Part 1 of a 2 part series where I dig into all things NFT.

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It’s time to set the record straight about what exactly are NFTs, and why they have the potential to change the world. I for one am tired of people immediately thinking of crappy JPEGs when I mention NFTs, and put a lot of the blame on the shoulders of mainstream media and a general lack of education. In the publics’ defence, NFT’s are an incredibly new concept having only really come into existence in 2021 (see Google search trends below), so confusion and misunderstanding is natural. In parallel, the hype wave hit contemporary culture like a Tsunami - NFT was Collins Dictionary’s word of the year, small fortunes traded hands on OpenSea, and celebrities such as Snoop Dogg, Serena Williams and Justin Bieber (amongst many others) ape’ing into collections only amplified the noise. 

Starting with the basics

I’ve read so many articles explaining what NFTs are, but honestly they almost all miss the point. If there is one thing to take away from this series, it is this:

NFT’s are representations of digital & physical ownership. (I’ll come back to this later)

I’m sure many readers are already familiar with the basic concepts of ‘non-fungible tokens’ (“NFTs”) - they are unique immutable records stored on the blockchain showing proof-of-ownership - but less familiar with the technical workings of NFTs. As illustrated below, NFTs are actually pieces of code (created by a smart contract) with a URL pointing to a JSON file. The JSON file contains an NFT’s metadata, which often includes the name, description, attributes and the underlying media file (jpeg/picture, audio, movie etc.). The media file can be hosted on a centralised server somewhere, such as a marketplace or local computer, or ideally on a decentralised storage network such as IPFS or Arweave. To ensure consistency, comparability and usability of NFTs, a unifying framework was created in the form ERC721 (for ETH).

For an easier to understand anecdote (shoutout to Dan Taylor), you might think of NFT’s like digital candy wrappers. You can stuff whatever you want inside the wrapper - music, images, a novel, festival tickets etc. - and the NFT will wrap it up and put a stamp outside saying who owns it. While there are limitations to this technology today, namely the reliance on the underlying asset (media file) being secured and attributable to the NFT, the potential implications are mind blowing.

The $40bn+ NFT market

Before going into future use cases, I want to spend some time talking about the market today, because many people have no idea what it actually looks like. 

Despite all the hype and media attention, NFTs are still incredibly niche, with best estimates pointing towards ~500,000 people who have ever bought or sold one. Compare that to the global population of 7+ billion people, this means only ~0.007% of people have used an NFT! Some might point to that figure and criticise NFTs as a useless technology with no mainstream applications, however I believe it is rather an indication of how early we are, and the immense potential once (not if) we see growing adoption. 

What is perhaps more staggering than the low penetration rate, is the size of the NFT market - $40bn in 2021. For a market which is less than 2 year old, it generates almost the same amount of value as the entire UK Hospitality Industry (peaked at £59bn in 2019, £47bn in 2021), which employs over 3million people. Yes, much of the volume is wash trading (where people sell themselves NFTs to claim marketplace rewards or manipulate prices), and there is a debate on what currency NFTs should be valued in (fiat or crypto), but the point remains, this is a huge & rapidly growing market of significant value. It is also interesting to highlight that primary sales (i.e. minting) account for ~15-30% of all volumes, with secondary sales (on marketplaces) the remainder and the clear majority.

If we look into the market’s participants, no surprise, it skews heavily male, aged 18-35 with above average incomes. This mirrors demographics within the broader tech industry, and I’m hopeful that greater diversity will come with time and as more users enter the ecosystem. A lack of diverse representation amongst the NFT collections themselves doesn’t help, although successes from the likes of Crypto Coven and World of Women are starting to bridge the gap.

Moving on to the collections themselves, OpenSea currently lists >10,000 different collections, however in reality there are around ~150 of what I deem ‘scaled’ collections (>$20million of lifetime sales volume), which account for >75% of the market by value. Eighteen months ago this was a very different picture, with only a dozen or so scaled collections, and Yuga Labs (BAYC + Punks) having a much larger market share (>50%). As the market matures, I expect further fragmentation and diversification of collections, which should be net positive for everyone as it will lead to greater wealth distribution amongst creators, and more choice for consumers.

If we look at the past 2 quarters (below), ‘collectibles’ (ie. non-art based collections, such as Punks, Clones etc.) are the vast majority of the market accounting for 60-75% of sales. The remainder is fairly evenly distributed between Art, Gaming, Metaverses and Utility. An encouraging trend is the growing share of ‘Utilities’ and ‘Metaverses’ sales in Q2, representing a shift away from pure PFP based sales towards NFTs like ENS and the Otherside’s drop. 

All of the above data is helpful to contextualise the market, but it fails to explain one thing - what NFTs are actually being bought / sold / used for? Sadly, and in alignment with most critics, I’d argue purchasing decisions are overwhelmingly being made based on speculation and a hope the NFTs will appreciate in value. This isn’t necessarily a bad thing, as you could argue the same is true for the majority of stock, bond, commodity & durable asset purchases, however if that is all NFTs achieve (speculation), then I’d be pretty disappointed. 

Tokenising Culture

One counter to the ‘NFTs as speculation’ argument, is Culture (the other is Utility, but we will cover that next week).

Its hard to argue against NFT’s as a cultural centre piece from the past 12 months… especially if the sheer number of memes is anything to go by! The ‘crypto as culture’ shoe really dropped for me when I saw this Snoop Dogg x Eminem video, two icons of my childhood, known for their huge cultural clout, rocking BAYCs.

Why are NFTs part of culture you may ask? Because of the power of a community. We said NFTs are representations of ownership right? Well, ownership is a reflection of identity, and identity manifests in communities.

If we take the Bored Ape Yacht Club (“BAYC”) as an example, this 10,000 strong community counts the likes of Snoop Dogg, Eminem, Serena Williams, Jimmy Fallon, and countless other celebrities as its members. By holding one of these NFTs, you are within rarefied territory and one of the most exclusive clubs in the world. Who wouldn’t want to go to a BAYC party (IRL) and meet the rest of that community? And therein lies significant value - the value of belonging, of being cool, of finding your tribe and associating with a cause. Vibrant discord channels, merch, IRL & URL events are just the tip of the iceberg. We are seeing the first generation of truly digitally native communities emerge thanks to the power of NFTs, and I expect the crypto-to-culture connection to only strengthen over time as awareness builds.

Thinking beyond overpriced JPEGs

We as humans own things - The things we own are different, some are sentimental, some are unique. Some are physical, others digital. You might say, we live in a largely non-fungible world - My car is different from my neighbours. My house is different from my friends. The old saying goes, “possession is 9/10ths of the law”, but what if it didn’t need to be so literal. What if we could see for every item, not only who owns it, but its history, its materials, how & where it was made, and much much more (i.e. its metadata). What if we could trust this data implicitly, irrespective of who possesses the item, and know when a value transfers occur, the system of record is updated automatically with information symmetry. 

This might sound like a data & privacy nightmare for some, but I see a future where assets (physical or digital) can trade hands in a decentralised world, free from reliance on centralised marketplaces, data inequality, or logistics constraining us to physical borders. If we go one step further and include intangibles like university degrees, medical records or more, the vision becomes even grander. 

I’ll pause here for now (as I have a tendency to write long articles) and save the crystal ball gazing for next week in Part 2 of this series, where we cover future NFT use cases and areas where I believe NFTs have the power to change the world.

Written by Joseph Pizzolato

😎 About the Author

I’m an Investor at Felix Capital, a London based early-stage and growth fund specialising in the intersection between consumers and technology. We have been fortunate to support the likes of Ledger, Sorare, Lightspark, Rally, Flooz and others, and actively looking for great crypto founders to invest in. For entrepreneurs looking for funding (or wanting to chat), you can reach me via email - Joseph@felixcap.com or Twitter @Jpizzolat0