Introduction
2021 saw the explosion of the NFT market as its rapid growth became the center of public attention. Research by BNP Paribas indicates that NFT trading volume totaled more than $17.6 billion in 2021, reflecting a 21,000% increase from just $82 million in 2020. Among these transactions include some of the most significant NFT sales in history. Digital artist Beeple sold his NFT art piece Everydays for approximately $69 million. Meanwhile, popular projects like CryptoPunks and Bored Ape Yacht Club were regularly sold for millions of dollars. With coverage by national media and involvement from celebrities like Snoop Dogg and Jimmy Fallon, NFTs ingrained themselves in the public spotlight and did not appear to be leaving anytime soon.
However, since early 2022, the NFT market has significantly declined, as indicated by decreasing transaction volume and user interaction. A Chainalysis report reveals that the decline was worst in June 2022, which saw an 88% decrease in transaction volume. Furthermore, average NFT prices dropped from $3,894 in May 2022 to just $293 in July 2022. From its immense peaks in 2021 to its current market decline, discerning why the NFT market has diminished significantly is vital to understanding its future valuation. This article will delve into NFT mechanics, use cases, and market trends to assess the potential of this disruptive technology.
What is an NFT?
Because of their widespread popularity, NFTs are often defined with simplified terminology for easier understanding. However, dissecting the technical aspects of this technology is essential to understanding the potential of NFT applications. In general terms, an NFT or non-fungible token is a cryptographic asset on a blockchain with unique metadata that distinguishes itself from other NFTs. An NFT can represent either real-world items like real estate or online assets like digital artwork. The primary difference between NFTs and cryptocurrencies is that NFTs are not traded at equivalency. Whereas cryptocurrencies of the same type are identical, NFTs have individual pricing based on the specifics of their market valuation. While the idea of digital representation for physical or digital objects is not new, the use of blockchain and smart contracts adds legitimacy regarding true ownership. This concept of untamperable ownership has been the primary growth driver for the potential use cases of NFTs.
But to understand what an NFT represents, it is vital to investigate the steps that occur when an NFT is minted, and a transaction takes place. In the back end, multiple steps are required before an NFT is minted to the blockchain. First, an NFT must be digitized correctly, meaning that the file, title, and description of the NFT are accurate and encoded. That raw data is then stored either on the blockchain directly or in a database outside the blockchain. Once an NFT sale occurs, the current owner of the NFT signs the transaction, which includes the hashing of the NFT and the creation of a smart contract that will transfer ownership of the asset. The specifics of the minting process then vary depending on the NFT standard being used to implement the NFT. Because each blockchain is decentralized and not managed by a central developer, communities agree on a set of standardized rules for NFT creation. Below are some of the most popular NFT implementation standards and their respective features.
ERC721:
Ethereum is the current standard for the NFT space and is the most widely used blockchain platform to power NFT creation. On the Ethereum blockchain, the most commonly used implementation standard is ERC721. Released in 2018, ERC721 is a standard for NFTs that allows each token to have an individual price and be assigned a unit256 variable tokenID. Furthermore, ERC721 possesses an ownership function (ownerOf) that allows users to check the owner of different assets. Additionally, it contains a transaction function (transferFrom) that allows for the transaction of assets between wallet addresses.
ERC1155:
ERC1155 is another popular NFT standard implemented on the Ethereum platform primarily designed for DeFi gaming applications. This is due to ERC1155 representing both fungible and non-fungible tokens. Within a game, ERC1155 could be used to represent a currency in a game, while the NFT use case could be implemented for specific in-game items. Another primary difference between 1155 and 721 is that 1155 can represent an infinite number of assets by using an add function to the current smart contract. While creating a new NFT requires the creation of an entirely new contract in 721 standards, 1155’s add function can add a unique asset to a pool of existing assets.
Flow-NFT:
After the success of their NFT project Cryptokitties, Dapper Labs developed the Flow-NFT standard after realizing issues with using ERC721 at scale. There are considerable differences between Flow-NFT and other implementations. One is that it is written in Cadence, a more easily accessible language to developers unfamiliar with blockchain-specific languages. Additionally, Flow-NFT contracts are “upgradable,” meaning they can be consistently updated until they are fully deployed in a final state after being minted.
Another technical concept relevant to NFTs is storage. This is specifically in regards to metadata, which is a file attached to an NFT that includes variables describing its specific characteristics. For example, an NFT metafile could contain an NFT’s name, ID, and owner address, which are all needed to describe that particular NFT. Developers have two options for storing this metadata: on-chain and off-chain.
On-chain Storage:
On-chain storage means the metadata file is stored directly on the blockchain with the NFT. This results in the metadata being governed by the same logic that other assets on the blockchain follow. On-chain storage ensures the security of the NFT since it is not reliant on any third-party storage or software to access the asset. However, on-chain storage is associated with higher costs due to the computational energy required to attach the metadata file to the blockchain.
Off-chain Storage:
Off-chain storage means that the NFT metadata is stored in a database outside of the blockchain. There are two primary ways to store this file: centralized and decentralized servers. Centralized servers include cloud storage like Azure or AWS, in which the NFT contains a URL to access the asset stored on these databases. Decentralized servers include systems like IPFS, where the metadata is stored across a multitude of different servers. Decentralized servers ensure greater security than centralized servers since it prevents users from changing the metadata as it is stored and confirmed across multiple peers. An illustration of the differences between off-chain and on-chain storage is represented in the following figure:
History of NFTs
The public conception of NFTs is usually associated with the crypto-art category popular today. The first NFT art project can be traced to Kevin McCoy on May 3rd, 2014. McCoy minted his first NFT art titled Quantum, which featured an octagon with arcs emitting from its center in different colors and patterns. During the peak of the NFT market in 2021, Quantum reached a valuation of $7 million. However, NFT art is only one segment of the NFT market, with a more extensive history dating back to 2012.
NFTs initially emerged from the early 2012 concept of “colored coins” on the Bitcoin blockchain. Colored coins were tokens built on the blockchain representing real-world assets like real estate, precious metals, and equity. The concept gradually evolved to represent digital assets, including coupons and digital collectibles. This idea evolved in 2014 when developers Robert Dermody, Adam Krellenstein, and Evan Wagner created the Counterparty platform. Counterparty is a peer-to-peer financial platform built on the Bitcoin blockchain, allowing asset creation that would eventually facilitate the start of the NFT market.
Counterparty would form multiple partnerships in the coming years, resulting in more industry attention toward NFTs. In 2015, Counterparty partnered with the developers of video game Spells of Genesis. Spells of Genesis was one of the first games to issue in-game assets on the Bitcoin blockchain through Counterparty. Later in 2016, Counterparty partnered with the trading card game Force of Will to launch their cards as assets hosted on Counterparty. The success of both these games on the Counterparty platform signaled to other developers the potential value of NFT implementations.
The success of NFT game assets on Counterparty would facilitate the initial growth of crypto-art on the platform. This was carried by the momentum of “meme art” in 2016. Specifically, assets colloquially known as “Rare Pepes’’ would become incredibly popular on Counterparty. These meme art pieces featured the extremely popular “Pepe” character, a popular internet meme at the time. With Ethereum’s growing prominence in 2017, Rare Pepes would also begin trading on the Ethereum blockchain, increasing global NFT transaction volume. 2017 also saw the creation of Crypto Punks by developers John Watkinson and Matt Hall. CryptoPunks were digital art pieces of characters, each unique from other CryptoPunks. As some of the first crypto-art minted, CryptoPunks are now sold for millions of dollars in NFT marketplaces.
The NFT market would reach its peak popularity once crypto-art integration transitioned from meme art to mainstream art. This is attributed to artist Kevin Abosch, who in 2018 minted his art piece, The Forever Rose, in a partnership with NFT platform GIFTO. The minting of this piece resulted in a $1 million transaction that would begin to bring public attention to the space. As news of the large transaction sizes gradually spread in mainstream media, the NFT market would receive its first mainstream public attention, resulting in its explosion throughout 2021.
Major Players
With its rapid rise throughout 2021, multiple platforms, marketplaces, and projects have established themselves as major players in this space. Analyzing which players have grown and which have declined is essential to understanding what makes players in the rapidly changing NFT market successful.
Openseas:
Having launched in 2017, Openseas is the current industry leader among NFT marketplaces. In 2021, Openseas captured approximately $14 billion of total NFT transaction volume. The next closest competitor only captured $216 million in total sales volume. This can be attributed to Openseas hosting the most popular projects in the NFT ecosystem, including Bored Ape Yacht Club and CryptoPunk assets. Due to its popularity, large transaction volume, and ease of use, Openseas is considered the best place for beginners to get started in the NFT market. However, despite being the clear industry leader, Openseas has not been invulnerable to the down period in the NFT space. Decreased overall transaction volume has resulted in the company implementing heavy job cuts, a practice seen widely across other players in the NFT space.
Rarible:
Rarible is an NFT marketplace specializing in art, collectibles, and video game assets. Rarible differentiates itself from other platforms like Openseas in its transaction currencies and governance. Rarible offers a feature to buy and sell NFTs using a credit card, allowing transactions to occur with fiat currencies. Furthermore, Rarible also has its own native RARI token. Holders of this token can vote on company decisions and policy changes that affect the platform’s ecosystem. Rarible has also announced partnerships with major companies like Adobe to improve the security and verification of NFT metadata.
NBA Top Shot:
NBA Top Shot is one of the most popular NFT projects that saw its rapid rise and decline occur throughout 2021. NBA Top Shot is a marketplace that allows users to purchase and sell NFTs of moments in basketball history. Transactions of these video clips and art pieces grew immensely in 2021. In February 2021, NBA Top Shot saw over $224 million in transaction volume, with clips of famous players like LeBron James selling for hundreds of thousands of dollars. Because of these sales numbers, Top Shot received national media attention, only further increasing its popularity. However, issues with supply management of its digital assets resulted in a quick decline in its platform ecosystem. Queue times and transaction issues plagued the marketplace, significantly decreasing the platform’s user base. By April 2022, transaction volume eroded to just $26 million, and unique buyers dropped to just 37,000 on the marketplace. Having been one of the first examples of major companies entering the NFT space, NBA Top Shot represents the knowledge barriers for major companies trying to integrate NFTs into their operations.
Issues within the NFT Market
Compared to its 2021 highs, the current NFT market has seen a notable decline in user counts, valuations, and transaction volume. The reasons for this decline can be associated with many issues stemming from a rapidly emerging industry with little regulation. However, the most impactful of these issues on the long-term success of NFTs is the prevalence of exploits and scams in space. Media coverage of these malicious activities has contributed to public sentiment turning against the industry, resulting in a decline in user interaction and transactions across the market. These harmful practices include wallet address phishing, rug-pull scams, and pump-and-dump schemes. The following are other malicious activities in the space that significantly limit the growth of the NFT market.
Wash Trading
Across the exploits currently seen in the NFT market, one of the most significant has been the growth of wash trading. Wash trading is the practice in which the seller is on both sides of a transaction, leading to a misleading valuation of a project or asset. This has been a historical issue in the cryptocurrency industry to make trading volumes appear greater than reality. For NFTs specifically, NFTs can seem more significant in value when their owner sells them to a wallet that the owner also owns. This is particularly potent in NFTs since many marketplaces allow users to create new accounts with little to no proof of identification. However, identification of these wash trades is possible by looking at wallets funded by the selling or receiving wallet, revealing the commonality of this practice in the market. Analysis performed by Chainalysis of these trades reveals that hundreds of NFT sellers are performing these transactions to inflate the price of their projects.
Money Laundering:
Money laundering has been prevalent in the art industry, as the use of art to store illicit funds has been a common criminal practice. This process is similarly seen in the NFT market as malicious groups or individuals use NFTs to hide illicit funds. A Chainalysis assessment of illicit funding sent in NFT marketplaces demonstrates the widespread degree of money laundering in the space. The third quarter of 2021 saw $1 million worth of cryptocurrency sent by illicit addresses traced to stolen funds, scams, and darknet markets. The prevalence of these money laundering schemes has caused public perception to shift on the security and safety of being involved in the NFT space.
False Ownership:
One of the most prevalent problems in the industry is the theft and plagiarism of artwork. There are multiple forms of this issue, One is NFT artists who have artwork duplicated and minted on other NFT marketplaces. G. Sujan is an NFT artist and photographer who minted a collection of photos as NFT projects, only to discover many of these photos duplicated across other marketplaces. These NFTs had multiple transactions that resulted in no royalties to the original artist. Another kind of theft occurs when artists who do not want their art minted have their art turned into NFTs without permission. Aja Trier is a digital artist who had her online art turned into approximately 86,000 NFTs without her permission. As these stories reached greater media attention, many became disillusioned with the market knowing the prominence of art theft across these platforms.
Future of the NFT Market
Future market trends and transformations will be critical for the long-term success of NFTs and recovery from its current decline. There are multiple trends in the market focused on improving efficiency in transactions and creating more NFT use cases. Some of these trends hoping to transform the market are the following:
Cross-Chain Marketplaces:
The potential of NFTs has been limited due to transactions only occurring on the same chain the NFT was originally minted upon. Although most NFTs are minted on the Ethereum blockchain, the inability to access NFTs on other blockchains has limited transaction volume. New exchanges like that provided by FTX have developed cross-chain NFT marketplaces that will allow trades between Ethereum and Solana blockchains. Removing these chain-based restrictions enables NFTs to transfer at higher volumes than and contribute to the markets recovery.
Token Ecosystems:
More NFT marketplaces are becoming more involved with token ecosystems to improve the internal economies of their respective platforms. This is mostly seen in the growth of curation tokens, which are given to NFT curators and provide rewards if art pieces are curated on that specific marketplace. NFT marketplaces are investing in these systems to ensure that only high-end NFTs are being provided on their platform. Attracting high-profile curators to their platform with these tokens creates more competition in the space and drives creativity in the art itself. The growth of airdropping tokens has also become popular in the NFT space. These airdrops attract more consumers to use a specific platform for a chance to receive these rare drops.
DeFi Integration
Integration between NFTs and DeFi is a newfound focus for marketplaces to differentiate themselves from competitors and increase returns for platform users. NFT marketplaces are introducing new liquidity mining models where rewards are now illiquid NFT tokens that can be sold in NFT marketplaces. One of these platforms bridging the gap between NFTs and DeFi is Sudoswap, which proclaims itself as the first NFT automated market maker. Sudoswap integrates liquidity pools into the NFT market, allowing users to trade assets between NFTs and ETH. By adding the incentive of liquidity-providing in the NFT space, Sudoswap is one of many companies innovating on users creating higher returns on their respective platforms.
Ultimately, the NFT space is very still and is certainly bound for a lot of innovation in the future!
Thanks for your time — Juanbug.
