Don’t dismiss the NFT digital art boom

Conservative investors need to see behind the speculative fever surrounding blockchain-enabled non-fungible tokens.

The Nyan Cat art video meme, which sold for $US590,000 worth of the Ethereum cryptocurrency.

If you are a rational and level-headed investor, you might be wondering what cryptocurrencies and NFTs have to do with you. I agree there are aspects of the cryptocurrency space that represent that which is typical of the late stages of a financial market bubble.

Indeed, there has been a veritable conga-line of greying fund managers who have decried cryptocurrencies as utter folly. But these same fund managers pontificate about the importance of being open-minded and voracious learners.

You might ask then, why even give the area attention? The answer is the nuanced and parallel universe that exists in blockchain.

Blockchain was an enigma to me until I began digging. I discovered the argument put forward by some crypto zealots that bitcoin is a currency “system”, and that it will become a universal currency replacing our world of fiat money is probably unsupported by reality.

But here’s the thing, it’s equally erroneous to suggest everything in the blockchain universe, including all currencies, is speculative nonsense.

Up to the end of 2017 and again in 2020, bitcoin took centre stage in the minds of more adventurous speculators, but in 2021 Non Fungible Tokens (NFTs) and Decentralised Applications on the Blockchain (Dapps) have claimed the spotlight, and it’s in the currencies supporting these projects that there might be something worth understanding.

NFTs came to universal attention when the “nyan cat” was sold in February for $US590,000 worth of the Ethereum cryptocurrency.

More recently, auction house Christies sold an NFT — a digital collage of hundreds of weird, brightly coloured images created over 13 years by a South Carolina artist known as Beeple — for $US69.3m ($90.4m). The price has only been exceeded by the works of two other living artists: Jeff Koons and David Hockney.

Now that I have your attention, NFTs create a digital token in the blockchain (the distributed ledger) that cannot be duplicated or swapped for another and is therefore “non fungible”. Each NFT is a ­tokenisation of asset ownership on the blockchain.

Think of a work of art in the physical world. When acquired, the art buyer signs a purchase contract transferring ownership, and receives a receipt and/or a certificate of authenticity. While copies and fakes may exist, the possession of the certificate of authenticity is proof of ownership (provenance) of the original work.

The NFT autonomously tracks and records the complete provenance and selling price history of the underlying digital artwork. This transparency means any ­potential buyer of an NFT knows when the underlying asset was “minted”, purchased, sold, at what price, and by whom. Additionally, all transaction history is completely transparent, further democratising information pertaining to asset transactions.

Your mind may now be turning to a vast array of possibilities. The rising popularity of NFTs might just represent the next evolution of blockchain machinery.

However, we have learned in recent decades that many businesses that failed to embrace new technology in preference for protecting legacy business models failed themselves.

According to trading platforms, NFT trading volume exceeded a record $US400m in February, more than the total volume traded last year. And with Google searches for “NFT” at a record, and the number of weekly users on digital-collectable platforms exceeding 450,000, the exponential growth looks set to continue.

Ethereum is the blockchain on which NFTs are growing, but an entire universe of Dapps — including games, gambling, collectibles, marketplaces and exchanges — is forming and each has its own or preferred currency.

The development of interest-earning cryptocurrency accounts is perhaps one of the more important recent developments in the sphere.

Ethereum, on which NFTs have been developed, is a decentralised, open-source blockchain that features smart contract functionality that a number of cryptocurrencies have also taken advantage of. More importantly however, the growth of NFTs demonstrates the potential of the blockchain for digital assets and therefore an emerging value for the currencies that can be transacted on it.

In addition to NFTs, Ethereum has become the largest platform for so-called DeFi dapps. An example is Compound.finance, which has $US12bn worth of crypto assets earning interest across 10 markets. Compound.finance uses an autonomous interest rate protocol algorithm on which developers build open-source financial applications.

Decentralised interest rate markets now allow lenders and borrowers to supply and access a pool of Ethereum-based tokens. If that sounds a lot like a bank’s business model generating a net interest margin, you’re not far off.

The consequence of these developments on the Ethereum blockchain is that cryptocurrency Ethereum (ETH) is now the second-largest cryptocurrency by market capitalisation behind bitcoin.

And therein lies the potential of some, but not all, cryptocurrencies to become a valid investment class. Cryptos are the currency of the blockchain. The more useful and widely adopted a particular blockchain project becomes, the more demanded its currency of choice.

There is every possibility that Blockchain 1.0 walks through the same refining fire that TechBoom 1.0 visited in 1999-2000, but there is an equal possibility that from the ashes an equally valuable 2.0 emerges to transform the world the way Google, Amazon and Facebook have already.

Roger Montgomery is founder and chief investment officer at Montgomery Investment Management