Why NFTs Are Up and Crypto Is (Temporarily) Down

Despite a (likely temporary) decline in cryptocurrency prices, NFTs are still booming and offer many creative possibilities.

Photo by Joshua Mayo on Unsplash

Shortly into the new year, the price of major cryptocurrencies began to fall. There are a number of explanations, which was explained in one of our recent articles, but we’re beginning to see a rebound already.

Where’s the accountability for the crypto naysayers?

And yet, what’s interesting is that NFTs did not see a comparable decline in the start of the new year — in fact, they continued surging and reached an all-time high, at least when looking at OpenSea transactions.

Temporary Declines in Crypto

Predicting price and quantity fluctuations in cryptocurrency, let alone any currency for that matter, is not easy. There are many idiosyncratic factors that go into the price, especially when factoring in the international nature.

That’s compounded for crypto because we do not have decades of time series evidence on it — we only have data for a handful of years for most crypto.

Nonetheless, it’s useful to take stock of the various factors behind the recent decline so that we have perspective.

  • Federal Reserve and regulatory policy—changes in interest rates naturally influence the value of crypto as a hedge against traditional fiat currencies, but an even bigger challenge has been the regulatory threats. Since the U.S. is such a large source of investment for crypto, those threats create risk and volatility that affects the entire crypto market.
  • New entrants —the number of new wallets has grown from 66.2 million in January 2021 to 81.25 million in the start of February 2022. While an increase in new investors reflects a heightened demand for crypto, which would bid up the price, there is also an influx of new and more heterogeneous tastes in the supply of crypto now. That can have an even bigger effect on the short-term price dynamics as the market adjusts.
  • Geopolitics —although every year admittedly has its own challenges, 2021 had ended with an especially high uncertainty and global risks. Crypto admittedly benefits from some of the uncertainty as people look to it as a hedge against traditional fiat currencies, but we’re all still people and influenced by subjective factors that can make us risk averse.

That’s not to say that there is not speculation — that is, deviations from market fundamentals as a result of possibly unrealistic growth expectations. But, the reality is that there are still strong fundamentals in the crypto market.

The reality is that there are still strong fundamentals in the crypto market.

Crypto versus NFTs

Although it’s easy to bundle crypto and NFTs together when talking about the Web3 economy, they’re fundamentally different. Recent research by Professor Michael Downing shows that the two display quite different dynamics.

Put simply, crypto is fungible in that one ETH is one ETH — they indistinguishable. NFTs are, well, “non-fungible tokens” — each is unique.

That’s both a blessing and a curse. On one hand, that creates much more potential for each NFT because there is something inherently unique about it. That novelty comes from utility or consumption value — the two are not mutually exclusive for each NFT.

That is, the NFT either conveys some utility (e.g., NFTs for ticketing over music performances and concerts), or some consumption value (e.g., the art is pleasurable to look at… and that also includes signaling effects to friends and others to say “hey, look at what I bought”).

On the other hand, not every NFT can sell for millions — or even thousands — of dollars. Whereas crypto coins are inherently fungible and the upside is differentiated by the asset class (type of coin), NFTs are inherently non-fungible and differentiated by a range of factors, including the marketing, the seller, the utility, the consumption value (real or perceived), and so on.

Nonetheless, NFTs can be used for so much more than art or music. For example, in one of our articles, we talked about how NFTs have the opportunity to displace traditional patents and trademarks over the long-run because they tokenize content at their most granular level.

NFTs can be used for so much more than art or music… NFTs have the opportunity to displace traditional patents and trademarks over the long-run because they tokenize content at their most granular level.

Admittedly, legal scholars and technologists need to come together to lay the groundwork, but the potential is unambiguously there.

NFTs have many other applications too. For example, as Henrique Centieiro has talked about before, they can be used for staking. Since some Layer-1 platforms use a proof of stake consensus mechanism (see here for a distinction between Layer-1 and Layer-2 technologies), that means users can lock their NFTs away and gain passive income.

That said, it’s important to recognize that there is probably a bubble in the NFT market. That stems from at least two sources. One factor stems from someone who sells an NFT to themselves on another wallet to generate hype about an NFT and point to momentum. Recent analysis suggests that this might be a non-trivial amount and should not be dismissed.

Another factor arises from the overall bull market, so people are buying and selling with a lower threshold over what constitutes value.

That means many NFTs are probably overvalued. But, that doesn’t diminish the novelty of NFTs and their potential to fundamentally transform the way we create and trade content, especially in the digital economy. Indeed, as many, like Adrien Book has noted, there are many new jobs in the creative economy that are forming in the Web3 economy and NFTs are the fuel.

This article was written by Christos A. Makridis, the Chief Technology Officer and Head of Research at Living Opera. He is also a research affiliate at Stanford University’s Digital Economy Lab and Columbia Business School’s Chazen Institute, and holds dual doctorates in economics and management science & engineering from Stanford University. Follow us at @living_opera!

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Why NFTs Are Up and Crypto Is (Temporarily) Down was originally published in DataDrivenInvestor on Medium, where people are continuing the conversation by highlighting and responding to this story.