Topical issues in the field of economy, (responsible) investment, pension and income: every week, one of APG's experts provides a clear answer to this week's question. In this edition: Portfolio Manager Jean-Paul Koopmans on the question whether non-fungible tokens (NFTs) are the future or are just a hype.
Paying 200K for a digital image of a monkey wearing a baseball cap and a slice of pizza in its mouth. That doesn't come as a surprise anymore to anyone involved in the world of the non-fungible tokens. In this case, the digital ownership of the image also provides access to an exclusive virtual club: the Bored Ape Yacht Club. The monkey images belong to the most expensive NFTs of the moment, in a market where a value of 44 billion dollars was traded last year. The trade in objects that only exist digitally. In short: a non-fungible token is a digital ownership certificate of an object or event. This certificate is registered in the blockchain: an enormous database distributed globally across many computers. Such token can be bought using ethereum or any other cryptocurrency on a digital marketplace, like OpenSea.
The value of an NFT is determined by the application it offers, Koopmans explains. Think about access to a virtual club or a digital piece of clothing or attribute you can use for a digital avatar in a computer game. If an NFT is not offering a specific application? “The only purpose in that case only really is to show off being the rightful owner or resell it on a trade platform.” The possibility to buy or sell it through the blockchain is something the NFT has in common with a cryptocurrency. But the comparison should stop there. A cryptocurrency first of all is a payment instrument to pay for digital transactions, for example, while an NFT is a unique registration of a good.
“NFTs are mined. During that process, people are in the race to obtain a virtual good, such as an image of a monkey,” says Koopmans. “In the case of the Bored Ape Yacht Club, 10,000 different images were involved. These images all had unique characteristics and the rarer the characteristic, the more popular the image. But it is totally arbitrarily whether you receive an image that appears to be popular or not. And that is exactly the major disadvantage of the trade in NFTs: it is highly speculative and therefore extremely difficult to attach a value to it. This is the difference with asset management where we utilize calculations showing the approximate worth of a company. Those methods are widely accepted. Every NFT is unique, on the other hand, meaning you just have to guess how much such image is or can become worth. New collections of these tokens are constantly issued and 99 percent thereof is worthless. That is why I absolutely consider this a hype. The same as baseball cards and stamps were a hype once.”
However, Koopmans sees a real future for the NFTs. “The activities of a notary in the Netherlands can be fully digitalized in a blockchain. The title deed of an apartment will in that case become an NFT. That can have major consequences for home ownership. It is difficult to divide a title deed into multiple smaller deeds at the moment going to a notary. An NFT makes it easy to split a house, for instance, among multiple owners. The monthly rental income is then distributed amongst them through the blockchain. That saves on notary costs and makes it possible to make very illiquid assets liquid. A house of 500K, for example, can be distributed among 100 NFTs with a value of 5000 euros each. To me, that would be a great, neat application of NFTs. But for the time being, an NFT has no judicial base and the notary's signature does.”
However, the question is whether trading an NFT is safe. “If a name or address on the title deed is incorrect, you can call the notary who can very easily correct the mistake. But the blockchain has no help desk or insurance. That means if you accidentally sent the NFT of your expensive image of a monkey to the wrong digital wallet, you lost it. A mistake is severely punished. And that's not just theoretical. A few days ago OpenSea was confronted with a hack, making it possible to send the monkey images from one account to another by means of a phishing mail. Even OpenSea is unable to reverse that because everything on the blockchain is immutable or unchangeable. In other words: the technology is robust but there's no room for error on the side of the user. Blockchain can however be considered as more open.” That open nature lies in the fact that NFTs can be traded day and night, and that there are no rules yet restricting the trade.
The lack of a judicial base and the safety risks are what stops an institutional investor, such as APG, from investing in NFTs. “Before authorization is given by De Nederlandsche Bank or the Netherlands Authority for the Financial Markets to invest in such instruments, quite a few hoops still have to be jumped through,” says Koopmans. “In order to make it widely applicable, a lot of research still has to be conducted. We are clearly in an experimental phase right now. The progress may be accelerated once the digital euro is introduced. It also stands or falls with the question whether or not it is backed by a community. But that community will only arise if NFTs can be applied in a practical way. I am an investor myself, so an application to me would be the development of cash flow from such digital ownership. This means, for example, music samples or news photos of which the NFTs can be traded.”
Something similar is already happening in the world of digital art that clearly takes the lead when it comes to digital ownership. “It opens many opportunities for artists to gain more grip on what is happening to their creations, as an NFT allows for a transaction to return a part of the selling price to the artist. When Van Gogh sold a piece of art, he would only receive an amount once and some name recognition at best. NFT makes it possible for an artist to earn, for instance, 5 percent of the transaction amount each time, thus leading to cash flow from art. The same applies if you sell the digital ownership to a song. Everyone using the song has to pay a certain amount that ends up with the owner of the song and the artist. That's how you can exclude record companies.”