growth continued, albeit at a markedly slower rate, with QoQ gains of 111% through 2Q21.
This unprecedented growth poses some obvious challenges for prospective investors. For one, the start-up cost of creating a portfolio with exposure to the fastest-growing and most sought-after NFTs is astronomically higher now than it was in late-2020 and earlier. As a result, there are significant barriers to entering into the blue-chip NFT markets. Although new projects are seemingly launched ad nauseum for comparatively cheap initial prices, it is often difficult to secure tokens in the primary market when the collection is surrounded by a great deal of hype. This leaves the vast majority of investors with little choice but to buy at inflated secondary market rates. Additionally, the lofty valuations prevalent throughout the market pose risks of substantial losses for investors. It is effectively impossible to predict when the market has peaked, leaving better-capitalized investors who are able to pay the steep asking prices susceptible to losing large sums of money.
Examining trends for popular NFT projects solidifies that current prices are quite high in both relative and absolute terms. For instance, the Bored Ape Yacht Club collection has enjoyed tremendous price-appreciation since its late-April launch, growing at a blistering 52,293% rate. This is in no small part thanks to tailwinds which have affected the entire sub-market for NFT-based avatars. The crypto-art world has exhibited an even more impressive trajectory, with the popular Fidenza project having undergone an 89,134% growth in prices since it dropped in mid-June.
An even more recent example of these price dynamics can be observed in the launch of Loot, a collection of 8,000 NFTs backed by lists of random ‘adventurer gear’ which can form the foundation for an attire system in a role-playing game. It is critical to note that the assets underlying Loot NFTs are not themselves the artworks for the attire, but merely text describing it. The project has been highly polarizing, with many lauding it as a creative breakthrough for blockchain-based gaming and others deriding it as a low-effort signal that the market has reached its peak. Despite the project’s lukewarm reception, its secondary market prices have risen roughly 16,000% since its launch.
A Market Flooded with Tokens
A quick glimpse at Etherscan’s listing of ERC-721 tokens – the standard for creating NFTs on the Ethereum blockchain – reveals that 16,497 unique token contracts exist. The rate of increase in this figure accelerated greatly throughout 2021, as NFT markets exploded and many opportunists sought to introduce their own projects to realize quick profits. Further complicating this issue is the fact that NFT collections can comprise thousands and even millions of individual tokens, all of which vary in value based on their aesthetic appearance and their overall rarity, among other attributes. Accordingly, it has become increasingly difficult for the untrained eye to identify which NFT projects have a high ceiling, and which are meritless copycats or money-grabs with no longevity in the market.
DAOs and the Punctuation of Risk
To more efficiently allocate capital and coordinate the purchases of high-value NFTs by a collective of individuals, DAOs have become the de facto approach for ardent supporters of blockchain technology. At a high-level, DAOs represent a crypto-native corporate structure whereby individuals can pool their money and cast their votes as to what actions the DAO should take. Importantly, there are no trusted third-parties and the operations of a DAO are dictated by logic encoded in its underlying smart contracts.
Some DAOs have been formed with the primary focus of investing pooled capital into NFTs. This collaborative approach enables individuals to co-own tokens which they would not otherwise have been able to afford as standalone investors. Examples of NFT-focused DAOs include PleasrDAO – best known for its USD$6.5M purchase of the famed Edward Snowden NFT – as well as FlamingoDAO and Yield Guild Games, to name but a few.
Since the infamous 2016 hack of the inaugural DAO, a watershed moment which resulted in the theft of USD$60M in ether and the hard fork of the Ethereum blockchain, concerns have existed as to the security of a smart-contract-based organizational structure. While significant advancements have observably been made in securing DAOs since the hack, and several projects and protocols responsible for many millions of dollars worth of ether have successfully implemented a DAO model, there is reason to believe that outside perceptions will be more difficult to change. Traditional investors will likely be aware of the riskiness of NFTs, and as such will seek to minimize the risks they accept beyond those inherent to the asset class itself.
Additionally, there may be concerns pertaining to the decentralized governance model of DAOs among investors who are more accustomed to a centralized approach. While it is not without its merits, steering an organization’s activities in a decentralized manner can potentially invite widespread inefficiencies. This is especially true where an action being voted on is divisive within the community. Also, the legal status of DAO tokens remains an open question. While the US Securities and Exchange Commission has ruled that the original DAO’s tokens were securities and therefore were required to be registered with regulators, its unclear whether the same treatment would apply universally to all DAO tokens. On these bases, it is unlikely that traditional investors will consider participation in a DAO as a viable pathway to ownership of high-value NFTs.
Core Vertical 2: Investing
Fundamentally, the existence of whales forces NFT market participants to be well-capitalized and mindful of large trades. For prospective investors not fortunate enough to have been early entrants into the highest-growth markets, their only recourse to combat tokenholder concentration is to wield scale advantages and to be acutely aware of significant liquidations that could depress prices in their chosen markets. To circumvent the barriers to entry created by whales, NFT Technologies will adopt an unabating fundraising mentality, courting substantial amounts of equity to finance our entries into the highest-growth markets. Additionally, to address the potentially disastrous effects that whales can have on the supply-side of markets, we will utilize on-chain analytics techniques to monitor the activities of the largest whales in both markets we have invested as well as those we aspire to invest in.
There is little doubt that with the fervent community of supporters that has formed around them and the sustained mainstream coverage they have received, NFTs will continue to exhibit periodic supercycles in the near-term and multi-million-dollar price tags for select tokens in the long-term. Accordingly, successful investors must acquire new NFTs around their launch, and must have the requisite market knowledge to extract upside from investments in higher-priced tokens. In order to acquire those tokens with the greatest potential to appreciate, NFT Technologies will leverage its wide-spanning reach and knowledge of the crypto-markets to acquire promising NFTs when they initially drop at cheaper prices. Additionally, NFT Technologies will apply its institutional-grade investment criteria to selectively enter higher-value NFT markets and mitigate the risk of loss on these more expensive tokens.
The sheer size of the NFT market in terms of how many projects exist has made it exceptionally difficult for beginners to make educated investments. The number of tokens issued under individual projects only serves to further obscure the highest-potential projects. To cut through the fat and discover the true gems in the market, the NFT Technologies investment team will practice disciplined conservatism and apply its holistic institutional-quality criteria to identify promising projects that are worthy of deeper due diligence and investment.
As vital as the existence of NFT-centric DAOs has been to advancing their case as legitimate corporate structures, and as bullish as we are on the concepts of decentralized capital-coordination and governance, we believe there remains room for more traditionally centralized organizations in the NFT sphere. This is especially important for catering to non-crypto-native investors whose appetite for Web 3.0 does not include entrusting their capital to smart contracts with potential security flaws. By serving as a sort of interface between old-world investors and new-world assets, NFT Technologies’ centralized structure can help to de-risk a notoriously risky asset class and render it more digestible to a wider scope of interested investors.
An Overview of NFT Technologies’ Investment Criteria
In order to avoid the negative impacts of whales, capitalize on the tokens with the greatest upsides, and mitigate risks for our investors, NFT Technologies has devised and begun to battle-test an institutional-quality set of investment criteria segmented by NFT asset class. At a high-level, our investment criteria comprise of:
Coupling the above criteria with our investment team’s acute focus on risk-management and strong rapport with key figures throughout the cryptocurrency and NFT markets, NFT Technologies will originate and execute upon investment opportunities with the best founders at an attractive cost basis for our firm.
Going forward, NFT Technologies intends to expand its investment mandate beyond NFTs. While we will continue making selective principal investments in NFT markets, we will widen our scope of focus to also include growth equity funding for innovative startups building the future of blockchain, digital assets, fintech, data warehousing, cybersecurity, and artificial intelligence & machine learning, among countless other related technologies.
In much the same way that DAOs have enabled crypto-forward individuals to invest in high-value tokens, NFT Technologies is enabling crypto-curious investors from more traditional capital markets backgrounds to also gain exposure to this fast-paced and exciting asset class. Through our robust investment process of organization, prioritization, and deep-dive due diligence, we ensure that average investors seeking to diversify into the NFT markets are not hindered by their budgets and can rest assured that their funds are placed into first-class tokens backed by world-class technologists.
Herrera, P. (2021, August 26). Whale Analysis Report - NFT Perspective. Retrieved from DappRadar: https://dappradar.com/blog/whale-analysis-report-nft-perspective
Niftex. (2021, July 29). The Emergence of NFT DAOs - Overview. Retrieved from Niftex: https://blog.niftex.com/nft-dao/
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