Before diving into the blog, I would like to let you know that Sfermion is hiring!
Sfermion is an investment firm that is fully focused on the NFT sector. We are hiring for multiple positions:
Investment Analyst/Associate: If you love NFTs, crypto, the metaverse, and want to work for an investment firm that is 100% dedicated to this sector, please send your resume, a writing sample, and your public crypto address to the email address below. The writing sample should be 1-2 pages max, focusing on a particular project or practice within the NFT space, in the form of a short research piece, investment report, or trade thesis.
If you are applying to the Content Creator & Manager position please send a resume as well as links to your social accounts (Twitter, Instagram, YouTube, Twitch, TikTok) and/or samples of content you have created.
Please send applications to firstname.lastname@example.org. We are Chicago-based but fully remote so anyone can apply.
Note: This is not financial advice, this is the personal opinion of Andrew Steinwold.
What drives value to non-fungible tokens (NFTs)? It’s a hard question to answer because NFTs are a very diverse and wide-ranging group of assets. It’s a challenge because many of the NFTs today are highly subjective and difficult to value based on quantitative factors. Nonetheless, I am going to discuss my framework for valuing different categories of NFTs.
TLDR - Value Drivers
Collectibles value is derived from the narrative around the assets. I define collectibles as assets with little to no utility, or very basic utility (e.g. access). They generally have traits or properties that indicate a specific rarity within a group of assets. Collectables usually have a limited supply which makes collectors confident in the rarity of the asset. Although collectibles are subjective in value, they generally lack major utility (“major” defined as the utility is needed or is the main focus of the asset, opposed to the utility being added on as a bonus to the collectible). This low amount of utility is often paired with high levels of narrative which define its value.
The dictionary definition of a collectible is an item worth collecting; of interest to a collector.
This definition is vague, but the important part is “of interest to a collector.” That means in essence that anything could be a collectible asset. Some people collect rocks, while others collect bugs. It is really the individual collector’s personal interest that drives the value. But what is driving these people to collect? It is the story and narrative that they tell themselves, or more commonly, that other people tell them.
You could say that baseball cards are just pieces of cardboard with images on them. What makes them valuable are the players on the card, the rarity of the cards, the condition of the cards, and other contextual clues like historical significance. All these factors matter because they help build context around the asset. If I know the player is one of the best, the rarity is a 1/1, and the condition is perfect - I will have the context that allows me to perceive that collectible asset as valuable.
This narrative can fetch serious value. For example, in August of this year (2021) a single baseball card sold for $6.6M.
And it’s not just sports cards, there was also a $375,000 Pokemon card that sold in February of this year. So why are these pieces of cardboard selling for vast sums? It boils down to the narrative or story built around these assets.
Let’s explore some of the narrative factors that could have contributed to the baseball card selling for $6.6M.
There is a large community of baseball fans around the world. Looking at the data, roughly 500 million people consider themselves baseball fans. Many of those fans know that Honus Wagner was considered one of the top baseball players ever. If the baseball community largely agreed that Honus Wagner was not a great player, then the card’s value would probably be significantly less than $6.6 million.
People like to collect old and historical things. This card was made between 1909-1911 - making it over 100 years old. It is even more incredible when you realize that the very first baseball card was created in 1886, only about 25 years earlier.
It should be obvious that if there were 100,000 of these cards then it probably would not have fetched such a high sale price. People like rare things and this card is apparently a 1/50. And because of its age, it’s likely the only one left in existence.
The record of ownership is extremely important because it allows people to see if the asset is increasing or decreasing in value over time by looking at its past sales history. It also serves the purpose of making new buyers comfortable with paying for a piece of cardboard because if you were the only baseball card collector out there, you would not want to spend anything more than $20 on a card. Seeing others throughout many years spend large amounts of money collecting these assets gives you a sense of security that people want this item. The Honus Wagner card has a well-documented history from 1973 onwards because that is when it was first sold at auction. Then in 2012, the card sold again at an auction for $1.2M before selling this year for $6.6M.
Being a physical object (in this case a piece of cardboard), we have to take into account the condition of the collectible. It turns out that this card was in essentially pristine condition, and was rated a 3 or “Very Good” by Sportscard Guaranty Corp which is one of the top sports card rating companies. This is a very important factor because it shows a third-party company exists just to grade these assets. You can think of this grading process as an auditor who looks into a company’s books to make sure the company is financially healthy. In this case, this company is inspecting every centimeter of this card to verify that it is in great condition.
If we combine these factors:
Combine all of these factors together and they build the narrative and story around this asset. Not sure if I would be willing to pay $6.6MM for a baseball card as I am more of a JPEG guy, but when I look at all these different factors it does start to make sense how and why collectible assets achieve some sort of value.
The value of a game asset is derived from the asset’s utility within its “universe”.
This beautiful creature is named Angel. Angel sold for ~$135,000 on November 6, 2020. Why did Angel sell for this much? Because it has the potential to be one of the strongest assets within the game Axie Infinity. Mystic parts can be upgraded to enable the Axie to have legendary battle moves which will be very powerful in combat. Angel has three Mystic parts which means it can have up to three legendary battle moves - making it extremely powerful. Point is, Angel can win more battles, acquire more assets, and potentially earn more money. This increased utility directly correlates to the value of a game asset.
We can look at this Axie named PC and see that in March of 2021 he sold for ~$110. The reason why PC cannot command an extremely high price is because the direct utility of this asset is comparatively lower than Angels. PC is a regular Axie with regular stats, and therefore it can only win a normal amount of battles, which means it only has an average amount of potential yield generation. I speak about the potential for these assets to generate an actual monetary return because Axies can literally do that, but the value driver thesis of greater utility = more value stays the same even with game assets you can’t generate returns from. In World of Warcraft, for example, you can’t generate yield by killing more monsters or completing more quests, but if your weapon is exceptionally powerful it is still very valuable.
At the end of the day, it really is that simple with game assets. My sword does 10 damage and your sword does 100 damage, your sword is likely much more valuable.
Similar to the physical world, the value behind virtual land is derived by its location, parameters, and content. Let’s take a look at the photos below.
We have a massive skyscraper in Manhattan on the left side and a very small single-family home located in let’s say, middle-of-nowhere Ohio on the right.
The location on the left side is Manhattan, one of the most densely populated places on earth, in contrast to the sparsely populated town in Ohio on the right side. Obviously, the Manhattan location will be much more valuable. How does location relate in the virtual world where transportation costs and time are generally zero or near zero? Locations near where players spawn are generally quite valuable because they receive the most “foot traffic.” Also locations near guilds, DAOs, or other entities that are active and generate content can generally drive the whole value of an entire area. A great example would be the Gangnam district in Cryptovoxels. This district was bought by a group of builders who created a Gangnam-style theme around the neighborhood and the entire value of that neighborhood increased in value.
The content is really what type of structure exists on that piece of land. If there are two plots of land with the same size, but one plot has a skyscraper and the other has a single-family home - obviously the skyscraper plot will be worth much more. In the context of virtual worlds, if I created a building - it would be simple, small, and not very impressive because I am not good at building. But if a company like VoxelArchitects created a building, then that piece of land would instantly be more valuable than before because the quality of their builds is unmatched.
A VoxelArchitect virtual building in Cryptovoxels.
Parameters are essentially the zoning laws surrounding your piece of land. What is the height, width, and length that you are allowed to build on your piece of land? If I am allowed to create a tall skyscraper on my land it will be more valuable vs if I am only allowed to create a two-story building. In the context of virtual land, the Frankfurt neighborhood in Cryptovoxels commands a large premium over most other lands in that world because those plots of land allow for the tallest buildings.
The value behind crypto art is derived from the artist’s reputation and brand.
Imagine an alternative universe where this beautiful painting by Banksy was actually created by myself, Andrew Steinwold, the NFT guy. I show it off to all my friends and family, everyone thinks it’s really cool and is very proud of me. I put it up for sale and fetch a handsome $20.
Now imagine the world of today where Banksy releases this exact same art piece. It immediately sells for +$1MM. Sure it is a really cool piece of art, but the reason why it can command a sale price of $1MM is that it was created by the world-renowned artist Banksy. Banksy commands a much higher price than me because I have zero brand recognition and no historical track record of creating pieces of art.
Saying that the value of art is completely reliant on an artist’s brand and reputation is definitely controversial but it’s just the framework that I use (other people are free to use any framework that works for them). To balance out my very black and white methodology, let’s look at what factors Sotheby’s uses when they look to value art.
Sotheby’s valuation factors:
How do we adopt Sotheby’s valuation metrics for the digital world? I wrote a blog about that here. While I think Sotheby’s valuation methodology is valuable, I am going to stick with my ultra simplified version of focusing on the artist’s reputation and brand as the main factor driving value to the art.
Other NFT Markets
The above-listed markets are the main sectors within the NFT ecosystem but no doubt more markets will emerge and when they do, I will have to update this blog and develop new theses on what is driving value towards those assets.