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Non-fungible token prices are still high for now and may continue to rise for some time, but a crash will follow. With central banks poised to tighten monetary policy in an effort to rein in inflation, new and untested asset classes are likely to be hit harder than more reliable ones.

LAUSANNE – In March 2021, Christie’s auction house sold a JPEG file created by artist Beeple for $69.3 million, a record for a digital work of art. Ownership of the “original” JPEG – titled “Every Day: The First 5,000 Days” – was secured as a non-fungible token, or NFT.

The sale made headlines and NFTs have been red hot ever since. Investors poured $27 billion into the market in 2021, and Meta, Facebook’s rebranded parent company, today says it has plans to allow users to create and sell NFTs. There is only one problem: the NFT market will end up crashing, for one of many reasons.

In essence, an NFT is tradable code attached to metadata, such as an image. A secure network of computers records the sale in a digital ledger (a blockchain), giving the buyer proof of both authenticity and ownership.

NFTs are typically paid for with the Ethereum cryptocurrency and – perhaps more importantly – stored using the Ethereum blockchain. Combining the desire for art with modern technology, NFTs are the perfect asset for Silicon Valley’s newly wealthy assemblage and its train of acolytes in the world of finance and entertainment, as well as the wider community. of retail investors.

But like other hype-fueled, impulse-buying and hype-fueled markets, the fast-moving and speculative NFT market could hurt many investors. The current craze invites comparisons to the Dutch tulip mania of 1634 to 1637, when some bulbs fetched extremely high prices before the exuberance wore off to make way for the bubble to collapse.

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

Let’s start with the problem of infinite supply. NFTs offer ownership of a digital asset, but not the right to prevent others from using your digital copies. Part of the reason there are wealthy investors willing to pay tens of millions of dollars (or more) for traditional physical artworks by artists like Rembrandt, Van Gogh or Monet is that the number of masterpieces is finite; the artists are long dead and cannot produce new works of art. NFT copies, on the other hand, could become a commodity.

Also, as with all things digital, there is no difference in appearance between an original JPEG sold for $69.3 million and a copy downloaded online for free. In theory, the supply of legally usable copies of NFTs is infinite, potentially saturating demand for these pieces and causing prices to collapse.

Since the blockchain cannot store the actual underlying digital asset, someone who buys an NFT is buying a link to the digital artwork, not the artwork itself. While buyers obtain copyright from the link, the transaction costs associated with monitoring the myriad online platforms where NFTs are exposed, identifying illegal use, and enforcing and punishing any infringement make it nearly impossible to enforce copyright or deter wrongdoing. use. This strongly limits the monetization of the asset.

Another risk is that NFTs are being made and sold with nascent technologies – blockchains and cryptocurrencies. Today there are multiple competing standards on how to generate, safeguard, distribute, and certify NFTs, including ERC-721, ERC-998, ERC-1155, flow and non-flow standards, and Tezos’s FA2. The resulting uncertainty about how certification of ownership in perpetuity will be guaranteed jeopardizes the value of the assets and even their ownership.

In fact, the value of NFTs may evaporate if the next wave of more advanced technologies to replace cryptocurrencies or the blockchain is incompatible with secure NFT ownership. Companies working in the NFT market today may not exist tomorrow, generating waves of ownership claims.

The price volatility of the cryptocurrencies that underpin the NFT market is a central issue as well. NFT prices tend to move in tandem with cryptocurrency prices. When cryptocurrencies fell apart in 2018, so did the nascent NFT market.

The psychology of buying luxury goods is also likely to put downward pressure on NFT prices. Most luxury goods are often referred to as Veblen goods, with limited utility beyond allowing owners to advertise their wealth. For that reason, they often generate large profits for sellers.

NFTs allow buyers to promote their wealth essentially through the high price they paid, but only if they receive a positive reaction from their peers. If that spending doesn’t resonate with their audience, the investor might as well use cash to light up a cigarette.

As owning an NFT does not prevent others from displaying the same assets and mentioning an ownership, these tokens do not serve as effective indicators of unique spending power. And many NFT buyers remain anonymous anyway, because the blockchain ensures that ownership knowledge is limited.

Finally, changing macroeconomic conditions could negatively affect the prices of alternative assets such as NFTs and traditional works of art. In the last two decades, the number of billionaires in the world has increased more than fivefold, and disposable income to invest in alternative asset classes has skyrocketed as a result. The Covid-19 pandemic has so far reinforced this trend. Much of the huge economic stimulus injected by central banks went into financial markets, further boosting the net worth of the super-rich.

But investors’ attention can be fleeting. After the global financial crisis of 2008, sales of art and other luxury goods fell almost 40%. As central banks begin to tighten monetary policy in an attempt to rein in inflation, new and unproven asset classes are likely to be hit even harder than more reliable ones. And the immensely volatile NFT market, based on digital currencies with nothing to back them up, cannot be a safe haven.

In short, the prices of NFTs will suffer a significant and permanent decline. They are still high for now and may continue to rise for some time, but the drop will happen. Investors who think they can rip off the market have every right to try, but their optimism is likely to be misguided.

Patrick Reinmoeller

He is Professor of Strategy and Innovation at the Institute for Management Development.

Karl Schmedders

He is Professor of Finance at the Institute for Management Development.




www.eleconomista.com.mx

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