The art market shows how NFTs can work as investments

NFTs, or non-fungible tokens, are an emerging technology trend. Will they be good investments? The art market offers some clues.

What are NFTs anyway?

Blockchain technology can verify ownership of digital and physical assets. Specifically EIP-721 has been widely used for this purpose. You can prove ownership of anything (not just cryptocurrency) through the blockchain. It is important. Most people would only want to gamble large sums of money for something if they can prove that they own it.

Lindy effect

However, this NFT trend may seem precarious. Pessimists may argue that something will break with this process in the future. It could. However, the history of cryptocurrencies and the so-called Lindy Effect suggests that the technology may prove to be robust. The longer a technology lasts, the more it can be expected to endure. NFTs have a short history of only a few years, but Bitcoin has now lasted two decades. The technology therefore seems destined to stay and evolve, even if valuations can be debated.

What the art market tells us

The long-term history of the art market suggests that there may be a future for some NFTs as, for now, NFTs are the closest to the art market. However, there are also some big caveats. A detailed analysis of the history of the art market by Rachel Pownall at Tilburg University shows that art yields were around 7% per year over the period 1980-2006.

It is important to note that this is an average and that art yields have varied, being quite strong in the 1980s, generally lower in the 1990s, with prices often falling, and more robust in the 2000s.

Maybe that’s a reason to be optimistic about NFTs if they are indeed fine art, maybe the feedback can be similar.

Dead artists and rarity

A crucial economic principle is that of scarcity. Water or oxygen may be necessary for life and therefore essential, but they are inexpensive because they are plentiful.

Some cryptocurrencies have performed well, in part because their supply is limited by design. As far as art is concerned, Matisse’s works are highly regarded, but he died in 1954. So there will be no new paintings by Matisse.

Indeed, most of the value of the art market is made up of deceased artists.

This is a problem for NFTs. Of course, they no longer plan to produce CryptoPunks beyond the 10,000 that exist. Yet Larva Labs, which produced the CryptoPunks, also produced 20,000. Meebits. Then there is Super Yetis, CyberKongz, Dead heads, Voxies and the Bored Monkey Yacht Club. The list goes on. Mike Winkelmann, a leading NFT artist, is alive and well at 40. He is unlikely to stop producing.

The point is, because NFTs are successful, others jump into action. The supply is increasing. It’s classic economics. It’s seldom good for retaining value. In addition to scarcity, we have a second crucial point, selection bias.

Selection bias

Even the average annual yield of 7% of art, as a rough figure, could well be overestimated. The reason is that we have much better data on auction valuations than the less glamorous and more routine dealer transactions.

The quality bar

Only art passing a quality bar is auctioned. If something turns out to be a fraud or if its value decreases in some other way, it is likely that it will not be auctioned. If we just follow the winners and see a 7% return, the return for the average person buying art might be a little lower. Maybe they’re picking the wrong artist, or maybe an artist is falling out of favor.

Auction houses have chosen art for sale. This is part of their usefulness and their criteria change over time. Indeed, some auction houses now sell NFTs, but of course only the best performing ones.

Winners tracking

So, art indices that track auction house valuations, because that’s where the good data is, likely overestimate art returns in general by looking only at long-term winners. . John Constable was certainly not the only British artist in the 1800s, but he is one of the few that we still hear about.

This is a big problem for NFTs. Yes CyperPunks has done well for many holders with CryptoPunk # 3100 sold for over $ 7 million in March 2021. But launched in 2017, it was part of the first NFT projects. Many other NFT projects receive much less attention and are worth much less. It is important to note that many more NFTs are expected to arrive in the coming years.

So maybe some NFTs that stand the test of time can make sense as a long term investment, much like fine art. However, the increase in supply does not bode well. Investing in NFTs may seem easy in hindsight, as we will continue to talk about the winning projects and forget about the others. In this way, investing in NFTs can be a bit like investing in art.

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