How do NFTs derive their value?

Any asset can be categorized into two categories. One is ‘fungible’ and the other is ‘non-fungible.’ Let’s take an example of each to understand further. A currency note represents a fungible asset, which means it is not unique and can be divided. The value of the currency remains the same even if it is replaced with another currency note.

On the other end, an NFT (Non-Fungible Token) is a non-fungible asset that exhibits a unique characteristic, and it cannot be replaced. NFTs are in the form of digital art, videos, music, collectibles, etc. These forms of art are on the blockchain network, are unique, and you can also prove their ownership.

Here are some of the components which determine the value of any NFT

1. Usability

Usability is one of the prime reasons some people buy NFTs. These NFTs could be used to attend concerts, shows, events, gain access to exclusive communities, early access to sales, special discounts, and much more. Because of these extra features in an NFT, users are willing to offer a higher premium to get exclusive rights to a community. Therefore owning such an NFT makes you an investor, community member, brand member, all at the same time.

2. Rarity and Overall Supply

Another reason why NFTs are so highly-priced is the rarity of the art itself. Imagine there were 1,000 original Mona Lisa’s at the same time. Do you think all of them would be valued the same as the one that we have now? No right! similarly, multiple creators create only a limited number of NFTs which makes them difficult to get, hence valuable. By the laws of economics, something which has higher demand than its supply is bound to become more expensive. One of the most popular examples is that of Bored Apes and Crypto Punks. There are only a finite number of NFTs that you can purchase (Bored Apes- 10,000, Crypto Punks- 10,000). Due to the limited supply, the existing holders of these NFTs charge a premium in order to sell them.

3. Ownership History

The ownership of an NFT plays a major role in the determination of its demand and therefore its price. If the creator of an NFT is famous or popular, the NFT will automatically command a higher price in the marketplace. It is because of this, many NFTs from famous celebrities or brands command such lofty prices. For example, the NFT of the first Tweet of Jack Dorsey, the CEO of Twitter was sold for $2.9 million, similarly, the NFT sold by Beeble (an artist), was for a record $69.3 million.

Some of the most expensive NFTs

Here are the top 5 most expensive NFTs ever sold.

1. ‘The Merge’ by Pak, Sold for $91.8 million

2. ‘Everydays: The First 5000 days’ by Beeple, for $69.3 million

3. ‘Human One’ by Beeple, sold for $29.8 million

4. ‘CryptoPunk #7523’, sold for $11.75 million

5. ‘CryptoPunk #3100’ sold for $7.67 million

Should you invest in them?

Although the steep pricing of some of the popular NFTs might seem unreasonable to most of us. However, investors are willing to pay such astronomical prices for a piece of art. It is primarily because they feel, there is much more potential in the underlying. But remember NFTs are still non-productive assets and only give access to an exclusive community. The greater the social awareness a project has, the chances of it growing in the future will be higher. And the lower the number of tickets to the community, the higher the value of the NFT will be.

Even if you are interested to invest in NFTs, first make sure you have a well-diversified portfolio across various asset classes. And only look towards investing in cryptocurrencies if you are not a risk-averse investor. As cryptocurrencies and NFTs are some of the riskiest and most speculative investments that you can make, therefore, it is important that you allocate only a small percentage of your total portfolio (4-6%) to NFTs. By performing this you make sure that even if your NFT portfolio does not provide any returns, your remaining assets will compensate for it.