NFT WTF

Research Jul 06, 2022

Key takeaways

  • Since inception, gas usage on the Ethereum blockchain has been driven by a series of mini-booms as new use-cases for smart contracts get deployed.
  • The latest driver has been minting and transacting NFTs and this has accounted for up to a third of overall gas use on Ethereum in recent months.
  • As the cold headwinds of the crypto winter have blown across the sector, NFT activity has slowed and their prices have fallen - the apes are looking slightly less bored ;-)
  • Many of NFT innovative use-cases are negatively impacted by the way NFTs are structured, something many fail to appreciate.
  • That said, solutions are being found and as they get rolled out the much-hoped for potential of NFTs (beyond being a digital receipt for cartoon primates or pixilated cryptopunks) stands to be realized. Watch this space.

The upcoming Ethereum merge, which I covered in a previous article, is edging closer to reality. On June 8, Ethereum's Ropsten PoW (Proof-of-Work) testnet moved to Proof-of-Stake (PoS) – something Tim Beiko, one of the lead developers working on the project, described in a recent tweet as “the first dress rehearsal” for the real Merge still scheduled to take place in Q3 (August seems to be the earliest possible date, but “by October” looks a safer bet).

This is not the only interesting date Ethereum fans should be keeping an eye on. Another is July 27, although I am sure most will have no clue as to why that date has any significance at all. Let me explain.

Jumpin’ Jack Flash

In the Merge article I noted the following:

“[A]s long as people wish to use the Ethereum blockchain for financial transactions, creating ERC-20 tokens, minting NFTs or deploying dApps (including Defi dApps) then ongoing demand for ETH is assured by EIP-1559 and the Merge.”

As luck would have it, the wonderful folks at glassnode in a recent blog took a detailed look at the use cases of Ethereum based on gas consumption – see chart below. It provides a really useful breakdown of transactions being conducted on Ethereum blockchain and how they have evolved over the past several years as a percentage of the overall total.

Relative Ethereum Gas Usage By Transaction Type

source: glassnode

In the early days of the Ethereum blockchain, transactions were dominated by what glassnode calls “vanilla transactions”, which they define as pure Ether transfers between wallets, and a residual catch-all “other”, which includes transactions not recorded in the specific categories they identified and includes such things as “multi-signature contracts of exchanges, centralized lending platforms, and gambling sites”. Over the six year period shown in the chart, the transaction shares of these two categories has fallen from 100% of gas used to roughly a third.

This transition has, however, not been a gradual one. It has been punctuated by a series of mini-booms, each one associated with the development of a new use-case for Ethereum’s infrastructure - an evolutionary process not dissimilar to the evolution of Bitcoin narratives I discussed in an earlier article.

Use-Case Mini-Booms

The first mini-boom was the creation of ERC-20 tokens, which are altcoins running on the Ethereum blockchain, whose popularity exploded with the ICO boom in 2017/18. At its peak, ERC-20 tokens accounted for 40% of ETH gas usage. Its gas share has subsequently fallen back to around 5% at present. This was followed a year later by the surge in stablecoins issued on the Ethereum blockchain – the largest of which was Tether (USDT) closely followed by USDC. Gas usage associated with stablecoins rose to more than 15% of the total during the 2020 surge. But, like the earlier ICO craze, their ETH gas share has subsequently eased also to around 5% with many stablecoin issuers migrating to lower cost blockchains like Tron. Replacing stablecoins as the primary gas user in mid-2020 was Defi. Its share topped out at around 35%, and has subsequently fallen back, although at around 12% it remains a significant driver of Ethereum blockchain usage.

The latest mini-boom responsible for driving ETH gas usage, and the one that relates to the aforementioned July 27 date, is NFTs. They account for roughly a third of overall activity on the Ethereum blockchain because, as the chart below confirms, Ethereum is by far the most popular blockchain for NFTs.

NFT Trade Volume by Blockchain

Source: theblock.co

Fungi What?

NFTs, for those who have beaten Elon Musk in the race to inhabit Mars or those who choose to inhabit a strictly analogue world, are non-fungible tokens. Unlike cryptocurrencies, which need to be fungible in order to function as money, they are tokens registered on the blockchain whose non-fungibility conveys proof-of-ownership of the unique digital asset in question.

According to wikipedia, the first NFT was Quantum, an octagonal animation generated by code that personally I find nausea-inducing after watching for anything longer than a couple of seconds (try it out for yourself). It did, however, showcase one of the main (not to mention profitable) uses of NFTs: digital art.

Two of the most popular series of NFTs are CryptoPunks, which are 10,000 unique characters whose image conjures up a 1980s retro-pixilated look (see image below), and the Bored Apes of Yacht Club fame, which are 10,000 cartoon apes (see image below). Back in February, CryptoPunk # 5822 sold for 8,000 ETH, equating to $24m making it the most expensive CryptoPunk ever sold, while the most expensive Bored Ape #8817 was sold by Sotheby’s in its Metaverse auction held last October for $3.4m. However, the record for the most expensive NFT was achieved last December when the anonymous artist Pak sold 266,445 shares in an NFT project called the Merge for $91mn. Big money!

Two Popular NFT Series

Source: cryptopunks.app and Sotheby’s

Since these NFTs were sold, and in keeping with the general malaise that has impacted crypto markets over the past several months, NFT sales and prices have fallen back quite sharply – see chart below which plots both total USD sales (orange line) and primary USD sales (white line). For example, Cryptopunk #5364, which was donated to the Aid for Ukraine crypto fund, sold last week for $100,000 - less than a third of the price it was estimated to have been worth when it was given to the fund back in March.

NFT Sales Volume – Total & Primary

Source: nonfungible.com

Whether NFT’s digital art use-case recovers its former lofty heights remains to be seen and this is why the July 27 date is worth noting.

Last July, Damien Hirst, the British artist best known for pickling large animals in formaldehyde filled tanks, released a collection of 10,000 NFTs with a sale price of $2,000 each. The series, known as “The Currency” has a rather interesting twist. No later than July 27 this year (i.e., one year after the sale) the purchaser of the NFT must decide whether to keep the artwork in purely digital format as an NFT or alternatively take delivery of the physical painting. Once decided, the format not chosen is destroyed. The owners cannot have both.

They say that beauty is in the eye of the beholder, but for me I don’t see the attractiveness of “The Currency” artworks – see below image. To me they look very similar to the colour blindness tests I took as a kid (and failed by the way – thanks Mum). But, the current floor price for the works is just over $8,000 so clearly a fair few people do not share my view.

Art vs. Colour Blindness Test

Source: Heni

The more interesting question for NFT fans though is how many owners will prefer to keep hold of the NFT versus taking delivery of the physical artwork they can hang on their walls at home? We will shortly find out. Anything less than 70% would, in my opinion, represent a significant dent in the digital art narrative for NFTs. After all, Damien Hirst is a well-known artist famed for pushing boundaries and this was his first NFT series. As such, I would argue, one would/should expect these NFTs to command higher values over the longer run given their additional novelty value relative to those that get converted back into more vanilla physical artworks.

Metaverse Land Grabs

Of course, digital art - albeit a popular one - is only one use-case for NFTs. It may, in the end, not even prove to be the most lucrative. As mentioned, their non-fungibility conveys proof-of-ownership. They are, in effect, an electronic title deed that is registered on the blockchain. Given this, it didn’t require much of a mental leap for NFTs to be used as exactly that in another tech growth area – the metaverse.

The notion of a metaverse has been around for a long time, the phrase originating from Neal Stephenson’s classic 1992 sci-fi novel Snow Crash, and its first incarnation was as the virtual platform Second Life that debuted in 2003. However, given the ensuing improvement in software and hardware more – and larger - companies and capital are being deployed to bring the idea closer to reality (albeit a virtual one). For instance, last year Facebook took the decision to change its company name to Meta and stated that it would focus on building a metaverse.

In an ideal world there would be one Metaverse (hence the capital M) where everyone interacts virtually. However, this seems unlikely to happen for both technological and social reasons. The technological challenges of delivering such a product are formidable and while companies talk about interoperability they all want their version of the metaverse to be the one that gets adopted globally. (Let’s not even bring in political objections that may arise from governments whose boundaries are defined by physical geography that, by design, has no relevance in any metaverse). As a result, there are a multitude of metaverses being developed in tandem and the companies driving these projects are seeking to convert their virtual world into revenue generators by selling in-world assets using NFT technology.

A recent success in this regard was Yuga Labs, the creator of Bored Ape Yacht Club. The company is developing a virtual world called Otherside which the team behind it describe as a blend of MMORPG and Web3-enabled virtual worlds. Despite the fact that the only thing people have seen of the Otherside so far is a short trailer and a flashy website, on May 1 they conducted a virtual land sale, selling  55,000 plots of virtual land in the Otherside (45,000 were kept in reserve for employees and affiliates and existing owners of Bored Ape NFTs). It raised over $320m and proved so popular it managed to lock-up Ethereum’s blockchain as users raced to bid for Otherdeeds NFTs (in the NFT sales chart shown above, the Otherdeeds auction caused the spike on the right-hand-side), prompting the company to issue an apology on twitter – see image below.

Is Any One Home?  

Source: twitter.com

Collectibles

On a slightly smaller scale, NFTs can also be used to establish ownership of other virtual assets such as clothing and wearables, or collectibles more generally, within the digital space. This is already happening in the gaming world where blockchain-based games, such as Axie Infinity, allows players to purchase NFTs that can be utilized within the game and can be sold or transferred to other players. As the chart below confirms, the sums involved in this sector are not inconsiderable.

Weekly Trading of NFTs by Category

Source: theblock.co

Digital Identity

Obviously, owning an NFT of a fuzzy creature in a game isn’t going to revolutionize the world (at least I don’t think so, I might be wrong) but there is another potential use-case for NFTs that could – their use in establishing a digital identity. Just as concert tickets can be stored on the blockchain as an NFT, they could also be used to store personal information, essentially becoming a digital passport that could be used in the metaverse (or more likely for reasons already alluded to, metaverses) or even, eventually, in the real world.

In January, Twitter unveiled a feature that allows users to display their NFT avatars on their profile page displayed within a hexagonal border, unlike the regular circle border. In this way Twitter users are able to demonstrate visibly they are the owners of the NFT displayed (anyone who uses a copied image of the NFT will not be able to display it within the hexagonal border). Discord allows its community to use NFTs in the same manner and Reddit is apparently testing a similar feature.

That said, from using a monkey (bored or otherwise) NFT as your Twitter avatar to having all of your critical personal information stored on a blockchain, as would be required for an NFT passport to be used in the real world, is quite a big step. Nevertheless, it is clear this is the direction of travel. Last July San Marino issued Covid-19 vaccination passports as a NFT stored on the VeChain blockchain ledger and many NFT proponents eventually expect all personal medical records will be stored this way. At this point, assuming we ever get there, having relinquished this much personal information to a blockchain, the additional information required by a passport is minimal.

Combining all these use-cases, not to mention their potential to be used to monitor global supply chains and logistics (another popular proposed use-case), many estimates put the overall size of the NFT market at around $150bn by 2030, 10X higher than in 2021. Like all projections – and I know this having worked as a professional economist for almost 30 years – these should be taken with a large pinch of salt, but if they prove to be anywhere near accurate then there is considerable upside in the space.

Ongoing Challenges

As mentioned in footnote 19 (Ed note: My articles have a lot of footnotes. I know these days people find them painful and often ignore them but please don’t pass them over, they often contain some of the best bits of the article as well as source links) NFTs only contain meta data about the digital asset. This is what is stored on the blockchain. The actual data or digital asset – for example, a JPEG file of a bored ape - is not on-chain as it would be prohibitively expensive to store it. This meta data contains within it a URI (Uniform Resource Identifier) which points to the URL where the data is actually stored.

While the blockchain the NFT smart contract runs on may be decentralized there is no guarantee that the file storage system where the digital asset is stored is decentralized, that depends upon the storage option chosen by the person who minted the NFT. It could very easily turn out that the data is held in a centralized data storage system. If any part of the process incorporates centralization – such as storing NFT data on AWS - then it should be considered centralized no matter what other decentralized features it has. This is problematic for many crypto fans because the underlying rationale for using blockchains in the first place is to mitigate the need for trust and this is achieved by decentralization, namely distributing ledgers.

In addition, NFT smart contracts, such as the popular Ethereum ERC-721 token standard, do not specify anything about the nature of the content at the URL being referenced, just what the URL is. Hence, if someone, somehow, was able to get write access to the server hosting the URL and replaced the image with something else the smart contract would still be valid (storing a hash of the image within the meta data would be one obvious mitigating step because at least it would contain some reference as to what the NFT referenced in the smart contract was supposed to be). For those using simple storage methods, the risks from this should be obvious – hackers, server disruptions or even good old fashioned link rot.

To mitigate such problems, major NFT creators, like Bored Ape Yacht Club, put their images on a decentralized storage system like IPFS (Interplanetary File System) which is a peer-to-peer network of data storage nodes that splits the file into smaller pieces and distributes this and the unique address around the network. Once the image is stored it cannot be changed and will survive as long as the IPFS network survives. Given IPFS claims to have 200,000 nodes longevity doesn’t seem to be an immediate worry, but it does raise another issue. What if you want to delete a file for some reason – say due to a GDPR-breach, legal infringement, or just simple error? Although there is the ability to remove a file from the nodes, there is no way to compel the files to be deleted by other nodes.

The Road Ahead

The aforementioned are all “live” challenges for the NFT community. Only by resolving them will NFTs fulfil their potential. This will take time and effort, but progress is being made. One NFT innovation worth examining in this regards is so-called secret NFTs, which run on the Secret Network blockchain. Unlike traditional NFTs they have an additional private meta data field which accepts encrypted inputs and can produce encrypted outputs. Providing this additional field allows ownership and transaction histories to be kept from public view, giving creators of NFTs the right to determine who has access to the content. For sensitive personal information like digital IDs, having privacy-by-default is a rather obvious positive. That said, Secret Network, which launched on mainnet in September 2020, only has 80 active nodes operating as validators, who must maintain high uptimes and use hardware enabled with a Trusted Execution Environment  (TEE) safe box in order to remain active. This is not terribly large number of nodes compared with many PoS blockchains and clearly does not tick the decentralized box of most crypto users.

NFTs have been the latest boom for the Ethereum network and while demand has moderated in tandem with the emergence of the crypto-winter there is still considerable long-term optimism about what uses they will be put to and their potential market size. However, one cannot escape the fact that they are still very much a work-in-progress. Much needs to be done if NFTs are to realize these optimistic projections and become more than just digital receipts for images of cartoon primates or pixilated cryptopunks.

Until next time.

Ryan Shea


[1]    See: https://blog.trakx.io/peering-into-the-ether/

[2]    See: https://twitter.com/TimBeiko/status/1531369111938138112

[3]    Think about it! For those without no appreciation of fine music just google the subtitle, hopefully all will become clear.

[4]    Their blog came out a day or two after my Merge article was completed - see: https://insights.glassnode.com/a-short-history-of-the-etherverse/

[5]    That is to say it does not illustrate the trend in gas used, which until April this year had been steadily rising. Since then it has fallen quite sharply, down by roughly 20% - see: https://etherscan.io/chart/gasused

[6]    See: https://blog.trakx.io/bitcoin-the-inside-out-narrative/

[7]    Tether has roughly equal amounts of its USDT token on Ethereum and Tron (USDT 32bn on each) - see: https://tether.to/en/transparency/)

[8]    Mycologists will not be interested unless of course they are e-mushrooms.

[9]    Actually what you own by owning an NFT is not as straight forward as many NFT buyers think as we will see.

[10]  See: https://news.artnet.com/market/sothebys-is-hosting-its-first-curated-nft-sale-featuring-the-very-first-nft-ever-minted-1966003

[11]  10,000 seems to be the magic number for NFT issuance. Big enough to attract attention but not too big to detract from each NFT’s uniqueness, which their creators calibrate by providing their characters with certain features.

[12]  The seller bought the Cryptopunk NFT in July 10, 2017 for 8 ETH or $1,646, quite a handsome return by anyone’s standards – see: https://cryptopunks.app/cryptopunks/details/5822

[13]  See: https://twitter.com/Sothebysverse/status/1453042450788982794?ref_src=twsrc%5Etfw%7Ctwcamp%5Etweetembed%7Ctwterm%5E1453042450788982794%7Ctwgr%5E%7Ctwcon%5Es1_&ref_url=https%3A%2F%2Fwww.cryptotimes.io%2Fmost-expensive-bored-ape-yacht-club-nfts%2F

[14]  Some argue that it should not be considered a single NFT.

[15]  See: https://decrypt.co/103396/cryptopunk-sale-raises-100k-in-ethereum-to-support-ukraine-war-effort

[16]  That magic NFT number once again!

[17]  For those readers who purchased one of Damien Hirst’s colour blindness tests – sorry paintings – the exchange window is open – see: https://palm.io/studio/the-damien-hirst-currency-exchange-window-opens/

[18]  Colour blindness is a genetic trait passed down the female line.

[19] Most NFTs are the metadata file relating to the artwork, it does not guarantee transfer of the copyright of the image, that (at least under UK law) remains with its creator.

[20]  Heni, the company managing the collection, provide regular updates on how many of The Currency NFTs have been burned for physical artworks. At the time of writing it stands at 1,638 (or 16.4% of the total) – see: https://twitter.com/HENI.

[21]  Well worth a read in my opinion. Last month Neal announced that he is co-founder of a new project call Lamina 1, which is a a base-level blockchain protocol for the Open Metaverse to help build out his original concept – see: https://www.lamina1.com/

[22]  See: https://www.youtube.com/watch?v=qt1equGhkQE

[23]  See: https://otherside.xyz/

[24]  Binance this week announced a multi-year partnership with Christiano Ronaldo which will see the creation of a series of NFT collections on the Binance NFT platform – see: https://www.binance.com/en/support/announcement/c91e9b1c1492456f9909e16f2ff3427e

[25]  During a recent conversation with someone knowledgeable in the space and a strong critic of Web3, they stated that in their opinion this was the only valuable real-world application of NFTs.

[26]  See: https://www.businessinsider.com/how-to-use-nfts-real-world-passport-concert-tickets-2022-3?r=US&IR=T

[27]  See: https://www.coindesk.com/business/2022/01/20/twitter-launches-nft-profile-picture-verification/

[28]  One company offering NFT-based digital identities is PhotoChromic – see: https://photochromic.io/

[29]  The mingling of decentralized blockchains with centralized entities is by no means limited to NFT storage. It is a problem that impacts large sections of the crypto-sphere.

[30]  See: https://dash.harvard.edu/bitstream/handle/1/37367405/NYT%20Link%20Rot.pdf.

[31]  Anyone interested in doing this exercise just follow these simple instructions contained in a Medium post – see: https://medium.com/coinmonks/how-to-find-your-nft-on-ipfs-e51bc5e7c8a1

[32]  As of August 2021 IPFS claims to have 200,000 network nodes

[33]  See: https://protocol.ai/

[34]  See: https://scrt.network/about/secret-nfts

[35]  See: https://secretnodes.com/secret/chains/secret-4/validators

[36]  Secret Network is a Delegated-Proof-of-Stake (DPoS) consensus protocol that runs Tendermint.

Carole Laizet

Senior marketing manager with 15+ years of experience in the Financial Industry (traditional Banking as well as Crypto Assets). Responsible for market research @trakx.io