In August 2021, Gartner released a report that located emerging technologies along what it calls a “hype cycle,” which illustrates the maturation of new industries and products. It placed nonfungible tokens, or NFTs, at the top of a curve termed the “Peak of Inflated Expectations”—a moment in time when a technology receives a great deal of publicity, both positive and negative, attracting some companies to embrace it while scaring off many others.
However, I would argue that NFTs haven’t yet reached that point but rather are still at the “Innovation Trigger” stage, where the technology’s commercial viability is still being developed. This innovation breeds imitation, creating an exponential curve of product delivery and value creation. That means this is a prime time for businesses, especially for those with media and entertainment assets, to begin considering their own NFT strategies and how best to leverage any early-mover advantage to establish a sustainable competitive edge.
An NFT can be any digital asset whose ownership is recorded on the blockchain—typically art, collectibles, and other unique assets used in games or virtual worlds. As companies enter this new sector, blockchain-native startups are unlocking the optimal commercial models for the technology, while established companies are exploring how to leverage these assets within existing business models.
Among established businesses, many early NFT investments seemed aimed at simply capitalizing on the buzz, like Arizona Iced Tea’s purchase of a popular Bored Ape NFT or Fox Corp.’s development of NFT memorabilia for a show called “Krapopolis.” But some companies are taking a longer view, crafting strategies that reflect how transformative this technology will turn out to be.
The Rise of NFTs
NFTs pierced the popular consciousness in 2017 with the creation of CryptoKitties, a blockchain game built on Ethereum. With Bitcoin entering a bull market the same year, a media frenzy erupted as prices for rights to images of big-eyed cartoon cats that could be virtually bred and traded soared to more than $100,000 each. Until that time, NFTs had been the domain of hip technologists, but speculators soon rushed in and entrepreneurs founded exchanges, helping to solidify a functioning market for the assets.
Industry leaders have since emerged. In 2020, the NBA partnered with Dapper Labs to launch NBA Top Shot, a platform that has enabled the trade of more than $780 million of basketball collectibles. It grew thirtyfold in 2021, with more than 13 million transactions recorded. In Europe, the French firm Sorare has partnered with hundreds of soccer clubs in dozens of leagues worldwide, allowing fans to trade unique digital cards for star players on its blockchain-powered global fantasy platform, generating sales of $130 million.
A digitally native art market has also flourished, with auction houses like Sotheby’s and others muscling into the action. In March 2021, Christie’s sold a digital collage called “Everydays: The First 5000 Days” by Mike Winkelmann, known as Beeple, for a whopping $69 million, the third-highest price for art ever fetched by a living artist. The NFT market has since reached record levels after cooling off briefly in the spring when crypto token prices like Bitcoin dipped from their record levels. Interest in NFTs hasn’t dimmed, though: One major marketplace, OpenSea, has now surpassed 26,000 users and had more than $3 billion in sales in August 2021, a tenfold increase over July. Clearly, people believe NFTs have staying power.
I’m sympathetic to the criticism that these prices make no sense. At their worst, NFTs are peddled by opportunists converting bits of JPEGs and GIFs into crypto assets by uploading a file onto a blockchain, creating a token that is a record of ownership, and auctioning it off. What value do they have if anyone can still watch those video clips for free or copy those images fetching millions of dollars? Why does creating a record on a blockchain confer such value to an otherwise ephemeral asset?
These are legitimate questions. What is important to understand, though, is that the true value of these crypto assets is in the power of the blockchain. Because the digital ledger is maintained by thousands of computers around the world, it is impossible to forge any record of ownership stored there. There is only one digital certificate of ownership on the blockchain that can be bought and sold. This creates scarcity for NFTs, which creates value.
The tokens are also growing in influence because they satisfy behavioral impulses, according to tech blogger Eugene Wei, who in a 2019 essay called “Status as a Service” explored the interplay between human nature and social networks. People, Wei wrote, are “status-seeking monkeys,” searching for “the most efficient path to maximizing social capital.” Hungry for affirmation, he wrote, they earn authenticity and trust through the acquisition of scarce or unique tokens, building critical social capital in their networks.
This insight is important for grasping how markets for these assets will persist and flourish in an increasingly virtual world.
More Than Just Marketing
In 2021, Coca-Cola auctioned its first-ever NFT collectibles for charity, getting more than $575,000 for four so-called loot boxes that contained NFTs, including custom-designed jackets that can be worn by characters on the Decentraland 3D virtual platform, which is built on the Ethereum blockchain. It was a marketing tactic, but it also gave the company an important introduction to key players in the industry, like marketplaces, developers, and agencies, as well as strategic insight into the emerging technology.
There are numerous consumer brands experimenting with similar types of digital marketing, including Taco Bell, Nike, and even Campbell’s Soup. A smaller segment with significant intellectual property has introduced new products over an entirely new, futuristic digital channel built on blockchains, developing partnerships with digital platform companies and identifying NFTs as a new and profitable revenue stream. This is what the NBA has done with its Top Shot business.
Other companies in this segment include Marvel, Time magazine, and Lionsgate, as well as the top professional soccer leagues in Spain and Germany. They share some characteristics that make them ideal early adopters:
- They possess extremely valuable intellectual property with widespread appeal and a large and loyal fanbase.
- They are able to package their IP in a format that is familiar and similar to existing products. For example, comic books or trading cards are replicated in a digital format that resembles the existing product.
- They have existing commercial processes for licensing this IP for profit.
These characteristics allow companies to quickly convert their assets into NFTs, and their partnership strategies facilitate immediate access to marketplaces. The competitive advantage these companies gain by moving quickly outweighs the lower margins that come with renting someone else’s infrastructure.
Of course, finding the right partner is a critical process, and there is no easy guide to doing so in an industry that is so young. In 2021, Marvel partnered with the New Zealand-based startup Orbis Blockchain Technologies Limited, which operates the VeVe digital collectibles app. Time magazine is working with the startup behind the Cool Cats community. Entertainment giant Lionsgate inked a deal with Autograph, a startup backed by NFL quarterback Tom Brady that also signed up a number of individual sports stars.
The NBA and its Players Association began working with Vancouver-based Dapper Labs in 2019 after the company was spun out from the creator of CryptoKitties to develop a more robust blockchain called Flow. The Top Shot platform shares revenue with the league and players when digital trading cards capturing moments like dunks or blocks are dropped, and collects commissions from its secondary market. Top Shot typically offers packs of three moments for sale for as little as $9 each, while the LeBron James dunk that was an homage to Kobe Bryant sold for nearly $400,000 on the platform.
Another significant marketplace, Nifty Gateway, typically has drops every day from two creators, in which each releases five to 10 pieces, and also facilitates secondary buying and selling on the open market, creating liquidity.
Keys to NFT Success
The financial models I have built for clients working on NFT opportunities echo the excellent unit economics suggested by Top Shot, and all include at least some of these elements:
Low marginal cost. One of the biggest benefits of virtual trading cards or comics over traditional physical ones is the lower marginal cost of production and distribution. While both require upfront costs for designers, distributing assets through a digital channel means saving thousands or tens of thousands of dollars in production costs for printing, as well as managing retail channels to get products into stores. Converting digital artwork into NFTs requires paying what are known as “gas fees” to mint tokens on a blockchain, which can cost around $150, as well as a small monthly subscription depending on which platform or marketplace you use as an outlet.
Increased customer engagement. NFTs can expand or enhance customer bases, allowing companies to engage meaningfully with digitally native generations. I anticipate that this will have a positive impact on customer retention and produce a spillover effect, especially for sports teams, inspiring more game attendance.
Recurring revenue potential. When Marvel began dropping thousands of variations of comic book cover graphics on the VeVe marketplace this year, the sticker price was $6.99. But built into the smart contract was a 6% licensor fee, ensuring the comic book giant is sharing in revenue from the surge in prices of some of the NFTs in the secondary market.
Know the Risks
So what’s stopping your company from diving into the NFT pool? Even a believer like myself recognizes that this is an immature and essentially unregulated market. For starters, not all NFTs are created equal. Yes, the certificate of ownership stored on the public blockchain ledger is immutable and cannot be forged. But it’s crucial to remember that this token is simply the link to the actual digital file stored on a server. And not all servers are created equal.
One significant risk is link rot, which happens when hyperlinks break. Usually this happens because the target file gets moved to a new server without updating the link or because the server goes offline. When creating or purchasing an NFT, note where the digital file is stored. Storage on a local server significantly increases the likelihood that the NFT could be lost one day. Storage on a public cloud reduces this risk but even better is a decentralized server like the InterPlanetary File System or Arweave. You’ll want to check that the token’s metadata is stored on a decentralized server as well.
Intellectual property rights are also crucial to consider, though this is an area that is still evolving. The lack of legal precedent in the US over NFT ownership means a number of important questions around the retention of commercial rights by creators and future licensing are still being debated or need to be refined, says Sarah Bruno, privacy, advertising, and IP partner at Reed Smith.
Finally, the environmental impact is an important issue to consider. NFTs are largely bought and sold on the Ethereum network, which emits as much carbon as some small countries. That’s largely due to the amount of computing power it requires to operate the decentralized consensus mechanism it uses to verify transactions, called proof of work. Companies—and individual artists, for that matter—may risk pushback or loss of business from climate-conscious customers.
There is, however, growing momentum in the blockchain community to reduce or offset the carbon costs of mining. For instance, Ethereum’s operators have promised an upgrade in 2022 that they say will cut emissions by 99%, deploying what is known as a proof-of-stake operating system that requires significantly less computing power. Some marketplaces like NBA’s Top Shot, which operates on the Flow blockchain, already use networks that employ the more environmentally friendly proof-of-stake mechanism.
The Potential Is Limitless
Even if your company doesn’t own valuable IP, the use cases for NFTs are so immense that opportunities may be limited only by your imagination. Future possibilities include sports and entertainment event tickets, which once were saved in scrapbooks and could be again, except virtually. Bluetooth-enabled products could graduate into the crypto realm as well, with an immutable NFT warranty that travels with a product when it’s resold.
The early evidence indicates that the technology supporting NFTs will be a true disruptor from a customer experience perspective, and a wide variety of industries will be able to leverage this technology for shared reward. The spectrum of companies in this space is not only growing, it’s converging, as exemplified by the partnerships between tech startups and established enterprises with vast amounts of IP. While price volatility is likely inevitable, NFTs are poised to occupy a central place as the internet continues to evolve and digital worlds flourish.
[“source=toptal”]
