Non-fungible tokens (NFTs) have captured the hearts of millions around the world. So much so that it’s now moving beyond the “cute fad” phase and into the “life-changing technology” phase. We’re even seeing massive brands like Nike, Apple, and Meta (formerly Facebook) jumping onto the NFT bandwagon lately. What’s interesting about this movement is that NFTs have entered the mainstream zeitgeist with the large majority of people not understanding how NFTs work or why NFTs hold value. It’s complicated but not undefinable.
Experts have determined NFTs get their value from a mixture of emotional attachment, digital scarcity, and a dash of hedonism. Whether this value will translate to longevity remains to be seen but from all accounts, we’re on the right track.
Before we delve into the value behind NFTs, we first must understand what NFTs are. Simply put, NFTs are just a type of digital token. In the cryptocurrency world, tokens fall into two different categories:
NFTs are particularly interesting because this uniqueness can be verified thanks to blockchain technology. Anyone can go onto the blockchain and see that token recorded on the digital ledger, thus verifying its existence. Furthermore, the blockchain allows it to be easily traded across borders and through secondary financial markets. This opens up numerous opportunities for use cases, investment strategies, and business models.
While this all sounds lovely, to the majority of people, NFTs are just some meaningless lines of code in a world they don’t understand. So let’s try to break it down from an economic perspective to see why NFTs hold value.
In an attempt to rationalize the seemingly outlandish world of NFTs, let’s examine some tangible economic theories and see how the two relate. In an interview with Vox, Matt Stephenson, a Ph.D. graduate from Columbia University and expert on behavioral economics said that
“in economic literature, there’s this interesting division between functional value and hedonic value.”
Essentially, what this means is that value comes from two questions: “what can I use this thing to do?” and “how much do I like this thing?”
To further explain:
NFTs fall under both categories. A huge part of the mania surrounding NFTs is the profit potential. People can make money from speculative investments in the NFT resale market. The ability to trade NFTs as one would stock is a function. Another function is the tokenizing of real-world assets and putting them on the blockchain. For example, artists are tokenizing artwork, music, and even real-life buildings and putting them on the blockchain in the form of an NFT.
On the other side of the spectrum, we have the hedonic aspect of NFTs. People love to show off their Bored Ape NFT they bought for $300,000. This “digital flexing” is a huge part of the NFT culture but the hedonic value is not only about bragging about how much money one spent. It is also about associating emotional response with value.
In 2015, researchers from Nottingham Trent University Jack Cleghorn and Mark D. Griffiths conducted a study on “Why do gamers buy ‘virtual assets?” This in-depth insight unlocked the psychology behind certain purchase behavior. For example, let's say a player in a video game gives another player a sword as a gift. This sword doesn’t have any particular value. Sure, the friend paid $20 for it and gave it as a gift but there are infinite copies of this sword that can be bought on the online store by anyone. Based on the principles of supply and demand, this sword should be almost valueless. However, the player that receives the sword will never sell it. Why is that?
The player doesn’t see value in the sword because it is rare or expensive. The player sees its value in where it came from. This sword was a gift from a friend. If he bought the same sword from the online store, it wouldn’t have the same sentimental and emotional value. NFTs are the same way.
NFTs generate emotional responses in some people. Just like a piece of art may speak to you or a property may be filled with years of memories, NFTs too can come with emotional aspects that add value. If you look at some of the most popular artworks of all time like The Mona Lisa or The Starry Night, they are not highly ranked because of the artist’s skill alone. They come with fascinating histories and backgrounds that add to their value.
While this emotional aspect is certainly something to consider, especially in the early days of NFTs, it is not the only reason behind NFT value. The tangible use cases continue to grow in 2022.
As described earlier, NFTs have both functional value and hedonic value. While the latter certainly takes center stage in the media, it’s important to know that brilliant minds all around the world are working hard to make NFTs functional beyond investment purposes. Here are a few examples.
Certainly, NFT applications have been specially designed to assist healthcare professionals by storing medical records on the blockchain. This way, the records are stored safely without compromising confidentiality or external tampering. Every NFT transaction is validated by a node network before permanently being stored on the blockchain. Hence, every single record is 100% accurate and safe from manipulation.
One of the best parts about NFTs is that they can be used to prove ownership of any piece of content. This is currently not possible with traditional intellectual property tools like copyrights and trademarks. NFT blockchains are immutable. The owner of an NFT can always prove they are the original creator of a piece of work at any time
NFTs and real estate are a match made in heaven. By tokenizing property deeds, NFTs can be used to transfer deeds easily and provide proof of ownership. Since it’s on the blockchain, these NFTs can also represent timestamps of the property value over time. Imagine searching for a property online and buying that house with just a few taps of a button. That is entirely possible with NFTs. You could see when the property was built, who first bought it or built it, what renovations were done, and even buy property across borders in minutes.
We are already seeing NFT users explode in the gaming industry. With blockchain-based games such as Axie Infinity and metaverses like Decentraland, NFTs are proving their worth in the international gaming community. NFTs can be easily integrated into the gaming world with cross-platform playability. Furthemore, NFTs give game developers new ways to build their brand and make a new revenue stream. Not only that, gamers can earn money from playing games with NFTs. To use Axie Infinity as an example, digital monsters called “Axies” are represented in the form of NFTs. Players can train and develop these monsters and eventually sell them to other players for profit.
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Those are just a few real-world use cases of NFTs. Suffice to say, we may be beyond the “fad” stage of NFTs and moving into territory that’s here to stay. Many experts believe NFTs are currently in a bubble and that may be true. But as we have learned with the dot com bubble and early cryptocurrency bubbles, these periods of extreme growth can be healthy for the development of the industry and are necessary growing pains. NFT value is still being explored and is still vague in some regards however, millions of people cannot be wrong…can they?