In March 2021, the auction house Christie’s sold a JPEG file created by the artist Beeple for $69.3 million, a record for a digital artwork. The ownership of the “original” JPEG—entitled “Everydays: The First 5000 Days”—was secured as a non-fungible token, or NFT.
The sale made headlines, and NFTs have since become red-hot. Investors poured $27 billion into the market in 2021, and Meta, Facebook’s renamed parent company, now reportedly plans to allow users to create and sell NFTs. There’s just one problem: the NFT market will eventually collapse, for any of a host of reasons.
In essence, an NFT is a tradeable code attached to metadata, such as an image. A secure network of computers records the sale on a digital ledger (a blockchain), giving the buyer proof of both authenticity and ownership.
NFTs are typically paid for with the Ethereum cryptocurrency, and—perhaps more importantly—stored using the Ethereum blockchain. By combining the desire to own art with modern technology, NFTs are the perfect asset for newly wealthy members of the Silicon Valley set and their train of acolytes in finance, entertainment, and the broader retail-investor community.
But, like other markets driven by exuberance, impulse purchases, and hype, the fast-moving and speculative NFT market could burn many investors. The current frenzy invites comparisons with the Dutch tulip mania from 1634 until 1637, when some bulbs fetched extremely high prices before the exuberance dissipated and the bubble collapsed.
The NFT market will likely suffer a similar fate—but not, as some might think, because of environmental concerns. To be sure, NFTs consume considerable amounts of energy, because cryptocurrencies like Ethereum and Bitcoin are “mined” using networks of computers with a large carbon footprint—one that grows with every transaction. But when it comes to understanding what will bring down the NFT market, climate impact is a red herring. The real problem is that the current NFT boom is built on a foundation of sand.
Start with the problem of infinite supply. NFTs offer ownership of a digital asset, but not the right to prevent others from using its digital copies. Part of the reason why wealthy investors are prepared to pay tens of millions of dollars (or more) for traditional physical artworks by the likes of Rembrandt, van Gogh, or Monet is that the number of masterpieces is finite; the artists are long dead and cannot produce new artworks. NFT copies, on the other hand, could become a commodity.
Moreover, as with all things digital, there is no difference in appearance between an original JPEG file sold for $69.3 million, and a copy downloaded for free online. In theory, the supply of legally usable copies of NFTs is infinite, potentially overwhelming demand for them and causing prices to collapse.
Because the blockchain is unable to store the actual underlying digital asset, someone buying an NFT is buying a link to the digital artwork, not the artwork itself. Although buyers gain copyright to the link, the transaction costs related to monitoring the infinite online venues for displaying NFTs, identifying illegitimate use, and pursuing and prosecuting infringement make it nearly impossible to enforce the copyright or deter misuse. This strongly limits monetization of the asset.
Another risk is that NFTs are being made and sold with infant technologies—blockchains and cryptocurrencies. There currently are multiple competing standards regarding how to generate, safeguard, distribute, and certify NFTs, including ERC-721, ERC-998, ERC-1155, flow and non-flow standards, and Tezos’s FA2. The resulting uncertainty as to how ownership certification will be guaranteed in perpetuity endangers the value of the assets and even their ownership.