• Sat. Feb 24th, 2024

What is the NFT Bubble and Has it Burst?

Key Takeaways:

  • A bubble forms when the value of an asset class is inflated to a point where it is no longer justifiable or exceeds its utility. 

  • This is rampant in markets where investor behavior is primarily driven by speculation. 

  • Since its peak in May 2021, OpenSea has experienced a decline in transaction volumes by almost 99%, suggesting that the NFT bubble we saw in the past two years might be bursting. 

In March 2021, Sina Estavi, an Iranian-based crypto enthusiast, bought a Non-Fungible Token (NFT) of Twitter founder Jack Dorsey’s first-ever tweet for a whopping $2.9 million. On April 6, 2022, the buyer listed it on the OpenSea marketplace, hoping to fetch $48 million, and promised to give away half of the profits to charity. The auction closed a week later with the best offer of 0.96 ETH ($1,226.63).  

The sharp decline in NFT prices and sales has made critics jump on the news with speculation that the air has come out of the NFT bubble. Could that be true? What’s happening in the NFT market and what does the future of NFTs look like?

What are NFTs?

Non-Fungible Tokens, often abbreviated as NFTs, are blockchain assets representing unique asset classes like digital artwork, music, pictures, real estate, videos, in-game items, domain names, event tickets, and non-digital collectibles. You can think of an NFT as an irrevocable digital certificate of ownership and authenticity for any digital and/or physical asset. You can trade them on NFT marketplaces using crypto, and they are secured with the same blockchain technology as cryptocurrencies. 

While NFTs have existed since 2014, they came into the public limelight two years ago and have become popular means of buying and selling digital artwork. In 2021, the NFT market reached a staggering $41 billion, almost the total value of the global fine art market. NFTs are engineered to be cryptographically verifiable, unique or scarce, and easily transferable.  

NFTs are created by artists, creators, developers, or license-holders via minting on a blockchain network. Minting is the process of authenticating a blockchain transaction that stipulates the basic token details, triggering a smart contract function to issue the token and assign it to the creator. Essentially, NFTs contain unique token identifiers, mapped to owner identifiers and kept in a smart contract. When the token owner wants to transfer it to another person, it’s easy to prove ownership and legitimacy through the historical tokens transferred data.

Popular digital artist Mike Winkelmann, nick-named “Beeple,” designed a collection of 5,000 daily drawings to mint possibly the most famous NFT collections of 2021, “EVERYDAYS: The First 5000 Days,” which he auctioned at Christie’s for $69.3 million

Source: Christie’s Images LTD/Beeple

Astonishingly, any internet user can see the individual images or even the whole collection for free! So, why are investors willing to spend millions of dollars on something they could simply screenshot or download online? Well, NFTs enable the buyers to own the original asset. Besides, they have inbuilt authentication, which acts as proof of ownership. Investors value these indicators of ownership and the exclusivity they confer even more than the items themselves.   

What is an NFT Bubble?

In financial markets, a bubble is an economic event defined by the rapid growth in the market value of an asset. These ridiculous prices are caused by high demand and driven by speculation, making the market value of an item exceed its intrinsic value. After the demand falls flat, investors realize the real value of those assets, and prices typically start to reduce swiftly. The swift decline in value is known as a “crash” or a “bubble burst.” 

In the case of NFTs, investors were mainly driven by the fear of missing out (FOMO). Every crypto user wanted to get a cut of the latest NFT collections before they sold out, hoping to make a killing from inflated price valuations in the future. The high demand sent the prices of most NFTs to the sky. Even simple JPEG images with little or no utility were valued at thousands of dollars.  

The Inflation of the NFT Bubble

NFTs have been in existence for almost eight years. Nevertheless, it was only in 2021 that they attained wide adoption. According to Gauthier Zuppinger, co-founder of Nonfungible.com, the trading volume for NFTs exceeded $17 billion in 2021 – a 21,000% increase from 2020. Collections like CryptoPunks, minted in 2017 and originally auctioned for a few dollars, attracted thousands per piece in 2021. Consequently, numerous NFT projects, most of which saw rapid success, came into the scene.  

Beeple’s NFT ‘EVERYDAYS: The First 5,000 Days’ was auctioned for $69.3 million. Then came the Bored Ape Yacht Club (BAYC), a collage of 10,000 unique Bored Ape NFTs, each valued at hundreds of thousands of dollars, with participants including some of the world’s celebrities like Justin Bieber. Sultan Gustaf Al Ghozali, a 22-year-old Indonesian college student, uploaded and auctioned almost 1,000 selfies as NFTs on the OpenSea marketplace. According to Ghozali, he had captured images of himself for five years to commemorate his college life. He made a cool $1 million overnight! 

Going by these inflated prices and demand, NFT skeptics warned that the industry had formed a bubble destined to burst at some point. 

Signs that an NFT Bubble is Bursting 

There are multiple indicators of an NFT bubble on the verge of bursting. Before purchasing NFTs and other digital assets, it’s advisable to know the risks, including the signs of an impending crash. The major ones to watch out for include NFT prices declining sharply, reduced trading volumes, and little media attention about NFT sales. 

NFT Prices Decline Sharply 

When NFT prices start deteriorating significantly, it could indicate that the bubble is about to burst. However, like cryptocurrencies, NFTs are prone to wide price swings. Depending on your risk appetite, you may want to wait out the low prices when you see them depreciating throughout a highly volatile bear market, or you may choose to cut your losses, especially if a decline in prices is accompanied by additional indications that the NFT bubble is bursting.

Low Trading Volume

One of the most significant signs of the health of any financial market is its daily trading volume. When NFT trading volumes decrease for a prolonged period, it could signify a bursting bubble. When most collectors start listing their collections on marketplaces for sale, it may create a market condition where the sellers exceed buyers. In this scenario, it is more likely that the bubble will burst due to high selling pressure and a lack of buyers. 

Decrease in Media Coverage 

The last major sign of a deflating NFT bubble is minimal media coverage, indicating a loss of interest in the industry. Generally, the industry is likely doing well when there is plenty of news coverage about crazy NFT sales and upcoming minting activities. When media coverage starts shrinking, it may indicate that the bubble is deflating.  

Has the NFT Market Crashed?

The NFT market is also reflecting the 2022 crypto bear market. Investor confidence in the NFT market has been deteriorating, with the number of NFT market participants gradually diminishing since February 2022. However, in June, the depreciation intensified by over 77% in the decrease in trading volume on NFT marketplaces, as seen in the below report:

Source: CoinGecko Q3 2022 Cryptocurrency Report

The mean NFT prices have also dropped significantly, by more than 92% since May 2022, depreciating from $3,894 to $293, according to Chainalysis’ July report. 

Source: NonFungible.com

While the crypto bears may be behind the decline in NFT transaction volume and prices, the drop is too sharp to be explained by bears alone, according to Chainalysis economist Ethan McMahon. McMahon highlighted the hype in the past 18 months around what he calls “profile picture NFT collections,” like the Bored Ape Yacht Club where Bored Ape #8817 sold for an eye-watering $3.4 million, which could have resulted in an inflated market that caused the sharp decline in transaction values.

However, the interdependent relationship between NFTs and the crypto market is irrefutable. So, will the volatile nature of the crypto market always drive the NFT market? McMahon believes that as the blockchain art industry matures, it may reflect the physical art market, which is not often affected by the underlying fiat currency in trades.  

From the telltale signs of a bursting NFT bubble – prices declining sharply, low trading volumes, and a decrease in media coverage – we can assume that the bubble has burst or is almost bursting. 

The Future of NFTs

While the NFT market appears dead based on recent data, the crash is an essential catalyst that will shift the market away from assets lacking practical utility. Shifting focus away from baseless profile picture avatars could inspire ground-breaking NFT applications such as gaming, in-game items, royalties, and real estate. 

Irene Veng, the founder and CEO of Oxford-headquartered Certi.NFT believes one of such innovations is making NFTs less of financial assets and more of web3 tools with real utility. Vitalik Buterin, the founder of the Ethereum blockchain, shared similar sentiments in his May 2022 white paper. He expressed that web3’s present focus on creating transferrable, financialized products instead of encoding social relationships of trust, implies the current DeFi space cannot support activities prevalent in the real world, like undercollateralized lending and apartment leases. 

The original goal of NFTs was proof-of-provenance (PoP) of an exclusive digital item to signify ownership. NFTs found a home in digital artwork as it enabled creators to place a digital signature on their pieces that signifies ownership in a field where digital art theft is rampant. While the heightened popularity and hype surrounding profile picture avatars made many think that minting NFTs was a way to make easy money, that wasn’t the original objective.

In spite of the crash, analysts expect that the NFT market will continue to evolve and grow, potentially in the space of charitable NFT initiatives. Meanwhile, music NFTs are starting to take off, with Steve Aoki and Justin “3LAU” Blau using their CryptoPunks NFTs as their identities in a new conceptual music/art project PunX.

Final Thoughts

Even if the NFT bubble bursts, this revolutionary invention is here to stay. It forms a core element of the metaverse and web3 games, and these two use cases will be a force to reckon with in the digital era. According to Gartner, a global research company, 25% of the world population will spend a minimum of one hour per day in the metaverse working, shopping, learning, and socializing.

The deflation of the NFT bubble could also cause a shift in favor of creating utility as the core value of NFTs. Already, multiple NFT projects are trying to add real-world utility to their offerings to increase their value. Whether it’s social NFTs that reward artists and their supporters or POAP NFTs that offer certain privileges to investors, NFTs will certainly evolve with the shifting market dynamics.