Beginner's Guide to Non-Fungible Tokens (NFTs), (24/12/2021)
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Q’s Introduction: The Non-Fungible Token (NFT)
Quite perceivably, the initial rumblings of naysayers have gradually diminished.
Since the dawn of cryptocurrency popularisation, the explosion in adoption rates is likely fuelled in part by an undeniable fact:
Blockchain technology is extremely robust
Furthermore, many new and unique use cases have since been created through the use of smart contract technology and an immutable ledger.
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One of which, the Non-Fungible Token, or NFT for short, was created with the development and deployment of the ERC-721 token standard for the Ethereum decentralised application (Dapp) platform.
This ushered in the era of the NFT, with one of the first NFT projects being created on Ethereum - CryptoKitties.
NFT Case Study: CryptoKitties
CryptoKitties really showed the market the power of smart contracts, blockchain and Web3. These technologies have come together to form extremely complex and robust use cases and assets which will be the backbone of future financial systems.
With this in mind, let us proceed to a guide to purchasing NFTs…
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Practical Guide on How to Purchase NFTs
The majority of NFTs exist within the Ethereum ecosystem, as ERC-721 tokens, which can be bought and sold on online NFT marketplaces.
One of the most popular marketplaces for NFTs is OpenSea, which recently had over $3.4 billion in transactions completed in August 2021 alone.
An increasing number of alternative marketplaces exist on different ecosystems such as Solana, which are also gaining traction primarily due to reduced gas fees and lower NFT prices.
These marketplaces are still quite new and have a fraction of the volume that OpenSea covers.
Popular marketplaces in the Solana ecosystem include solanart.io, digitaleyes.market & magiceden.io.
Before interacting with any asset, it can be useful to understand what actually constitutes value…
Why are some NFTs valuable?
One of the most common questions investors may wonder - why on earth would anyone buy a jpeg when you can simply screenshot it..?!
NFTs can be thought of as certificates of ownership for virtual assets.
In other words, when you buy an NFT, you are buying the digital ownership behind this asset and you are the sole owner of it - pretty cool and exclusive, right?
Rarity is one of the most important factors in determining the value of an individual NFT. Rarity scores for most NFTs in the Ethereum ecosystem can be found at rarity.tools
NFT Case Study: Exploring rarity with CryptoPunks
A good place to start understanding rarity and assessing how it affects value is CryptoPunks. Let’s take a brief look at two examples from this infamous NFT collection.
Cryptopunk #3100 sold for a whopping $7.68 million. Here, the rarity score of 2288 ranks it at number 7 from a total collection of 10,000 punks. A key driver of rarity here is the Alien type, with this punk being 1 of 9 Alien punks from a total set of 10,000.
i) Rarity score for CryptoPunk #3100 is one of the highest in the collection
In contrast, the cheapest CryptoPunk currently on the market is punk #1254. The rarity score is ~69 with a final rank of 8,892 out of 10,000. The driver behind the average rank here the Male type which is majority type amongst punks (I guess humans are boring, hey?) combined with the low attribute count of 3.
ii) Breakdown of rarity score for CryptoPunk #1254.
Understanding how rarity works will be a key edge for traders and investors who are looking to flip or hold NFT’s long term…
So now what?
Now before you dive into the world of NFTs trading and investing, it is important to note that NFTs are quite illiquid.
i.e. They are not as easy to sell at specific prices.
With the recent NFT booms throughout the year on both Ethereum & Solana, it is safe to say that prices are generally cyclical. Furthermore, participants may also find prices also have accumulation and distribution phases.
When assessing an NFT project and its potential investment proposition, here are some initial metrics that can be used by anyone:
Community: Does the project have a strong social media presence backed by an active Discord channel with genuine members.
Questions to consider:
Is the community active, with its members engaging with each other, sharing cryptocurrency knowledge - or general banter
What is the frequency of the messages in the Discord channels?
Does Twitter have a strong level of engagement relative to Twitter followers?
Note that many NFTs buy fake Twitter followers or Twitter ‘bots’ which end up resulting in very little engagement. For example, if a project has 20,000 followers but only gets 10-20 likes on each post, their follower count is most likely bought and fabricated
Roadmap: What does the project want to do during the post-mint phase?
Here are some questions to consider:
Is it simply standalone artwork minted on the blockchain or will there be a DAO function that allows members to decide on the direction of the NFT?
This can include future NFTs airdropped to users, exclusive in-real-life meetups etc.
Royalties: Will a percentage of transaction fees of trading the NFT on an exchange be shared with existing NFT holders?
How will the team continue to contribute to the NFT ecosystem?
Team: What is their experience in the NFT space and cryptocurrency?
Questions to consider:
Who are the artists - are they well-known artists with a vibrant portfolio?
Is the team anonymous or identifiable with credentials?
Who is buying the NFT? Often projects will be promoted by influencers on Crypto Twitter or even celebrities.
Celebrities changing their social media profile picture can influence the floor price of an NFT and reinforce the exclusivity of the project.
Check out this example where Marshmello announced his purchase and change of display picture to BAYC NFT
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If the team had to highlight one of the coolest things of 2021, it would undoubtedly be that NFTs came one step closer to being mainstream.
Whilst it might seem like a bizarre concept at first glance, it is perhaps one of the most interesting real-life applications of the blockchain.
Further, it is important to understand that the NFTs explored in this article have been primarily limited to artwork.
There are, of course, a disparity of other use cases of NFTs, such as DAO citizenship or even in-game purchases.
Rest assured this Christmas long weekend that these exciting applications will be detailed in a deeper review of the technology in the second part of this series.
See you again for the next update.
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