On June the 10th 2021, a 24 x 24 pixel digital image of a punk alien was sold for the equivalent of $11.75 million, which equates to over $20k for a single pixel. Simply described as Punk #7523, it is an early and rare example of an NFT, a non-fungible token created on the Ethereum blockchain. The sale of Punk #7523 wasn’t a one-off, an NFT of a rock sold for just under $4million. There is now huge interest in NFTs, given the enormous sums involved, but many newcomers to crypto are left asking, how does an NFT have value?
An NFT is a digital record, like a receipt, proving ownership of something (either physical or digital) such as a collectible item, like the pixelated drawing on a Punk Alien.
It is a record of when the item was created - or minted to use NFTs unique terminology - and how much was paid for it, including previous sales, as an NFT can be exchanged/traded on NFT marketplaces.
At this point you might be thinking - so what? What’s the difference between the Punk Alien and any digital image, such as 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 created, and the qualities this gives them.
Minting an NFT, means creating a new record on a decentralised blockchain, in the case of Crypto Punks this is Ethereum, but NFTs can be minted on other blockchains.
One of the fundamental qualities of a decentralised blockchain is that the data they hold is immutable; in other words, it cannot be changed. No one can amend the information associated with an NFT, it is a unique unchangeable record.
Of course that wouldn’t stop someone simply duplicating and then minting the same image, but NFTs are non fungible tokens. They are designed so that they cannot simply be duplicated and exchanged for an identical item, they reflect ownership of a unique item, as recorded by a blockchain, for which there isn’t an interchangeable equivalent.
There is an agreed programming standard on Ethereum called ERC-721 - shared by other blockchains - that sets out the parameters to ensure a record is non-fungible.
It is important to distinguish the record from the image, as an NFT doesn’t necessarily represent the item itself. Images can be stored on a blockchain, but an NFT might simply indicate where the item exists, such as the url of a piece of digital art, photo or the location of a physical asset. This is the same with analogue receipts or certificates of authenticity that prove ownership and provenance of physical collectibles - like an autographed album.
The amount paid for Punk #7523 - a 24x24 pixel NFT
Though this might sound interesting from the perspective of technical innovation, on its own, it doesn’t explain why a tiny pixelated image of an alien is worth almost $12million.
To understand that you have to understand the two elements that give collectible items value - scarcity and intrinsic value.
If something is scarce, it has a limited supply. Most famous pieces of art, for example, are one-offs, but being scarce doesn’t, on its own, make something valuable.
I could do a one-off doodle on a notepad, put it in a frame and auction it, I’m pretty sure no one would be willing to pay anything for it, because it has no intrinsic value.
Intrinsic value is hard to define as it is subjective appreciation of something’s value, but boils down to being unique, irreplaceable and significant or sacred.
My doodle might be unique, but it is easily replaceable and certainly has no special significance, because I have no standing as an artist and haven’t generated any other fame.
Compare my doodle to the world’s most famous painting, the Mona Lisa, painted by Leonardo Da Vinco around 1503. Though some historians argue that Da Vinci actually painted two versions of the Mona Lisa, only one has ever been found, making it unique, and given he died in 1519, it is certainly irreplaceable.
The same could still be said about loads of paintings by long-dead artists. What separates Da Vinci and the Mona Lisa in particular isn’t 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 an archetype of Renaissance art.
So if we jump from 1503 to 2021 and back to Crypto Punks and Eth Rocks, we can use the idea of intrinsic value to try and understand why such huge sums have been paid for them.
NFTs are made to be unique, this quality is debatable as the same image can be minted on separate blockchains, or simply downloaded and duplicated, but isn’t this true of the Mona Lisa?
I can buy a poster print of La Gioconda and hang it in my room but it isn’t the same as the original hanging in the Louvre. The blockchain proves the provenance of an NFT - which was the first version - so its immutability really comes down to how much we can rely on the record remaining decentralised, and therefore free from amendment.
Not only does scarcity derive from the way the NFT is minted, but from the composition of the image itself. Punk #7523 is one of a limited collection of 10,000 algorithmically generated images of which no two are the same. The collection has certain common traits, within which there is relative scarcity.
It is an alien, one of nine in the collection, but the only one wearing a mask. 175 punks wear a mask. It has an Earring (2459 punks have this) and a Knitted Cap (419 punks have this).
NFTs aren’t irreplaceable, in the sense that an identical version could be created, which would be impossible to detect, but their value doesn’t necessarily derive from the technical skill of the artist.
Just as the Mona Lisa represents an important juncture in the history of art, Crypto Punks are the first of the NFT genre, representing the unique aesthetic of the crypto movement, which is itself an important milestone in modern society.
That significance cannot be engineered, or replicated, and gives Punk #7523 intrinsic value. That said, how is a value of $11.75million reached?
There is no equation for calculating the value of a piece of art, such as the Mona Lisa, given that intrinsic value is subjective. Artists and artistic movements fall in, and out, of fashion. Why that happens is complex, but generally reflects changes in society.
Interest in Chinese art, for example, has been fuelled in part by the growth in the Chinese middle class, with increasing disposable income, and a growing interest in Chinese nationalism and sense of identity. There is no guarantee that this will last.
In a similar way, the interest in NFTs is a function of the interest in crypto, which is itself largely speculative. The future value or adoption of cryptocurrency is uncertain, and has to be understood in a macroeconomic context.
For over a decade interest rates have been near zero, so investors have been looking elsewhere for ways to generate a yield on their money. The financial crisis that led to this situation has led the younger generation to be disillusioned with the existing financial system, and eager for a new approach.
These dynamics have come together to turn interest in concepts like NFTs into something more, a kind of fervour that borders on a speculative bubble. That doesn’t mean that Punk #7523 isn’t worth $11.75 million. That has already been proved, because someone paid that amount to own it..
It remains to be seen whether it can retain that value, but more importantly whether the value of the thousands of NFTs Crypto Punks have inspired are justified, given the same arguments around intrinsic value cannot be true for all of them.
Hype could be inflating the value of NFTs as they simply becoming more commonplace, decreasing the marginal value of simply being an ‘NFT, but the genuinely early examples are now becoming a form of digital conspicuous consumption, known in economic terms as the veblen effect.
A veblen good is one for which demand increases, as price increases, which seems counter to the normal rules of supply and demand but explains how branded goods, which look identical to cheaper versions, command such high prices.
But collectible art is by no means the only use case for NFTs and even within that genre, there is a huge amount of innovation.
NFTs are tradable on exchanges like Opensea. If you are thinking about buying your first NFT, deciding which to buy can be overwhelming, because there are now so many. The NFT market is becoming saturated, as artists all try to carve their own niche.
The majority are opportunists, making little effort to create something of intrinsic value, and simply thinking that the fact of creating an NFT is enough in itself to warrant value.
There is also plenty of anecdotal evidence of price manipulation of NFTs and them being used to launder money, or as part of complex tax mitigation schemes.
This doesn’t mean that it is all downhill for NFTs being created today, so long as meaningful innovation continues, and the signs are, that is just getting going.
An NFT collection called the Merge, was sold for $91.8million in December 2021, created by NFT artist Pak. It broke ground because buyers didn’t get an Ethereum token, but rather paid to own “mass” tokens that, following the token sale, will be combined to create a dynamic NFT collectible, hence the name, The Merge.
This concept is unique and marks another special moment within NFT history, justifying the astronomical valuation in the eyes of the 28,984 buyers of the tokens. This follows the rules of scarcity and intrinsic value, and benefits from the current hype around crypto.
Beyond collectible art, NFTs are playing a huge role in the Metaverse type games that are currently being built on a play-to-earn model. This may disrupt the entire gaming economy, and you might want to stop and think why Facebook rebranded to Meta.
NFTs can disrupt other common records of ownership, such as property or shares, both of which are enormous markets. Anyone who has ever bought a house will testify to the need for innovation, given the archaic processes.
NFTs can also be used to add a new dimension to the business models that power most of our digital lives, enabling secondary markets for on-demand and subscription services. The opportunities are endless, so long as the ownership of, or rights to something can be defined in a Smart Contract, it can probably be traded as an NFT. Most of that data is owned by trusted third parties, but when individuals are empowered to own it, things will get really interesting.
As for NFT as collectible art, there is no guarantee that the interest will be maintained. Punk #7523 will always and forever be a 24x24 pixelated image, what will change are the attitudes toward the context of its creation,
If decentralisation and crypto fail to establish a meaningful place in society, then the perceived value of NFTs will likely fall, if however, these ideas revolutionise the way in which all value is exchanged and stored, the future generations may consider that Punk Alien to be as important as the Mona Lisa.