How NFTs Became a $40 Billion Market in 2021

At the beginning of 2021, only a niche group of crypto enthusiasts knew what non-fungible tokens (NFT) were.

However, by the end of the year, nearly $41 billion had been spent on NFTs, according to recent data, making the market for digital artwork and collectibles almost as valuable as the global art market.

“This year, the NFT market exploded from a sub-billion-dollar market to a multi-decabillion industry,” said Mason Nystrom, research analyst at crypto data firm Messari, adding that buyers rushed to discover art that aligned with their “digital identities.”

NFT mania reached the mainstream in March when a collage by artist Beeple sold at Christie's for $69.3 million, the auction house's first sale of its kind. The artist, whose real name is Mike Winkelmann, responded with a tweet: “Holy fuck.”

Corporate players in art, sports and music — even Melania Trump — quickly began minting NFTs, essentially digital certificates of ownership registered on a blockchain, to capitalize on the hype and find new ways to connect with fans.

Other hits included numbered collections of NFTs that went viral, including CryptoPunks and Bored Ape Yacht Club, which denoted their owners' club status and are used as avatars on social media profiles.

“The core value is still exclusivity,” Nystrom said, noting that expensive collections also give buyers access to closed channels on chat platform Discord, as well as meetups and parties.

"They're country club-like: There's a high barrier to entry - cost of capital - and you're close to high net worth and other individuals," he added.

A total of $40.9 billion was put into the Ethereum blockchain contracts typically used to create NFTs in the year ending Dec. 15, said Chainalysis, a cryptoanalysis group. The total would be even higher if it included NFTs minted on other blockchains like Solana.

In comparison, the global art market was worth $50.1 billion last year, according to UBS and Art Basel.

Chainalysis found that NFTs have introduced a large number of retail investors to the crypto world, with small transactions under $10,000 accounting for more than 75 percent of the market.

But much like the cryptocurrency market, it continues to be dominated by a few large players or “whales.”

Between late February and November, 360,000 NFT owners held 2.7 million NFTs. Of those, about 9 percent – ​​or 32,400 wallets – held 80 percent of the market value, Chainalysis found.

Stephen Diehl, a crypto-skeptical software engineer, said many whales are "people sitting on hundreds of millions of dollars of crypto" from the boom in crypto prices "to turn their crypto into more crypto."

Others say they approach the market as professional dealers with collectors. A well-known NFT investor known as Pranksy on Twitter, which started with an initial investment of $600 in 2017, now has an NFT portfolio worth more than $20 million, it said.

They told the Financial Times that they invest in a mix of projects, “some of which have higher daily trading volumes and others of which have more niche appeal.” Aside from "flipping" lucrative projects, Pranksy said they have "certain pieces that I want to keep as a long-term investment."

So far, most new NFT collectors on the secondary market have not yet recouped the cost of their purchases, according to an analysis for the FT by blockchain analytics platform Nansen, where early collectors have also benefited from a rise in the price of NFTs as in the cryptocurrency they are traded with.

The unregulated space is also plagued by scams, scams and market manipulation, particularly because the identities of buyers and sellers are difficult, if not impossible, to discover in the real world.

Nansen's analysis found $2 million in suspicious activity in the CryptoPunk and Bored Ape collections in the 30 days ending in mid-December. Some NFTs, for example, have been sold at a 95 percent discount from the average selling price, either due to buyer and seller mistakes, tax write-offs, or other scams that took advantage of unskilled users.

Researchers have also warned that the market is likely to be inflated by wash trading - when a trader takes both sides of a trade to create the false impression of demand.

“You can buy and sell an NFT on a public platform and make it seem like there is a lot of interest in the piece if only you drive up the price,” said Rüdiger K. Weng, managing director of Germany-based Weng Fine Art.

“This happens in the traditional art world too,” he said, but added that if a manipulator gives a work of art to Sotheby’s and attempts a wash deal, he has to pay the auction house 25 percent of the sale, making it a costly venture. “With NFTs, the cost is a fraction of that,” he said, referring to the transaction fees, known as gas fees, required to mint or purchase an NFT, which can fluctuate depending on demand.

Nonetheless, there are many proponents who believe the market is maturing and will eventually offer a range of features, such as allowing artists to collect royalties in perpetuity.

“What can you do because it’s software?” asked Benedict Evans, an independent technology analyst and former venture capitalist. “It can be things like artist ownership and subsequent secondary sales,” he said, pointing particularly to early innovations in music rights.

The so-called “financialization” of NFTs is already taking place in some communities – for example, using NFTs as collateral for loans or dividing ownership of a single piece into smaller parts, known as fractionalization.

In the long term, enthusiasts hope that tokens will one day power e-commerce in every metaverse or metaverses, futuristic digital avatar-filled virtual worlds. Here, NFTs could denote ownership of virtual goods, be it clothing for digital avatars or art for the walls of their digital homes. Nike recently announced that it had purchased a virtual shoe company to coin virtual sneakers.

In any case, the future of the NFT market will also depend on the attitude of regulators towards the development of the freewheeling market.

Even among corporate issuers, there are concerns that NFTs share characteristics with certain digital investment vehicles and therefore could be viewed as securities by regulators. Devika Kornbacher, a partner at Vinson and Elkins, said that companies looking to issue NFTs regularly ask, "Is this NFT considered a financial instrument? Is it considered a security of our company?"

Meanwhile, tax authorities like the Internal Revenue Service have yet to deal directly with NFTs, but some experts argue that they could be considered “collectibles,” meaning they would be subject to capital gains tax.

“It’s a looming existential problem for the entire industry,” Pratin Vallabhaneni, partner at White & Case, said of the upcoming regulation.

Additional reporting by Eva Szalay and Siddharth Venkataramakrishnan