What guides the value of an NFT?

Why NFTs can be so expensive, and what motivations could make someone spend so much on them.

This post is Part 2 of 3 in a larger series about NFTs. This particular post lists some of the factors that might cause someone to buy an NFT for more than the price of a car or house. While NFTs may be a new concept, this post gives examples of how the NFT market is not too different from the modern art market.

What guides the value of an NFT?

Non-fungible tokens have been around for a long time. Even before the Ethereum virtual machine there were attempts at creating these with clones of the Bitcoin blockchain as far back as 2013. However if you’re reading about NFTs today, you most likely heard about them being bought at seemingly exorbitant prices. These might include:

Some of this raises the question of what makes an NFT so valuable in the first place. If you’ve been paying attention to cryptocurrency at all, this might also sound like the familiar questions of what makes this electronic money worth anything. Discussions about the value of cryptocurrency usually turn into discussions about why money itself is worth anything. Likewise, if we want to understand where an NFT gets its value, we need to understand what makes any kind of artwork, collectible, or asset valuable. Since most of the examples I gave above are related to things with more subjective value like artwork, we’ll focus on the factors in an art piece’s value.

Condition of the Asset - Put simply the better condition an asset like an artwork or collectible is in, the more valuable it is. As a simple example, an Ecce Homo fresco becomes much less valuable after a botched restoration. We like to imagine digital artifacts on the internet as being immune to this phenomenon, but many of us are increasingly aware that files on the internet either decay or disappear surprisingly quickly. The intent behind storing a digital asset on a blockchain is to get around this by having the integrity be checked and verified by the network each time the blockchain advances a block. Problem (theoretically for now) solved, but if NFTs are being sold at different prices despite all of them getting around this problem by definition, there are clearly other factors at work.

Credit to Randall Munroe of XKCD, and no, there isn’t a higher resolution version of this. That’s the joke. Also, please do not make NFTs of art that is not your own. Beyond being legally and morally wrong, public blockchains provide a paper trail that the artist (and/or their more obsessive fans) can and will use to hunt you down.

Artist Notoriety - Worship of the artist is much more common than the owner of the artwork. It’s not unheard of for bidding prices for artwork to skyrocket if it turns out a famous artist was behind it. As such, many of the NFTs that have been sold for high prices have been created by artists that were successful pre-NFT-craze. A recent example would be José Delgo, best known for penciling Wonder Woman for DC Comics back in the ’70s and early ’80s, and now making $1.85 million dollars by selling Wonder Woman drawings as NFTs (despite legal threats from DC Comics itself).

Many of us can name artists that may have been obscure in life and obtained fame postumously (e.g., Van Gogh). Still, it’s important to remember there are plenty of artists (like Andy Warhol) who benefited from cults of celebrity while they were very much alive.

Story behind the asset - Price can also be determined by the story behind an asset, such as the historical significance of an art piece. Many paintings from the early impressionist movement are highly valued because of how they inspired the rest of the artistic movement. Many have argued that much of the notoriety of Da Vinci’s Mona Lisa comes from a string high-profile heists of the Louve that the painting was involved in. For another example, Adele Bloch-Bauer II by Austrian painter Gustav Klimt was stolen by the Nazis during World War II. After being returned to a descendant of its original owner, it went to auction where it was sold for nearly USD 88 million. Given how recent of a phenomenon NFTs are this likely hasn’t been as common with other types of art purchases. That being said, there are still cases where this can apply to NFTs. The Nyan Cat GIF is ubiquitous on the internet, but a Nyan Cat gif that verifiably came from its creator Chris Torres recently fetched USD 453,807 on the NFT platform Foundation.

Chris Torres created Nyan Cat (or “Pop Tart Cat”) back in 2011. Fast forward to 2021, someone out there had half a million dollars sitting around. Given the choice between investing it in a company (or any other dividend-yielding asset like real estate), buying a luxury car, or buying an internet gif, they chose that last option.

Previous Owners (a.k.a. “Provenance”) - Sometimes artwork may be valuable simply by virtue of who has owned it previously. For example, Mark Rothko’s White Center was originally valued at around 10,000 USD when the Rockefeller family (yes, that Rockefeller family) acquired it. It would later be auctioned for 72 million USD. Even without famous past owners, records of previous owners are often used to confirm that the chain of ownership can be traced back to the original artist (to confirm that it’s not a forgery). The blockchain functionality was clearly built with confirming the chain of ownership in mind. Still, when Beeple sold his multi-million-dollar NFTs he made sure to include physical documentation as well, plus some strands of his hair that could be used for some kind of biometric matching to the original artist in the future (this part of the story tends to be the less publicized part, as though the NFT marketplaces don’t want people thinking of how unstable their platforms really are). While NFTs are still young, some have been around long enough to benefit from celebrity past owners.

In 2018, Figma Founder Dylan Field bought ‘CryptoPunk #7804’, an NFT avatar of a pipe-smoking, hat and sunglasses-wearing teal alien. Two weeks ago, he sold it for the equivalent of about $7.5 million in ETH. In an interview on Clubhouse he compared that NFT to a ‘Digital Mona Lisa’. This is probably an accurate analogy since, as mentioned before, much of the value of the Mona Lisa has nothing to do with the aesthetics of the painting itself. The buyer probably cared more about who was selling it rather than the NFT itself.

Probably the most notable example of this would be the sale of things like tweets. Jack Dorsey’s first tweet on the platform (below) was recently put up for auction as an NFT.

Rarity/Difficulty of Reconstruction or Forgery - Towards the much more cynical end of the scale, part of an art piece’s value may be in how difficult it is to create an identical or similar-looking work. This can range from the materials used in the piece, or the difficulty of the techniques used in producing it. For example, Yves Klein’s “IKB 191” looks like a lazy artist painted a canvas solid blue, until you learn that the artist invented the shade and the pigment from scratch. Jackson Pollock’s paintings often receive responses of “my child could do that”. As it turns out, there’s identifiable and consistent fractal patterns in these seemly random paint-drips that even simple computer-vision systems can recognize (it also helps that most forgers fail to replicate the lack of radioisotopes in the original painting’s pigments).

Examples of fractal dimension measurements from Pollock paint-splatters.

Even with digital assets there are still ways of creating scarcity. For example while Cryptokitty ownership is recorded on the public Ethereum Blockchain, the algorithm for creating the cryptokitty pheontypes is kept secret. For an artwork example, the artist known as “Beeple” sold a mammoth JPEG containing artworks (like the one below) that he made every day for over 13 years.

All credit goes to Beeple. Seriously, this was all Beeple. Not me. He unleashed this on the world long before I was even thinking of writing this post. Nobody can prove that I had any involvement with or connection to the creation of this cursed image. I bear no responsibility for the existence of this.

“Greater fool” theory - We’re gravitating into more cynical territory here. It’s entirely possible for someone to buy an asset like an art piece without having any appreciation or use for the piece. They’ll buy it because they expect they can sell it to someone else (i.e., the “greater fool”) for a higher price than they bought it for. This is arguably one of the biggest reasons people buy high-end artwork or expensive collectibles or antique cars. If you’ve been paying attention to the crypto space for any amount of time, you are more than familiar with this mindset. Buying because you expect to sell it at a higher price and for no other reason is an enormous motivating factor in all kinds of bubbles (not just crypto-assets).

‘For the Love of God’ by Damien Hirst (2007). Literally just a platinum cast of a skull with thousands of diamonds in it (£14 million in raw materials), bought by ‘an anonymous consortium’ for £50 million. If the art market were to suddenly collapse entirely, then at least they’d be able to sell it for the value of the raw materials.   Oh, and in case you’re wondering, Damien Hirst is somewhat predictably getting into the NFT game as well.

DISCLAIMER: As with any blockchain-based asset, both fungible and non-fungible crypto-tokens are all still speculative. The value could go to the moon, or it could collapse into nothing (or in the case of some crypto-assets, worse than nothing). Don't invest any amount of money into these that you are not 100% psychologically and financially prepared to see completely evaporate without hope of recovery.

Auction Dynamics - There are ways of setting up the sale of artwork such that it drives up the final purchase price as high as possible. Most methods involve setting up some kind of auction. Most people are familiar with ascending auctions in which bidders gradually drop out as the seller raises the price, until there’s just one bidder left. If one wants to sell an asset close to what a buyer thinks is the true value, a first-price or second-price sealed-bid auction can be set up (great for the buyer, not so much for the seller). There are entire textbooks on the game theoretic basis behind all types of auctions. Which one is ideal depends on whether you’re the buyer or seller. American economist Martin Shubik famously invented the “dollar auction”, a deceptively simple game which could trap bidders into bidding on a single US dollar with monetary bids far larger than one dollar. Beyond game theory, a seller can boost the value of an asset even further by making sure as many of the potential bidders are thrill-seekers with tons of money that they’d like to hide from the tax authorities. If you saw the news of Beeple’s record-setting digital art auctions and wondered what the point was of Christie’s auction house getting involved, this was precisely the reason. There are platforms like Upshot that seek to approach the true value of NFTs by crowdsourcing appraisals. While this would be good for would-be buyers, sellers would probably prefer to collude with an auction house.

Marcel Duchamp’s Fountain (1917), which kicked off the contemporary art market as we know it. In the 1930s Duchamp left art to take up chess because he was sick of the world of commercialized art that he helped create. Duchamp once remarked about chess, “It has all the beauty of art, and much more. It cannot be commercialized. Chess is much purer than art in its social position.” Later on, a version of his ‘Fountain’ auctioned for USD 1.7 million in 1999

Speaking of hiding money…

Usefulness in Money-Laundering - We move even further in the cynical direction. Spending tons of money on an artwork, one that can trade hands at higher and higher prices each time, is pretty handy as a method of transferring wealth. It’s incredibly dense and easy to transport and store. Many paintings will remain in a “dry dock” storage warehouse throughout their ownership, where they will remain even after their ownership has been sold to a new buyer. When we combine I even had one artist friend of mine (who shall remain unnamed) tell me at a party (this was pre-COVID) that many of the buyers of their art appeared to be upwardly-mobile Mainland Chinese that wanted to have some assets outside the reach of their country’s capital controls.

DISCLAIMER: While I talk about money-laundering being somewhat of an open secret in the space of cryptocurrencies and the art market, I should remind you that money laundering is a federal crime under the Money Laundering Control Act of 1986. I am not advocating for that at all. Beyond explaining how NFTs work, part of the motivation of this post is to insult those people trying to use cryptocurrencies, blockcain, NFTs, the art market, or any combination of those for money-laundering or some other get-rich-quick scheme. Laying out how money-laundering happens using these is intended to raise awareness, and by extension make it harder to actually carry out successfully.

The exact steps one can take to use art for money laundering can vary, but here’s an example:

  1. Alice and Bob are persuaded by their art dealer friend Carol to buy works of art by a certain artist for USD 1 million each.
  2. Over the next few years, Carol hypes up the artist while taking cuts of the increasingly high prices those artist’s works sell at auction for
  3. Carol puts some of the artist’s works into auctions. She bids prices up with the help of friends.
  4. Ten years later, Alice and Bob own works worth USD 10 million (on paper), due to the auction prices of the artist’s other works.
  5. In the meantime, Alice makes a huge profit from a real estate deal. She now owes the IRS USD 10 million
  6. Alice donates the painting to the local modern art museum. The trustees state the value at 10 million. The IRS accepts the valuation and allows the tax writeoff.
  7. Bob needs cash quick, but he can’t sell the artwork on the open market without Carol manipulating the price (and Bob doesn’t have time for that now).
  8. Bob goes to the bank to ask for a loan (using the artwork as collateral). The bank wants an ‘independent’ assessment of the artwork value.
  9. The bank gets the assesment from an expert, Carol, who based on previous auction prices (like the ones she ran) values the painting at 10 million. The bank agrees to loan bob 70% of the value (USD 7 million). If Bob doesn’t pay back the loan, all that really happens is the Bank keeps the artwork that’s worth USD 10 million on paper.
  10. RESULT: Alice saved herself 10 million in taxes, and Bob has 7 million to do whatever he wants with, after both made an initial investment of USD 1 million each. If either Alice or Bob got their original investment from shady means (like embezzlement or taking bribes), it’s much harder to spot that original source of the shady funds now.

Even before the days of using cryptocurrencies to buy drugs off of the dark web. This has been something of an open secret in the art market for a long time. This is partly why so many galleries are full of abstract works that much of the public doesn’t see any aesthetic quality in: aesthetic value isn’t really why the works are being bought in the first place. With the introduction of blockchain-based assets, all that really changes is how subject the specific blockchain is to KYC regulations.

Salvator Mundi by Leonardo Da Vinci (circa. 1500). It was sold at auction for $450.3 million on 15 November 2017 by Christie’s in New York to Saudi Prince Badr bin Abdullah, setting a new record for most expensive painting ever sold at public auction. Since then it has either been on Saudi Crown Prince Mohammed bin Salman’s half-billion-dollar luxury yacht, or in a vault somewhere in Switzerland.

Aesthetics/Utility - Okay, enough with the cynicism for now. I’m willing to admit that art-dealing isn’t only about money-laundering. Yes, there are definitely some people, even among those trying to buy expensive artwork as a “non-correlated hard asset”, who actually love the look of the art that they’re buying. Even when bought for enourmous sums, some buyers are still at least partly motivated by the emotions the art stirs.

The Song of the Lark by Jules Adolphe Breton (1884). According to Bill Murray in a 2014 interview, this painting inspired him to not go through with a suicide attempt after struggling in his early career. According to his story, Murray decided to go to a park where he could “float in a lake for a while”, and that’s when he realized he wasn’t too far off from the Art Institute of Chicago. “I walked in, and there’s a painting there. And I don’t even know who painted it… I think it’s called The Song of the Lark. And it’s a woman working in a field, and there’s a sunrise behind her. And I’ve always loved this painting, and I saw it that day, and I just thought, ‘Well, look, there’s a girl who doesn’t have a whole lot of prospects, but the sun’s coming up anyway.‘”

Likewise, one shouldn’t forget that even if we’re in the middle of a speculative bubble for NFTs (and that’s not really hypothetical anymore), NFTs can still have genuine aesthetic or practical value (recall the example of insurance policies recorded using NFTs).


All this theoretical knowledge might make NFTs more understandable to a casual observer. If you take away anything from this it’s that while NFTs have only been introduced recently, the motivations for buying them (either noble or ignoble) are not too different from the much older modern art and collectibles markets.

Generally, if you’re buying and collecting NFTs (e.g., on a site like the hicetnunc2000 marketplace), here are FOUR quick gut checks before buying any NFT:

  1. Does it have (or will it have) historical significance?
  2. Will the creator and/or community continue to support it after the drop?
  3. Are there social media links and information in OBJKT descriptions (Too many copyminters as well as artists are just re-minting OBJKTS. Why should you buy art when the maker is going to mint 200 more copies)
  4. Do you actually like it?

And remember, don’t spend any amount of money on an NFT that you aren’t prepared to lose entirely.

References

  • Shubik, M. 1971. The dollar auction game: A paradox in noncooperative behavior and escalation. Journal of conflict Resolution, 15(1), 109-111.

Cited as:

@article{mcateer2021nftvalue,
    title = "What guides the value of an NFT?",
    author = "McAteer, Matthew",
    journal = "matthewmcateer.me",
    year = "2021",
    url = "https://matthewmcateer.me/blog/what-guides-the-value-of-an-nft/"
}

If you notice mistakes and errors in this post, don’t hesitate to contact me at [contact at matthewmcateer dot me] and I will be very happy to correct them right away! Alternatily, you can follow me on Twitter and reach out to me there.

See you in the next post 😄

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