12-14-2022 - on NFT investments

When we think about NFT investments, it’s really hard because it’s almost impossible to predict markets, and there aren’t really any ways of justifying NFT valuations beyond having an opinion or belief about the speculative value of an art, a meme, or a brand. Instead, if we think from first principles–which is to say, if we think NFTs as primitives for software is a valuable concept–then we can discover which projects are leveraging NFTs as programmable digital assets and arguably build stronger NFT investment theses.

An NFT as a primitive for software to me means a digital object that stores data that can be read by external software and/or are capable of internally performing actions with that data. This could mean a piece of art whose metadata is stored completely in the contract from which web browsers interpret, render, and display the data. Some examples of this can be found in a blog post written by Simon de la Rouviere. It could also mean a digital object that stores data in the contract which is read and/or updated by external contracts–perhaps to use in a game or upgrade the rendering quality of the visual output. Corruption(s*) is a good example of this. As the community continues to write the Corruption(s*) narrative, Dom Hofman updates the data in the smart contract by writing upgrades to an external rendering contract.

In any case, NFTs as primitives for software are essentially building blocks upon which more software and NFTs can emerge. But using NFTs in this way is still very experimental, and currently it's not the most common use case.

The most common and widely accepted use case for NFTs is creating art and profile pictures to build brands and scale IP. The most basic, widely used forms of turning NFTs from digital objects into useful digital objects (i.e. those that possess utility) are airdropping supplementary NFTs to existing holders, issuing governance rights, and using NFTs to select holders for a whitelist or an IRL event. Holders tangibly benefit from these strategies because they earn or mint NFTs that can be traded for some value on the secondary market. Other more intangible benefits include identifying with like minded community, really appreciating the art, or going to a sick party.

But most of these projects don't really need an NFT to deliver the those benefits. Yuga Labs can issue the IP rights of their media, additional free media, and the governance rights for the company via traditional IP agreements, other digital platforms, and private stock offerings, respectively—some of which may carry some secondary market value. And of course they can perform IRL operations (such as throwing parties or selling merchandise) very similarly to way they do it now, which requires very minimal blockchain dependency.

Put differently, most projects use NFTs to distribute ownership of digital media and the IP rights associated with that media and, in return, bootstrap capital to execute growing the value of their business. This allows participants to speculate on the value of those NFTs and potentially benefit in the secondary market.

So, what makes most NFTs valuable? I’d argue that the value of the underlying NFTs depend on observations such as having a perspective on the world, artistic or curation skills, savvy code, comparing floor prices, evaluating a collection’s collector demographics, and modeling sales or hodler metrics. But modeling these terms to justify the long term investment value of an NFT is lofty, (admittedly though, I haven’t tried to create any models like this myself). Rather, I’d say a substantial amount of value for an NFT is captured in a speculative premium—that secondary market participants believe one day the NFT might have a lot of intrinsic value. DegenSpartan articulates this concept in this essay.

Simply put, while we can have an opinion on which NFTs accrue value over time based on a combination of tangible benefits, intangible benefits, and a list of observations about the secondary market, most of this value is speculative. And until there are more solid fundamentals around describing the intrinsic floor price value of an NFT, it’s still really, really hard to construct a good investment strategy around many NFTs.

(And for the avoidance of doubt, when I say most NFTs have speculative premium, I'm not saying that speculative premium = zero premium or that people are wrong for having a perspective on what that premium is. I'm just saying it's hard to measure.)

With this point of view, if our goal is to invest in NFTs and most NFTs are speculative, then deciding which NFTs to buy is missing the point. Instead, I believe protocols that successfully leverage NFTs as primitives for software possess better investment value. And these projects aren’t just specific to NFT projects.

For example, Uniswap leverages NFTs as a primitive by allowing LPs to mint NFTs that represent and track the performance and value of their LP positions. From here, Panoptic is building a perpetual options protocol on top of Uniswap, repurposing Uniswap v3 LP tokens as options, and facilitating a market where traders can swap those options and create more exotic strategies. Sudoswap is an AMM for NFTs, allowing users to manage and create NFT pools, which is a valuable service for large collections or even DAOs managing large NFT inventories. JPG is building a token curated registry (TCR) protocol where NFTs will be leveraged to curate, organize, and map NFTs—a potentially crucial piece of web3 infrastructure that can bring more legitimacy and therefore more cultural value to the exhibited NFTs and exhibition curators. Briq treats NFTs like matter and allows users to assemble NFTs with other NFT units (i.e. construct buildings with bricks). OKPC uses NFTs to collect, draw, share, and transfer other NFTs.

While it's unclear whether or not they design their protocols around the value of the NFTs, I believe all of these projects are better positioned to be better NFT investments than the field because by using NFTs as primitives, they’re effectively building crypto-native lego blocks upon which more legos and software can be built. From here, we can explore more sufficient token value accrual designs—align incentives with the value of the underlying tokens—and thus make progress toward rebalancing some of the current speculative premium into intrinsic value.

All in all, I’m a firm believer in the NFT space, broadly. In particular, I love collecting on-chain art and view my NFT collection as a leveraged speculative bet on Ethereum–a speculative vehicle where I can store ETH as Ethereum's cultural and financial significance grows.

Having said that, the real NFT alpha is finding which protocols actually use NFTs as primitives (and burn gas)!