Non-fungible tokens and the evolution of the Financial Internet

October 2021
 by Georgia Way

Non-fungible tokens and the evolution of the Financial Internet

October 2021
 By Georgia Way

Since the invention of the World Wide Web, the internet has been based on principles of openness and democracy. Internet users have made full use of the opportunities this provides, in both positive and negative ways. While the internet has led to an increase in the availability of information on a world-changing level, it has also caused problems, such as the loss of copyright control for artistic creators, and opened the door to digital scams and money laundering, deriving in part from issues with verifying the provenance of digital assets and monetising them over the long term.

Distributed ledger technology, most commonly known as blockchain, was created to solve some of these problems while providing the foundation for secure, traceable digital currencies such as Bitcoin and Ethereum. Such digital currencies are making an impact in the physical world, with hedge funds exploring cryptocurrencies, and the newspaper City A.M. intensively reporting crypto developments. But they are currently still considered ‘alternative’ assets, developing in a market separate to those of other assets.

How NFTs are transforming the concept of digital property and ownership

The sudden popularity of non-fungible tokens (NFTs), which have rapidly grown from being assets of very specialist interest to a market with a daily USD trading volume in millions, demonstrates the potential of blockchain technology to transform the way digital property is conceptualised and owned – creating an asset class that runs parallel to underlying physical or digital assets. Recent reporting has focused on NFTs as digital art, with examples including the artist Beeple making art and crypto history earlier this year when his digital image collage Everydays: The First 5000 Days became the first ever digital artwork offered by an auction house (Christie’s), netting him $69 million. But NFTs are not digital assets by definition: they are digital representations of ownership recorded on a blockchain as tokens, just like units of cryptocurrency. This allows their ownership, sale value, provenance and verification to be recorded, all of which can contribute greatly to their value.

Alongside digital artwork, NFT-related hype has extended to the purchase of moments of internet history: an early (misspelt) tweet by the founder of Twitter was sold as an NFT for over $2.9 million. Brands have also found opportunities in collectibles, with Marvel releasing a series of trading-card-esque NFTs as digital merchandise, linking culture and commerce in new ways. Once purchased, such items have a potentially considerable resale value on the secondary market for NFTs. In September 2021, there were around 25,000 daily buyers in the primary market for NFTs, compared to around 40,000 in secondaries, and the volume traded (in US dollars) is also higher in the secondary market.

This activity is currently driven by individuals, with little involvement from institutional investors to date. But in a sign that the financial ecosystem is becoming increasingly interested in the potential of NFTs as both a digital asset class and a digital representation of physical ownership, last month Visa purchased an NFT for $150,000. The announcement led to the total weekly amount spent on the primary NFT market to jump to its highest ever level.

NFTs as securities – with benefits, risks and costs

Reports of high-value sales of these items can distract from the wider-reaching point that NFTs are developing a new financial ecosystem in cryptoassets. An NFT is better understood as a security than as a piece of digital art or a collectible card. It is a contract of ownership, and there is a market surrounding it, with some liquidity. But although the Chairman of the SEC has stated that the majority of NFTs offered in the market are sold as securities, no solid regulatory framework currently exists. New crypto regulations introduced in multiple jurisdictions, including the EU and UAE, could provide a future framework and necessitate certain disclosures from market participants. In the event of a legal dispute, the valuations attached to NFTs could come under scrutiny.

Valuation and litigation risk potentially pose challenges both for traders and collectors of NFTs. Digital assets present the possibility of claims of misrepresentation, while market volatility could result in investors holding valueless assets – particularly if the underpinning blockchain supporting the NFTs were to run into regulatory, security or legal risk. And as with physical assets such as wine, securely storing high-value NFTs incurs costs: the file (and the investment) could be lost on a conventional server. Storage issues are at the heart of one of the most pressing concerns with all blockchain technology – its carbon footprint – with the Ethereum blockchain having around the same carbon footprint as Mongolia, so this adds ethical and environmental concerns to the NFT dynamic.

A new future for the financial internet

A project by British artist Damien Hirst explores the fragile dichotomy that exists between physical and digital value, through the sale of NFTs that denote the ownership of physical artwork. Buyers receive an artwork as an NFT, and can then choose to keep the NFT or swap it for the physical version of the artwork on paper. If they choose to keep the NFT, the physical version will be burnt in a fire – a concept that tests the assumption that digital items, built on the free and open internet, are worth less than physical assets. The perception of NFTs as valuable assets – no longer the poor relation of physical art – has solidified the connection between digital assets and monetisable ownership, breaking down of the wall between the ‘real’, physical world, and the digital sphere.

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