Status quo of NFTs - Part II

Nov 9, 2022 - 10 min read

Status quo of NFTs - Part II

NFTs entering the main stage

A flood of massive news hit the NFT space within the recent weeks. Not only Reddit’s avatars running on Polygon made headlines hitting a daily volume of >$1.5m and opening up the world of digital collectibles to almost 3m wallets, but also Instagram’s move into NFTs enabling creators to sell and mint NFTs in-app. Quick recap: NFTs are tokenized assets that are traded on a blockchain and differ from fungible assets like BTC or ETH since the underlying assets are unique and cannot be swapped like for like. As we outlined in Part I, collectibles and digital art were a massive adoption vehicle for users to enter crypto. This now translates to ever more entities embracing the NFT space.

Last week, the New York Times titled “Even as NFTs Plummet, Digital Artists Find Museums Are Calling” and indeed, we have long left the niche space that digital art NFTs circulated in. MoMa’s Antonelli, senior curator at the department of architecture and design noted that “being open to new technology is part of our responsibility” and as such more and more of the top-notch museums leave their reluctant positions and instead begin to approach digital art living on blockchains. With that, they are not only embracing new audiences that demand digital art but also boost their revenue streams after a long-lasting pandemic. NFT’s acceptance is momentous among respectable, well-established, traditional and conservative museums: The LouvreMoMARijksmuseumthe British MuseumLACMA. 6 out of 10 of the world’s top museums are already embracing NFTs or plan to do so. Meanwhile, dedicated NFT museums break out of the metaverse and pop-up left and right in meatspace as seen in Tel Aviv, Seattle, Barcelona, Zürich or Amsterdam. With all that interest from respectable institutions, the credibility gap for NFTs closes slowly but surely as mainstream warms up to the idea of digital art ownership. The acceptance in these museums cannot be overstated as they finally acknowledge the artistic worthiness of these pieces. It’s fair to say however that it’s not trivial to fully grasp the concept of NFTs.

Besides the most admired museums, traditional auction houses take notice as well and anticipate a revival of generative art. The world’s largest auction house Christie’s being one of the catalysts of the NFT boom, recently unveiled Christie's 3.0, its NFT auction platform that enables it to run fine art auctions fully on-chain. By permanently storing bids and payments on the Ethereum blockchain, the new platform will increase transparency and invite more collectors into the realm of digital art. Competitor Sotheby’s conducted a $2.3 million sale of generative art in April 2022, showcasing the works of artists Vera Molnar and Charles Csuri, both pioneers in generative art. Interestingly, both auction houses report that a significant ratio of buyers are new clients. According to Michael Bouhanna, co-head of digital art sales at Sotheby’s, an uptick in generative art sales and a greater focus in showcasing these types of digital art among auction houses is present, yet there’s still a lack of education.

Aside from museums and auction houses embracing the new movement, brands and companies increasingly adopt NFTs and the metaverse to advertise and bootstrap consumer engagement. The metaverse provides people with a digital realm that is derived from the traditional world where material goods are important. Beyond NFTs, the metaverse provides a space where digital ownership becomes functional. This functionality attracts brands and the overall gaming industry. Brands for instance experiment with the promotion and advertising potential of NFTs. For luxury brands, they might even become a significant source of revenue, see Illustration 1.

Illustration 1: NFT brand revenue on Ethereum
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Source: (Data) Dune, (Chart) Bitcoin Suisse Research *Nike revenue includes RTFKT (acquired by Nike) and its CloneX collection

Besides the increasing interest of traditional art institutions and a broad range of brands, another important element enters the NFT space: curation. Curators assign value and bring services such as distribution and strategy to enhance that underlying value. Curated funds and collector DAOs, that curate and collect together, scoop up massive amounts of NFTs. Flamingo for instance hit an estimated portfolio value of >$1b in February 2022. Other notable DAOs include SquiggleDAOGrailersDAOFingerprintsDAOStellarsDAO or NounsDAO. Even more demand is created by traditional thematic funds such as the $30m Curated fund backed by Chris Dixon, Marc Andreessen that is exclusively investing in NFT art. NFT funds are featured prominently among some of the more sophisticated asset managers with their collections of NFT investments publicly visible in virtual galleries. Back when 3AC was still solvent, they owned the impressive ‘Starry Night’ collection, that is now subject to liquidation. collectiveshift maintains a comprehensive list of collector DAOs and funds. Atop of that plethora of funds and collector DAOs, even brands started collecting valuable NFTs, such as Visa’s CryptoPunk or Tiffany’s perfect rocket of Tom Sachs Rocket Factory. NFTs do not only find a legitimate spot in meatspace art exhibitions and museums more frequently, but they do also attract institutional interest as indicated by the multitude of metaverse funds such as Fidelity’s Metaverse ETF or Proshares’ Metaverse ETF.

On-chain generative art and storage solutions

There is a critical misconception surrounding the technology that underpins NFTs: just because the blockchain is supposed to run eternally, doesn’t mean ones NFT does too. While the unique token and smart contract certainly will live as long as the underlying blockchain, the asset itself is often hosted on legacy technology that bears critical vulnerabilities to interference, corruption, and loss. The magic word in that context is storage. NFTs are a form of digital media, data represented by binary code. Data needs storage in order to make it accessible. By design, blockchains are limited in the amount of on-chain storage capacity and thus, blockspace is scarce and valuable. Depending on how the NFT is engineered, the storage might become extraordinary expensive. For instance, storing 1 GB of data on Ethereum is estimated to cost about 17’500 ETH. If the cost is excessive, NFTs offer the ability to reference data off-chain via URIs. As cost is a critical factor, most currently traded NFTs are stored via decentralized or centralized off-chain solutions. The name implies, that centralized storage comes with trade-offs since the owner faces critical third-party dependencies. In the worst case, the service might just shut down and one is left with a token pointing to unavailable data. Despite costly and extensive in maintenance, an option is off-site server storage.

Decentralized P2P storage solutions such as IPFS or Arweave build on redundancy providing resilience against failure and attacks, are censorship-resistant, offer permanent storage for NFTs and enhance performance - no single entity entails the power to shut it down. A full solution for finding, saving, and obtaining data is possible by combining Filecoin and IPFS content addressing, which decentralizes how resources are accessed and how resources are specified, respectively. Filecoin ensures content availability for retrieval and therefore provides resilience for content based addressing via IPFS. It leverages cryptography, consensus protocols, game-theoretic incentives and verifiable storage, the major innovation behind Filecoin. Storage verification solves a previously unsolvable problem of decentralized storage solutions via Proof-of-Replication and Proof-of-Spacetime. These proofs eventually end up on-chain.

An NFT is a component with multiple parts that go beyond the content, see Illustration 2 for a technical breakdown. NFTs are minted through smart contracts that record any transfers or changes in ownership and manages the transferability of the NFT. If stored off-chain, the URL or IPFS gateway is pointing to the file and usually utilizes a JSON metadata file. The metadata lives as a permanent, unalterable record on the blockchain. This record describes what the token represents, like a certificate of authenticity, as well as the token’s provenance (sidenote: provenance is a record of ownership used for authenticity or quality; according to estimates 50% of the traditional art market are forgeries and fakes – blockchain solves this). The JSON metadata file also contains the name, description and more. Off-chain NFTs therefore basically boil down to owning a metadata file pointing to a storage outside of the blockchain.

Illustration 2: Technical structure of NFTs
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Source: Wayfairing, (Chart) Bitcoin Suisse Research

Minting an NFT executes smart contract code that conforms to different token standards, such as ERC-721. Since the most relevant NFTs live on Ethereum, we give a brief overview of the available token standards creators choose from when minting an NFT. Most EVM chains such as BNB have similar token standards as Ethereum, Tezos leverages its FA2 standard to create NFTs, the Polkadot ecosystem uses its RMRK NFT protocol to establish a cross-chain standard, Cardano, Solana, Cosmos and NEAR, to name a few, offer native standards as well. Besides, some blockchains and sidechains like ImmutableX, Flow or Ronin were specifically designed for metaverse, gaming and NFT purposes. 

Like ERC-20 being the most adopted standard for fungible tokens, the most used token standard for NFTs is ERC-721, embodying ownership details, security, and metadata. In the future, an extended ERC-721 featuring stealth addresses to enhance privacy might be even in the books as proposed by Ethereum researcher Anton Wahrstätter. Other important NFT standards are ERC-998, a composable NFT standard, and ERC-1155, a multi-token standard. Unlike ERC-721, the ERC-1155 standard allows for faster creation and transfer of multiple tokens at the same time and enables access to multiple token types, both non-fungible and fungible, see Illustration 3.

Illustration 3: Schematic of token standards used for fungible and non-fungible tokens
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Source:  Wang, Qin et al: Non-Fungible Token (NFT): Overview, Evaluation, Opportunities and Challenges, (Illustration) Bitcoin Suisse Research

The ERC-1155 standard reduces computational overhead for dApps, reduces information stored on Ethereum and with it gas and mint cost. On the flipside, ERC-1155 increases the difficulty to trace ownership data.

Whenever possible, storing NFTs on-chain is the holy grail as it comes with a basket of benefits. It lets owners verify all facets of the NFT and provides reliable and sustainable data permanence. Storing an NFT on-chain means that the entire NFT including the image and all its metadata live on the blockchain while off-chain means that parts of the NFT is stored externally with the token mostly pointing to the data hosted outside of the blockchain.

Relevant on-chain NFT projects are Autoglyphs of Larva Labs, considered the first on-chain generative art project on Ethereum, their CryptoPunks, Nouns and most of the ArtBlocks projects to name a few. As on-chain comes in nuances, RLXYZ introduced a framework to classify projects based on their on-chain purity. Generative art and especially long-form on-chain generative art deserves a spotlight being a core catalyst as we enter a digital renaissance. It’s a niche subset where engineering meets art, where computer art meets blockchain, a perfect match. Generative art is a distinct form of art that mostly uses autonomous systems or algorithms to randomly generate outputs that cannot be fully predicted until the process concludes. A framework of rules such as a variety of colors and patterns is designed by the artist and then tested against randomness. According to Tate Modern, generative art has roots in the Dada art movement. It emerged with pioneers such as Georg NeesVera MolnárHerbert W. Franke and Charles Csuri in the 1960s. Interested in some outputs? Visit to browse some of the most iconic collections to date.

Since blockchains are supposed to run eternally, on-chain art becomes permanent and immutable too. Watching it resembles a live view of the code and the result of its generation mechanism while providing any resolution desired. Most of the Artblocks pieces render in real time running a script stored on Ethereum. Despite significant market pressure after the genesis boom cycle, most of the relevant generative art collections performed astonishingly well and may develop to investment grade assets with hedging qualities. As of writing, Artblocks and gm.Studio collections range among the top traded collections with healthy floor developments and some new ETH denominated ATHs.

Illustration 4: Examples of long-form on-chain generative art

The narrative around long form on-chain generative art remains strong and the recent market movement shows, see Illustration 4 for some outputs. It’s no surprise that the most prestigious museums start to approach the new movement alongside impressive collector funds scooping up the scarce historically and aesthetically relevant pieces. An art movement living aside mainstream for decades is finding its destiny in blockchain technology that matches the digital transition of society. Meanwhile, the demographic shift towards digital natives might add more fuel to the fire in the decades ahead.

NFTs beyond art and collectibles

Born out of a concept called colored coins mentioned in a 2012 article by Yoni Assia and followed up by a paper by Meni Rosenfield, the concept of NFTs on blockchains now already has around 10 years of history on its back. The momentum and basically the first boom and bust cycle of NFTs however breaks down to collectibles and digital art. As we saw above, both already have persistent impact on traditional art and global communities rallying around certain collections. Yet, the potential is far from being exhausted and not limited to art and collectibles. NFTs will very likely be able to disrupt more sectors such as supply chain management, real estate, ticketing, intellectual property (IP), digital identitygaming and the metaverse. Moreover, NFTs bear vast potential in finance enabling cost-efficient, error-free verification of bonds insurance that prevent fraud and manage debt. Finance needs better verification tooling for provenance of business contracts to provide more security especially in jurisdictions relying on paper records or jurisdictions that face corruption – tokenization solves all of these aspects.

For the time being, we want to highlight tokenization that will likely apply to a vast number of sectors and NFTs that extend the tooling in DeFi applications. With asset tokenization, physical or digital assets are converted into digital tokens representing the underlying asset on a blockchain. Besides cryptocurrencies, the industry is exploring tokenized real estate, cars or traditional financial assets such as bonds, funds or stocks of which Apple, Tesla, Alibaba or Netflix already find their tokenized counterpart on the blockchain. JPMorgan just announced last week the first ever FX trade via Aave leveraging tokenized cash deposits. Depending on the use case, four different token types are available: security tokens representing another asset (bonds, stocks), utility tokens enabling specific functionality, NFTs representing ownership of a unique asset (they might entail properties of other types such as utility as well) and currency tokens including stablecoins. Due to the unified utilization of open and permissionless blockchains, tokenization allows for broader investor bases, cross-borders, lower costs, less intermediaries and market friction, enhanced liquidity, settlement risk management and transparency. Since NFTs are not fungible, they also offer provenance enabling tracking across the asset’s on-chain history. According to Finoa, tokenized assets are expected to reach about $24t by 2027. Tony McLaughlin, from Emerging Payments and Business Development, Treasury and Trade Solutions at Citibank underpins these tendencies stating that “if the tokenization thesis holds true, then the 21st Century may see the creation of regulated, global, token-based, multi-asset networks. It would be undesirable for the functionality of unregulated multi-asset networks to pull too far ahead of regulated financial infrastructures. Financial transactions may migrate to the more capable platforms, even if they fall outside of the regulatory perimeter.”

Similar like NFTs pulled in mainstream users into crypto, they now might also attract them towards novel financial primitives and tools around DeFi. Leveraging NFTs in DeFi, some call it NFTFi, comes in various flavors. Disruptive protocols and products are operating as of writing designed to bootstrap liquidity and capital efficiency in order to close the gap between their fungible relatives. They include pooled and individual fractionalization, lending markets (P2P, P2Pool and CDPs), derivatives (prediction markets, options, perpetuals), renting, insurance, diversification via indexes and or investment DAOs and pricing. Despite key risks like the boom and bust tendency of the NFT space, bank runs on pooled fractionalization, oracle manipulation in derivatives markets, liquidation of NFT backed loans and the lack of standards and utility, the NFT financialization space is one of the most rapidly evolving in the cryptocurrency ecosystem. This growth will also increase composability between each other and eventually likely yields benefits for both DeFi and NFTs. For a deep dive into these topics, we recommend Galaxy’s highly comprehensive article on “NFTs & DeFi”.

Conclusion and Outlook

The first hype cycle for NFTs seems to be over. With everything surrounding NFTs, the bubble burst doesn’t seem to have a long-lasting effect though. Increasing adoption in the fashion, retail, real estate and supply chain management industries along metaverse-embracing tech giants such as Microsoft, Google, and Meta create the impression that NFTs are here to stay. As NFTs enter the temples of art and are now exhibited next to Van Gogh and Matisse, traditional art institutions warm up to the idea of a digital renaissance. Generative art finally finds its destined canvas providing provable scarcity and on-chain provenance and validate why permanent, scarce and ownable digital content is valuable. Synergy effects between DeFi and NFTs amplify while institutions increasingly utilize the tokenization market that constitutes a growing niche. They enable global decentralized markets for any non-fungible asset. Wrapping up, the NFT space matures after its first adoption cycles and stars could not be better aligned.

Disclosure: at time of writing, the author holds ETH, NEAR and XTZ.

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Dominic Weibel

Crypto Researcher