The biggest story of the last month in the world of crypto has been the rapid rise of non-fungible tokens. For the uninitiated, NFTs are basically one-of-a-kind “artwork” or “cards” that are put on the blockchain and auctioned off to collectors or speculators.
While NFTs have been around for years, the last several weeks have seen an explosion of interest and hundreds of millions of dollars invested in these assets. Many people are speaking in breathless terms about how NFTs represent the future of the art market and will unleash a flourishing of creativity and new forms of value and so on.
I am a little less sanguine. It is pretty clear to me that the explosion of the NFT is a reflection of technology’s impact on how we value assets, and offers a clear example of how people are rationally responding to the new realities and incentives of 2021 technocapitalism.
More and more, retail investors are starting to behave in ways that might seem crazy through the lens of the old economic thinking but make perfect sense given the new realities of modern techno-capitalism. The NFT craze is just the latest example.
To understand what is going on and the implications for the future of investing and the broader economy, I’ll offer some thoughts on how to consider these markets as an investor.
How technology is changing the way assets are valued
There are two key ways in which modern technology in general and the internet in particular are affecting how assets are valued.
The first is that the internet dramatically boosts liquidity in historically illiquid assets, which increases their value and decreases the relative value of the small number of highly liquid assets.
The second is that the internet creates historically unheard-of economic asymmetry. That’s because when things become successful or popular, they can grow much faster than they ever could before. That changes dramatically how many people think about smart portfolio allocation. It creates a bias toward investing in high-risk things that can go parabolic rather than assets that grow safely and consistently.
The implications of the shift in liquidity are clear.
Historically there were only a small number of highly liquid global currencies, equities and so forth that you could easily borrow against or rapidly trade when needed. Everything else—from baseball cards to real estate—were real assets, but you paid a steep liquidity penalty for owning them because it was hard to find buyers on a moment’s notice.
For the last 20-plus years, the internet has been creating more liquidity for these historically illiquid assets. In a world where you can reach everyone globally in an instant for free, it becomes much easier to construct a market or reach a pool of sellers at a moment’s notice for whatever you might own. This simple reality, which platforms like eBay started to express decades ago, has become more clear with the rise of everything from GOAT, Farfetch and Net-a-Porter to the broader crypto ecosystem.
What this means is that technology all of a sudden removes the penalty that used to exist for investing in illiquid assets, making investing in collectibles and NFTs rational even at scale.
It might not be obvious how releasing the upper bound on success enhances technology’s impact on rational portfolio management, but it is important to understand.
Forgive the gambling analogy: Imagine that you can get a small but guaranteed return on your money or you can go to the roulette wheel and make 100 times your money. Now imagine that technology’s impact on how big businesses can get and how fast they can scale has amplified that win at the roulette wheel by a hundred or even a thousand times.
Whereas before the guaranteed return might have been the rational choice, if the ceiling on your winnings rises a lot, then it becomes rational to consistently play the roulette wheel.
Especially given the low-interest-rate environment we live in and the crazy levels of inequality we face, it is perfectly rational for people to construct a portfolio of bets based on a maximum theoretical upside as opposed to prudently investing in high-certainty good companies.
Historically the search for extreme asymmetry in investment opportunities was limited to venture capitalists, hedge-fund managers using esoteric derivatives, and the art market—which, let’s be honest, is basically comprised of the same hedge-fund and VC folks. That’s no longer the case.
The upshot is that technology makes investing in weird or niche assets more appealing, and it shifts rational portfolio management toward playing home-run derby versus consistently hitting singles.
Cult Capitalism and the Monetization of Influence
It should be obvious by extension why the collectibles market in general and crypto NFTs in particular fit this narrative. These assets directly benefit from the trend toward increased liquidity and they have tons of the asymmetric wild-card upside that technocapitalists are seeking.
However, we face one other very important cultural reality today that is really making 2021 the moment for NFTs: the rise and recognition of the power of digital cults and cult leaders.
In the last few months we have repeatedly seen the ability of cults and memes to create massive economic distortions.
The GameStop incident elevated Keith Gill to the status of a cult leader and showed how following a community could create a massive economic event (the impact of which persists to this day with GameStop trading at 20 times its previous value).
Elon Musk’s focus on Dogecoin in the wake of GameStop put a more intentional point on the same theme. Musk, who is clearly one of the greatest cult leaders of our time, was able to cryptically and funnily signal to his disciples to buy the cryptocurrency.
Musk basically paid his most ardent followers for simply doing what he told them to, with the expectation that many more in the crowd would follow his call and the momentum trading it would kick off.
The point is that digital cults collectively deciding to follow one voice are increasingly aware that they can independently generate economic upside for themselves by targeting and taking over the narrative on a specific asset.
The problem for most cult leaders and cults, however, is that you have to be really powerful (or lucky) to use a public company stock or even a large crypto project as your fundamental asset to coordinate around. Things like that are too big and too liquid generally for a group to affect.
That said, a certain collectible or a digital NFT or group of NFTs generated or blessed by a cult leader is a much more approachable asset for a group of people to coordinate around, driving the price up, down or whatever way they need to send it to make money.
As a result, the best way to understand what is going on with crypto NFTs is that a bunch of leaders or notable folks have realized that they too can play a small-scale version of the game that Musk played masterfully with Dogecoin (and that many have played with different assets before him).
NFTs represent the easiest way to create an item that an influential person can imbue with value through their influence and reach, and that their followers can—in theory—profit from.
The dynamic of collateralizing influence in the form of tokens that people can then trade is both a way of rewarding influencers’ most ardent followers and incentivizing those followers to expand the cult for them.
So long as the social capital of the influencer continues to appreciate, everyone wins. But of course there are a thousand ways that the cult can fall apart, massively destroying its value.
Suggestions on how to act as an investor in these markets
As an investor in 2021, ignoring the realities of how technology is changing investing would be a huge mistake. The combination of increased liquidity, increased upside for winners, and the rise of cult capitalism are all important and strange new phenomena.
Here are a few principles to keep in mind:
1. This ecosystem is going to be far too large to allow picking individual stocks or assets to buy as a generalist.
I remember a long time ago my father, who was a career investment banker, talking about how old Wall Street was incredulous that you could possibly have more than a few hundred equities. There would be just far too many to follow. Even as a Silicon Valley early-stage investor used to following hundreds of new companies, this new world of NFTs is impossibly large and complicated to think about. Of course, when you let everyone in the world mint assets, how could anyone keep track?
Unless you know something deeply from a community standpoint, the idea of picking individual investments that cost hundreds or a few thousand dollars at a time is impossible. In the same way, because each asset is unique and of relatively low value, the whole NFT world is pretty structurally resistant to institutional capital as it is hard to put millions of dollars to work sensibly. It is biased toward individual retail investors, which is part of its fundamental appeal and is why it works.
2. You can do well if you pick the right cult to join.
While I don’t think you as an outsider can pick individual assets to invest in successfully, you could in theory pick the right cult to join and cult leader to follow and then just index whatever that person or group does.
If you are going to follow this approach, the key is to find a community you can be authentic in and a leader you can trust over the long run to grow their audience and create NFTs without overproducing them. Effectively, you are choosing a central banker, so choose wisely.
3. NFTs are particularly good for creating an asymmetric upside because they represent a triple bet.
Investing in crypto NFTs even beyond traditional collectibles represents an interesting form of triple bet: first, the unique digital asset itself; second, a unit from a collection of similar digital assets; and third, a unit of a unique creator’s work. This effectively means there are three different paths toward outsize upside—the artwork, the collection or the creator may attain popularity for whatever reason.
4. Consider investing in funds for NFTs or collectibles as well as the infrastructure that enables this ecosystem.
The thing I am waiting for is a platform—kind of like AngelList syndicates—on the blockchain for NFT funds run by individuals. People could send value (in the form of bitcoin, ether, whatever) to an address to invest. The controller of the address could use those tokens to buy NFTs. The investors could easily audit what was bought and participate in the upside from any sales of NFTs.
I would happily invest in funds like these (or other similar vehicles that paid a culturally tuned-in tastemaker to acquire and trade NFTs for me).
There is also a lot of money to be made in the infrastructure that helps the NFT world get ever more liquid, creates ever more asymmetric upside for investors seeking it and allows digital cults to get stronger.
Conclusions
We are living in a very strange period of human history. Our human communications infrastructure has deeply changed in a matter of just a few years, and—largely as a result of this shift—society is undergoing serious disruption.
This disruption unquestionably extends to how we think about value and how we trade with each other.
In a world of relatively low structural growth and growing inequality, the idea that cults are evolving to play “shoot the moon” on esoteric digital assets should be unsurprising.
NFTs aren’t about art. They also aren’t some crazy new way to unlock a massive new ecosystem. They are a way for people to monetize influence and create investment products that match new realities around liquidity and incentives.
Good investors should take them seriously even if at first blush they seem quite silly or outrageous.