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This article was contributed by Felix Xu, co-founder of ARPA and Bella Protocol.
Non-fungible tokens (NFTs) had a fantastic journey in 2021, ushering in one of the most notable episodes in the history of the emerging decentralized industries. NFT trading volume was $2.5 billion as of June 2021. Over the next six months, it grew 10-fold, with total NFT sales hitting a whopping $23 billion through December 2021. In contrast, the total NFT trading volume in 2020 was only $100 million.
To capture the extraordinary track record of NFTs, we need to chart their evolution over the past year. This article will take a chronological approach to explain the NFT craze and what lies ahead.
lay the foundations
Cryptocurrency historians often debate whether a single event led to the explosion of NFTs in the crypto space. While there’s no definitive answer, the $69 million sale of Beeple’s NFT art has made waves in the global marketplace. People suddenly saw a surge of NFT projects with attention-grabbing headlines in newspapers and web portals. Furthermore, most of these NFTs have reinterpreted the nature of artworks with their finite series of algorithmically generated collectibles.
One of the earliest NFT generative art projects on Ethereum, CryptoPunks surpassed over $1 billion in total revenue in August 2021. A single CryptoPunk collectible sold for $10 million in December, becoming one of the most expensive NFT collectibles. Another popular NFT series that recently surpassed the $1 billion mark is Bored Ape Yacht Club (BAYC). These projects have become immensely popular with active support and encouragement from NFT influencers.
For example, NBA player Stephen Curry bought a BAYC for $180,000, while hip-hop sensation Eminem bought another BAYC for $500,000. The diverse community of NFT influencers ranges from Reddit co-founder Alexis Ohanian and comedian Steve Harvey to Mark Cuban, owner of the Dallas Mavericks. There are also several anonymous NFT influencers on social media like Artchick, EllioTrades and money, which help generate interest in these projects. But it’s not just individuals who are expressing optimistic feelings about NFTs.
Several mainstream companies are using NFTs to diversify their investment strategies. Global payments giant Visa bought a CryptoPunk NFT for $150,000 in August 2021. Adidas, the famous sports brand, bought a BAYC NFT for $156,000 in September 2021. Additionally, some of the most popular NFTs have been sold by nearly 300-year-old auction houses Sotheby’s and Christie’s, which have posted $100 million and $150 million in NFT sales, respectively.
However, NFT collectibles are not the only assets driving mainstream crypto adoption among retail and institutional investors. NFT-based play-to-earn games have contributed tremendously to the growth of the crypto sector in 2021. Amid lockdowns and job losses caused by COVID-19, Southeast Asians have turned to NFT games like Axie Infinity. NFT gaming revenue has helped a sizable population put food on the table.
The examples cited above show that NFTs have become a cultural phenomenon with multiple use cases and benefits. On the one hand, people use NFTs to supplement their monthly income. But on the other hand, NFT collectibles are emerging as a status symbol for the affluent demographic. As a result, people are now posting their NFTs as profile pictures (PFP) on various social media addresses to showcase their collections. So much so that Twitter, which has already considered NFT verification badges, has now come up with a solution for Twitter Blue.
NFTs are opening up a previously uncharted territory of digital ownership and asset provenance using blockchain technology. These verifiable virtual assets are the core components of the emerging metaverse across multiple blockchain networks. However, NFT projects need to address a few issues if they are to survive in the long term.
Sailing through a troubled landscape
Currently, a handful of NFT projects are showing signs of instability. For example, the developers of the extremely successful Pudgy Penguins NFT spent all state funds, but could not follow the promised roadmap. As a result, the Penguins community voted out the founding members through its decentralized governance structure.
Apart from that, NFTs have insane price fluctuations, with speculators increasing the price even in illiquid market conditions. For example, last year a clipart rock NFT with no particular benefit had an outrageous reserve price of $2.2 million. This tendency for some speculative investors to exaggerate a price metric without reason or justification can be detrimental.
This turbulence in the NFT market is not very surprising. While the technology and concept of NFTs are revolutionary, the NFT sector is still in its infancy. At such an early stage of development things can be quite unstable. But NFT projects can be successful when they focus on three essential factors: innovation, community and ecosystem.
The most important task for any NFT project is to focus on innovative design and diversified utilities for its users. In addition, the NFT project that hits the market first will always have an edge over other competing projects when it comes to value creation. Unfortunately, while making copies of the original (forks) is easy, it doesn’t always result in a successful project.
For example, Larva Labs’ legendary Ethereum-based CryptoPunks are the inspiration behind PolygonPunks, which reside on the Polygon blockchain. Although PolygonPunks is very successful, many consider it a “derivative collection” that may compromise the safety of buyers. That’s why NFT marketplace OpenSea delisted PolygonPunks after a request from developers at Larva Labs.
The second characteristic of a good NFT project is how strong the community is. A truly decentralized project with a well-connected community is a major contributor to success. As shown above, the Pudgy Penguins and CryptoPunks communities are resilient enough to protect the projects’ legacy. Additionally, interoperable NFTs help forge and strengthen communities across blockchain networks.
Another critical factor is the blockchain that the NFT sits on, as every network ecosystem is different. For example, Ethereum has very high gas fees, with NFT whales holding more than 80% of the blockchain’s NFTs. On the other hand, blockchains like Binance Smart Chain, Solana, and Tezos have negligible gas fees. Additionally, many of them are carbon neutral networks, which attract many environmentally conscious NFT artists.
If NFT projects focus on the above qualities during the development phase, most of them will endure in the long term. But what will the NFT landscape look like in the near future?
Hope on the horizon for NFT-based projects
There is no doubt that 2022 will be a year of amazing innovation and growth in the NFT space. As a result, we could see a steady increase in NFT use cases in ways never before imagined.
Such usage can be through NFT-based financial instruments with tokenized insurance, real estate, bonds, debt and commodities. NFTs can open up new avenues of secured lending or leasing and help raise capital for startups. In addition, NFT derivatives could become very popular this year. This allows players to trade their in-game NFT assets like cars and guns on the derivatives market, bringing in more liquidity. In addition, blue chip NFT indices can allow new investors to get exposure to the most successful NFT projects. Several charities and businesses also use NFTs for fundraising. Although currently few NFT projects offer the aforementioned services, they are still immature and underdeveloped. Significant innovations and further diversification in everyday use cases have yet to reach people.
As the year progresses, the value and applications of NFTs will diversify, disrupting a variety of industries. However, the success of the NFT sector will depend to a large extent on how fair, transparent and secure NFTs are. Game theory proved that random numbers are the fundamental building blocks of any fair and secure system. Most blockchain networks, including most NFT protocols, rely on random numbers for their routine system operations.
First, they are used in cryptographically generated public-private keys and digital signatures. Second, randomness in input and output programs ensures a fair chance for all participants in NFT-based games. Third, random numbers are critical to hash power and in proof-of-work consensus protocols.
As the NFT industry expands, developers will need huge sets of random numbers for their projects. But as the American mathematician Robert Coveyou said: “Generating random numbers is too important to leave to chance.” Therefore, “Random numbers should not be generated using a randomly chosen method.” according to Turing Prize winner Donald Knuth. Rigorous research and solid science are critical to random number generation.
If all goes well, NFTs have a bright future ahead of them.
Felix Xu is co-founder of ARPA and Bella Protocol.
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