How to invest in NFT’s, according to data
How to
invest in NFT's, according to data.
- What we learned after 6.1 million NFT Trades
- The biggest misconception about NFT is that they live permanently in a blockchain.
- How to value the six different kinds of NFT's available today.
- The problem of making big money on NFT's is that they are illiquid.
- What's the best strategy according to data to trade NFT's?
Introduction:
"The top 10% of traders alone perform 85% of all transactions and trade at least once 97% of all assets." – nature.com
I'd been researching NFT's seriously for more
than two months straight, from coding to paid newsletters, from interviews to
research papers. I wanted to understand NFT's as an investment. What I found is
fascinating.
I'll start showing you data from a recent
research paper analyzing over 6.1 million NFT trades. Then I'll explain to you
the biggest misconception about NFT's. I'll classify them into six categories
to later propose a way to value each since they are different in concept. I'll
explain the problems and possible solutions of what to do when you make much
money in NFT's. Finally, I'll give you my opinion on the best places to focus on
making money in this industry.
What is an NFT?
"… is a unit of data stored on a blockchain that certifies a digital asset to be unique and therefore not interchangeable, while offering a unique digital certificate of ownership for the NFT" - Evans
There's no need for me to explain what an
NFT is; after all, you could google it; however, it is very likely you don't
know the major misconception about them: That they are indestructible.
The major misconception about NFTs I
found:
The major misconception about NFTs is that
they are engraved in the blockchain. That's not the case for most of them. It
would be too big and expensive. Instead, what is done is to host the content in
IPFS, a peer-to-peer (p2p) storage network. Content is accessible through
peers located anywhere globally, which might relay information, store it, or do
both. IPFS knows how to find what you ask for using its content address rather
than its location.
This means that it is centralized wherever
you bought your NFT since they must maintain it. If those servers fail, your
NFT's are gone.
What we learned from
6.1 million NFT trades.
I came across this research of over 6.1
million trades of 4.7 million NFTs: https://www.nature.com/articles/s41598-021-00053-8#MOESM1
The main points I saw are:
- ·
This paper shows that 10% of NFT traders
accounted for 85%+ transactions. Could these be "spoof trades"
trading with themselves in 2 different accounts?
- ·
" We observe that the average sale
price of NFTs is lower than 15 dollars for 75% of the assets, and larger than
1594 dollars, for 1% of the assets...only ∼20% of them had a secondary sale, only 0.07% of all assets are sold more
than ten times."
- ·
"We find that NFTs in small
collections tend to be bought in sequence with NFTs in other collections (see
Fig. 4e). On the contrary, NFTs in large collections, like CryptoKitties or
Gods-Unchained, tend to be bought in sequence with NFTs in the same
collection."
NFT's classification:
1. Art
2. Collectible
3. Games
4. Metaverse
5. Other, and
6. Utility
I must mention that there will be more
categories as the industry evolves. I recently read of an NFT used to open
doors like a code. So "the sky is the limit." Also, the popularity of
this category varies a lot, depending on the year.
How do we value each category?
Valuing art,
collectives and some metaverse NFT's:
As far as art, collectibles, and most
cases of the metaverse. They behave a lot like fine art in the physical world. Here is a 5-minute refresher of how the
art business work
These are 4 "tricks" you must be
mindful of when entering into the NFT markets that resemble the Fine Art
industry:
1. Sell or give it to elites NFT social media influencers, hoping to be seen as a better brand, so the rest of the paintings or, in this case, NFT's could be worth more.
"Traders are also specialized: measuring how individuals distribute their trades across collections, we find that traders perform at least 73% of their transactions in their top collection, while at least 82% in their top two collections combined."
These "specialized NFT traders" resemble art galleries.
2. "Chandelier bidding" in art gallery auctions are equivalent to NFT "spoof trades," where traders trade with themselves in 2 different accounts that they own. This is supported by the data mentioned in the study above. It turns out that NFT traders are very specialized in one or two collections
"We find that NFTs in small collections tend to be bought in sequence with NFTs in other collections…On the contrary, NFTs in large collections, like CryptoKitties or Gods-Unchained, tend to be bought in sequence with NFTs in the same collection."
3. Launder money.
4. Tax write-offs through donations.
Donate NFT's tax
write-off?
One of the areas Id haven't seen much written about is donating NFt's as
tax write-off.
The Irs has no official guidance on NFT's yet. However, from
conversations with accountants in the niche
is widely accepted that they are likely to be treated as collectibles
under Irs code 408 (m)(2):
"(1) In
general. The acquisition by an individual retirement account or by an
individually directed
account under a
plan described in section 401(a) of any collectible shall be treated (for
purposes
of this section
and section 402) as a distribution from such account in an amount equal to the
cost to such
account of such collectible.
(2) (2)
Collectible defined. For purposes of this subsection, the term
"collectible" means—
(A) any work of art,
(B) ..."
The taxation of Nft's will significantly
depend on how you interact with them 1) creator or 2) investor.
Remember that NFT and crypto like ETH are
treated as property and are taxed according to your holding
period (short term vs. long term capital
gains). If you sell your Nft's, they would be subject to ordinary
income tax.
High-income earning individuals face a 28%
collectible tax + 3.8 net investment income tax vs. 20% long-
term capital gains.
Valuing Games NFT's
How to value games?
I must admit this is outside my circle of
competence. All I can imagine is that it depends on the popularity of the game and
its uses. I can also say that these uses will change fast as the industry
develops, and you may be able to migrate these features between different
games.
Valuing Metaverse NFT's
Metaverse is developing and can have more
sophisticated cases that resemble the real world. Now you can buy virtual real
estate in the metaverse, and you can make it produce as you would property in
the real world: Farming, building a house, a business, using it for publicity,
etc.
Remember that $69M digital collage
NFT sold in March 2021? It was produced by Mike Winkelmann, who goes by
Beeple; it sparked a global frenzy for non-fungible tokens. The guy that bought
is Indian entrepreneur Vignesh Sundaresan, a bitcoin billionaire that initially
invested $5000 in bitcoin. He plans to create a museum in the metaverse where
he will charge for entry. That's how he justifies the price.
Source: https://www.wionews.com/technology/vignesh-sundaresan-buys-nft-for-69-million-people-can-download-it-for-free-433242
The metaverse is developing so fast that there are
already virtual real estate companies to develop and manage your virtual real
estate like https://metaverse.properties/
" Ultimately,
we see Metaverse Group as being a significant landowner and developer in the
digital world with the ability to pay out distributions in a REIT structure…
This also makes Tokens.com one of the first public companies in the world to
have exposure to the Metaverse"...CEO Andrew Kiguel of Tokens.com
Valuing UTILITY and Others NFT's
Utility NFT's are NFT's that
have another purpose. This is more likely to be valued rationally.
For example, you can buy an
NFT that would allow you to get into certain event once a year.
This is exactly what social
media influencer Gary Vee did.
"..in The last 90
days I've done 91 million dollars in revenue on my "v friends nft"
launch the first 51 million I kept which was in one week, then the next 40 I've
gotten a 10% royalty on every transaction last night while I was sleeping and
made $246,000 on the royalties of people selling my NFt's to each other…"
– Gary Vee
Gary Vee
launched https://veefriends.com/ with https://www.nft42.com/ (owned by Mark Cuban). Those Nft's come with other benefits, real-world use cases.
Look at the "current floor price."
The cheapest
one, below, is $31,247.61, and he made thousands! https://opensea.io/assets/0xa3aee8bce55beea1951ef834b99f3ac60d1abeeb/9180
Why are they so successful? Look at the description: "This token is verifiable for admission to VeeCon 2022, 2023, 2024."
You get the point;
they give access
to content creators and brands on a whole different level.
How we value
them depends on how you will value the underlying Utility or benefits it gives
you the right to.
The problem of making much money in
NFT's: Illiquidity.
One of the report findings is that the NFT
market has very low liquidity. It can be challenging to find a buyer for your
NFT. This indicates that the "floor price" of the NFT is not an
indicator of value.
Id identified only four options once
somebody finds themselves in this situation:
A)
You can wait to see if they
come back again (unlikely, according
to data)
B) Try to sell 10% of the portfolio
by lowering prices until you can liquidate and get the initial investment out.
C)
Try to borrow against
it using it as collateral. There are new companies doing
this.
D)
Use it for
a tax write-off
Is there a way to make money in NFT
consistently?
I'll mention the obvious low-hanging fruit
first. If you are a social media influencer and offer utility NFT's that create
much value for your followers, you can make it happen. And nowadays you can
sell those at a premium.
If you don't have a following to sell your
own NFT's, your odds fall drastically.
"We observe that the average sale price of NFTs is lower than 15
dollars for 75% of the assets, and larger than 1594 dollars
for 1% of the assets. Considering individual categories, NFTs
categorized as Art, Metaverse, and Utility reached higher
prices compared to other categories, with the top 1% of assets having
average sale price higher than 6290, 9485, and 12,756 dollars respectively…
Note that only 0.07% of all assets are sold more than 10 times."
– nature.com
As you can see, odds are not in your favor.
Especially if you think you can trade an NFT multiple times. However, the
research found a good correlation in a strategy: look for a project with a
big following that sold very well a week prior and has something visually
different, thank most NFT's.
"..The
prior probability of sale in the collection is also a strong signal, and
centrality and visual features combined can sometimes outperform other feature
combinations (e.g., in the Metaverse category)."
Keep in mind that these NFTs are the
minority. Less than 10% are sold within one week after the primary sale, and
only 22% are sold within one year.
"NFT's price correlates strongly with the price of NFTs previously
sold within the same collection (see "SI"). The median sale price of NFTs in
the collection predicts more than half of the variance of price of future
primary and secondary sales – nature.com
The research above also mentions that the
best time window to review the primary sell time is one week. The longer you
wait, the worst it is. This is an example where time is not your friend.
" visual features of the object linked to the NFT … explain roughly one-fifth to one-fourth of the variance …When considered in combination with the median price of previous sales, they increase the predictive power" – nature.com
In simple terms, this means that the way they measure how unique the image was could explain 1/5 to ¼ of the price variation.
"it becomes apparent that the predictability of future prices and the predictive power of different sets of features varies depending on the NFT category. The collectible category is the easiest to predict, with centrality and visual features" – nature.com
As I exposed before, each category
requires a different valuation methodology. But collectibles seem to be the
easiest to predict with this formula.
Final comments about this study to keep in
mind: it runs from June 23, 2017, and April 27, 2021, where they considered
mostly the Ethereum and WAX blockchains, but several other platforms offer
smart contracts and NFTs. They did not include information about the creator of
the (digital) object associated with the NFTs that, in my opinion, has a huge
impact and is maybe a good parameter of predictability to trade NFT's.
Conclusion
Based on a recent research paper running
from June 23, 2017, and April 27, 2021, that analyzed over 6.1 million NFT's
trades, I had been able to understand the economy of the NFT world a little
better, the odds and strategies of trading in it successfully.
I explain to you the biggest misconception
about NFT's indestructibility.
By classifying them into six categories,
we could describe how to value them more efficiently.
I analyzed the illiquidity problems of the
NFT world and theories of what could be done when you find yourself in them.
Finally, I explained that the best
strategy that the researchers describe is to buy popular NFT's within the first
week of launch, especially if they look unique than most NFT's
