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The NFTs drama
Don't try to fight the FED, don't try to fool the human evolution
Dear Readers,
this post highlights a crucial aspect of the financial markets: the irrational exuberance provoked by huge rounds of Quantitative Easing1 performed by the central banks of major developed economies during the 2020-2021 period.
This exuberance increases when a new technology meets inexperienced market players like the typical 2020-2021 NFTs buyer.
I have to admit that I’ve never been a NFT lover, so to speak…
I wrote this arrogant tweet in September 3, 2021, at the the peak of the NFTs bubble.
What you see in the picture is the CryptoPunks collection, the most relevant NTFs project, where #7804 was sold for 4200 ETH, corresponding at the time to $7.4M.
Let’s see the PUNK floor price (the price of the cheapest item in the CryptoPunks collection) since then, both in PUNK/USD and in PUNK/WETH2.
The NTFs hype involved actors, influencers and athletes from all over the world.
Here for example the story of a NFT bought by the youtuber Logan Paul: from $600K to… $10.
But I don’t write this post to prove that I was right.
Yes, the PUNK floor price plummeted both in terms of USD and ETH since the day I wrote that tweet, along with the whole NFTs market.
But after all, even BTC had a similar crash, and even the S&P500 Index is down about 15% YTD.
The FED hawkish monetary policy that started in Dec 2021 was the main factor of a catastrophic 2022 year for every risky/speculative asset.
The riskier the asset was, the largest the drawdown has been.
Here I want to tell you a bizarre story (do you remember “How bizarre”?).
Ok, back to business.
On September 4, 2021 (coincidentally just one day after my tweet) a non-fungible token (NFT) representing a voluntarily destroyed diamond was created on Ethereum blockchain.
Yes, you understood correctly.
In practice, the creator of the NFT first bought a real diamond worth approximately $5K, then she destroyed the diamond and she minted a NFT representing it on OpenSea.
She documented the whole process: you can find all the details in this link.
You see that the current best offer for this NFT is now 0.0046 WETH, that is $5.64.
The real diamond worth $5,000 is gone, but a unique digital identifier (a.k.a. NFT) worth about $5 (or more, but who knows if there are no bids at all?) is still there…
Her thesis was that the value of the real diamond associated to the Store of Value function (SoV) would have been automatically moved to the new NFT minted.
She estimated that the fair price of the NFT should have been about 75% of the purchase price of the diamond. The remaining non-transferable 25% of the purchase price represented, according to her thesis, the physical utility function of the real diamond (e.g. you can use a diamond for decoration or for industrial purposes).
In fact, the offers to buy the NFT in the following days were even higher than the purchase price of the real diamond.
So in September 11, 2021 she sold the NFT for 5.5 ETH, corresponding at the time to approximately $18,000 (highlighted in blue in the “Transaction Details” section).
The NFT buyer, Ivan Zhang (ivanz.eth), wrote even a post to explain the rationale of his purchase, not before declining another offer for 11 ETH (at the time corresponding to ~$33,800).
Let's retrace what happened:
Labor and capital were needed to make and sell the diamond.
The final reward of those inputs was $5K.Then the diamond was destroyed and a NFT was created.
The diamond doesn’t exist anymore: a piece of data in a blockchain that refers to its past existence took its place.That piece of data was sold in a few days for $18,000, more than 3.5x the original purchase price.
After about 1 year the same piece of data is now presumably worth about $5, with a capital loss of 99.97%.
The technology that makes possible the existence of the NFT needs labor and capital.
A double pair of (labor, capital) was needed to produce the same object, first in the physical form, then in the digital one.
The digital form of the object has now a much lower estimated value ($5) than the initial physical form ($5000): the former is worth 99.9% less than the latter (and I’m not even taking into account the current level of inflation: nowdays the real diamond price would most likely exceed the purchase price of 1 year ago, so the actual loss is even larger).
Do you see the surreality of all this?
I have nothing against the creator, she made $13K of profits in few weeks by… buying and destroying a diamond, so kudos to her.
But, what she wrote in the description section of the OpenSea link and in other sources in order to explain why she did this experiment makes little sense to me.
During an interview she said:
"When this diamond NFT is created, obviously it cannot fulfill the physical function of the diamond. You cannot wear it on your finger. But it can totally fulfill the asset function of the diamond. It should be able to take on the portion of the diamond price that is about the asset function.I calculated that that's about 75% of the diamond price. You can figure that out by looking at a price differential between a natural diamond and a lab-grown diamond. Cause the lab-grown diamond is not taken as an asset. It only has physical utility. My assumption was the NFT should be about 75% of the diamond's price, plus some liquidity premium, because NFTs have better features as an asset than physical properties like diamonds or houses. They're more liquid, more transferable, and easier to hold. So there should be a price premium on that.”
So far nothing so strange. What she said can in principle be right.
On the OpenSea description she wrote:
“But my basic idea is that a physical asset like a diamond has value because of two functions:
1) physical utilities function
2) asset function as a store-of-value (SoV)
When you destroy a diamond and create a NFT in its place, you transfer function #2 to the NFT. Since by destroying the diamond, the 1-to-1 mapping between diamond and NFT is cemented, the NFT should retain the SoV part of the diamond’s value. A NFT can serve the role as a SoV, because it’s able to satisfy 3 basic criteria for something to qualify as an “asset”:
1- durability
2- limit on supply
3- social agreement
I also think overtime NFTs will replace physical assets like diamonds and real estates, because NFTs are a much more user-friendly asset class for holding and transacting, compared to physical assets.”
Let’s focus on the last sentence: how can NFTs replace real estate if real estate has both the physical utility function and the SoV function and these functions cannot be separated?
In other words the SoV function of a house depends on its physical utility function.
But even if we focused the analysis only on goods that have only a SoV function with almost zero physical utility function, NFTs would hardly replace them.
Why? Because the human evolution happened in the real life, not in a blockchain: the real world has a much larger weight than the digital one.
Let’s take an art object as example. I mean, a true art object (yes, the words true and art don’t get along, but stay with me…after all this is not a newsletter on epistemology).
The art object doesn’t have a physical utility function (or this function is approximable to zero) but it has a SoV function.
Have you ever been at Louvre and admiring the Le Radeau de la Méduse by Théodore Géricault?
If the answer is yes you perfectly know the difference between a real art object and its jpeg.
Emotions triggered in the physical world cannot be triggered through a digital means if the source provoking those emotions belongs to the physical world: you cannot fool the evolution with algorithms.
Only a fool would barter the real “Le Radeau de la Meduse” with its NFT: this is because the emotions and all the remainders triggered by the physical artwork determine its SoV function.
And what about precious metals instead? The reasoning is quite similar.
The value of their SoV function depends on a social agreement, and this social agreement is anchored to atavistic real life dynamics that cannot easily be changed.
You might think that by following this line of reasoning, even if NFTs cannot replace physical SoV assets, at least they can create new SoV assets - like a bored ape or a crypto punk - just through a new social agreement, parallel to the old one.
Yes, I cannot exclude this possibility, but for now the NFTs fans seem just to suffer from a form of disconnection from real life.
Follow me on twitter @antonio_cat_
Disclaimer: This newsletter is for informational and entertainment purposes, and should not be construed as personal investment advice.
QE causes asset price inflation because it pushes interest rates down. This lowers the returns investors and savers can get on the safest investments such as money market accounts, certificates of deposit (CDs), Treasuries, and corporate bonds.
Investors are therefore forced into relatively riskier investments to find stronger returns.
ETH and WETH are two different types of Ethereum tokens. ETH is the original token created on the Ethereum blockchain. To make ETH more accessible, a smart contract on the Ethereum network allows users to wrap ETH into WETH. This process is known as wrapping, resulting in the creation of WETH tokens.
The exchange ratio between the two is 1:1.