NFT Investing: Deconstructing the Rabbit Hole

NFTs sit at the intersection of two sectors I love, art and the creator economy, as well as Flybridge’s overarching thematic focus on community-driven businesses and our successful blockchain investment practice (e.g. seed investors in FalconX and bloXroute). So, needless to say, it’s been exciting to watch the market evolve.

Before walking through current NFT market trends, and how to approach investing in NFTs, let me summarize some key findings. First, NFT investing can be approached from a multitude of perspectives — making money, collecting art, unlocking utility, accessing a community, or some combination of these motives. Investors should have a clear objective(s) before getting started, and align their due diligence accordingly. Next, there are several NFT project attributes to consider, falling broadly into two categories — qualitative and quantitative attributes. Qualitative attributes include the NFT project’s utility, aesthetic, creator, and community. The quantitative attributes include rarity, holding ratio, and price and trading volume. This is not at all an exhaustive list, just a starting framework. Ultimately, investing in NFTs is, at least today, a lot like investing in early stage startups. Qualitative attributes, like the strength and passion of the community, can be highly indicative of the potential vitality of a project, especially in the absence of historical data.

With that, let’s dive in.

Framing the Current NFT Market:

For quick context the NFT market, while NFTs have been around for years, they are still in the early stages of mainstream adoption. As of June 2021, it was estimated that roughly 4.1M Americans, or just over 1% of the population, had bought or sold NFTs (source). Comparing this utilization level to other technology adoption cycles helps illuminate the nascency of the NFT market. In 1991, for example, internet penetration was ~1.2% (source).

Over the last year, however, NFTs have seen incredible growth in pricing, buying and trading volume, and general mainstream familiarity. It’s likely that NFTs are at an inflection point, and moving from the “innovators” to “early adopters” stage of the technology adoption curve. Q3 of 2021, in particular, saw explosive growth, with NFTs hitting over $10 billion in trade volume, a 704% increase from Q2 2021 (source). As shown below, the number of unique wallets that have bought or sold and NFT increased from roughly 425,000 to 826,000 over the last three months.

(source)

It’s difficult to draw definite conclusions about what exactly is driving this growth (e.g. what percentage of growth is due to unsustainable “hype”), especially given the quickly growing number of applications for NFTs. Interestingly, however, I’ve found that some parallels can be drawn between the motives of traditional art investing, and NFT investing. Put simply, some people buy art because they love specific pieces or creators. Others treat art as an asset class. Oftentimes, motives lie somewhere in the middle, with overlapping objectives between appreciation and utility. Importantly, regardless of motivation, art ownership generally unlocks access to a certain status, social capital, or community (importantly, this access is often also a motive of its own).

In combing through Twitter, and talking to passionate NFT collectors, it seems that few people have concrete or mathematical approaches for identifying which NFT projects to invest in. Many legitimately shared that a project’s “vibe” was a key determinant in whether or not to purchase. For those who view NFTs as art versus an asset, this approach is understandable. (Or maybe because many early NFT collectors are high school and college students without prior investment experience).

While I’m by no means an expert, and it’s TBD if picking NFT projects on their way “to the moon” can be reverse engineered, there are likely some attributes that can help determine how “successful” a project could become.

Picking an NFT project to invest in:

First, determine your objective(s) before purchasing an NFT. In particular, are you interested in NFTs aesthetically, or as financial assets? If you plan to use NFTs as vehicles for financial returns, do you want to buy and hold (in the case of NFTs and crypto, the hold strategy could be a 6–10 year duration), or buy and flip? Is there a cause, or community, you care about that joining an NFT project may unlock access to? For many, it’s likely that motives touch on multiple objectives. But, regardless, having a clear picture of what “success” looks like is an important starting point. (I personally have approached different NFT projects with different objectives. For example, I evaluate some for utility, and others more artistically).

Once you’ve thought through your objectives, you can evaluate NFTs from two major project attribute categories — those that cannot be numerically measured (qualitative attributes) and those that can (quantitative attributes). The qualitative attributes I focus on (although not completely exhaustive) are a NFT’s utility, aesthetic, creator, and community. The quantitative attributes I focus on are rarity, holding ratio, and price and trading volume.

Qualitative Attributes:

Utility:

The most successful NFT projects provide some form of utility — either virtual or “real world” — to members. Bored Apes Yacht Club (BAYC), one of the most successful NFT projects to date, hosted a series of exclusive and extravagant social events during NFT.NYC. Events ranged from Yacht and warehouse parties to immersive gallery experiences, and were only accessible to BAYC holders. Other NFTs grant owners access to digital forms of utility, such as special features and resources within video games. (It’s worth noting that utility can live at the NFT project level, as well as at a specific NFT attribute level. For example, owners of NFTs that have a specific stylistic element may have access to additional layers of utility not available at the broader ownership level.)

Lastly, many projects will provide a project roadmap, detailing plans for future utilities. If the project is far along enough to do so, it’s worth noting whether or not roadmap milestones have been met, and how “valuable” future utilities will be.

Aesthetic:

This attribute of an NFT, while obvious, can sometimes be overlooked — what does it actually look like! Do you like the appearance of the piece? Are you proud to display, in private or to others, both digitally and physically? There are a growing number of digital galleries where owners of NFTs can share their pieces as part of curated collections. There are also dozens of hardware offerings that enable the physical portrayal of NFTs in both public and private spaces.

The Creator:

In addition to the piece itself, it’s worth spending some time learning about a project’s creator before purchasing an NFT. Is the artwork algorithmically generated? Or, is the creator a longstanding or respected artist who’s recently made the jump to the NFT space? There is no right or wrong answer regarding which is “better.” But, investors should consider their preferences, in line with specific and unique motivations for purchasing NFTs in the first place.

Personally, because I have a background in art, I’ve gravitated towards NFT creators that are artists in the more traditional sense. One of my recent NFT purchases, for example, was created by Steven Rea. Rea, or “Brain Vomit”, is a Bay Area artist who’s been painting and sketching since he was a kid. While he’s only recently entered the digital art space, he’s a respected artist within his category. And, importantly, I felt his aesthetic would translate well to the digital world.

Beyond his art, I’ve been incredibly impressed with Rea’s commitment to nurturing and growing his NFT community. He’s an active and positive participant on the project’s Twitter and Discord. And, moreover, although the project’s price floor is rising, he’s committed to reinvesting proceeds back into the community, other artists and and relevant social causes.

Again, these are qualities that resonated with me, given my buying objectives.

Community:

The size, activity level, and other measurable elements of an NFT’s community are important to track before making a purchase. However, it’s also worth trying to suss out who is a part of the community, why they joined, and how they’re engaging with other members. Comb through a project’s Twitter profile to see who’s elected to follow or post about the project. Do community members seem credible within the NFT space? Do they list, or display, NFTs of other well known projects on their profiles? Has anyone “high profile” in the NFT space endorsed the project (cough, cough Gary Vee)? And, looking at the current floor price of the NFT, does the overall quality of the community feel high in comparison?

Also spend some time combing through a project’s discord. In addition to message volume, what topics are getting the most attention? Are members just discussing how to pump prices up, or actually engaging in meaningful conversation about the future of the community or project? See below for a legitimately unprompted message from a NFT community I’m a part of.

The community of this NFT project, aesthetically centered around flowers and gardens, also spends a lot of time discussing how to make a positive impact, in particular around reducing carbon emissions.

Lastly, it’s worth noting how engagement is distributed amongst community members. Are there only a handful of loud voices in the room? Or, is involvement and contribution more evenly distributed. Additionally, is the creator of the NFT actively participating? (Arguably, at scale, the NFT creator shouldn’t have to fully manage and engage the community, as members need to derive value from interacting with each other. This is a theme I, and Flybridge, has thought at length about in regards to the creator economy. However, in the early days of a project, creator engagement can be critically important to building the initial community and overall excitement for the project). To that end, some NFT creators maintain anonymous identities, which can sometimes be a red flag.

Quantitative Attributes:

Rarity:

At a high level, “rarity” starts with the size of the project — essentially, how many NFTs a given project consists of. Some projects have 1,000 NFTs, others have 10,000+. Projects with 10,000+ can still be considered “rare”, but it’s worthwhile to note project size at the onset.

From there, each NFT within a project will have specific attributes with varying levels of rarity. Take one of my NFTs from Brain Vomit’s Garden. Under the “properties” tab on Opensea, you can see the rarity of each NFT attribute (e.g. background, mouth, eye, etc.) Platforms like rarity.tool help provide an overall rarity score for NFTs given these qualities. Interestingly, I’ve used rarity.tools to assess the correlation between NFT price and rarity score, and the two are not necessarily always perfectly correlated. In other words, there are times when NFT “X” is priced higher than NFT “Y” within the same project, despite being less “rare”. This could be a result of multiple factors — overall aesthetic, number of “likes”, trading history, etc. I’m still monitoring rationales for price and rarity discrepancies.

Lastly, while mostly supported by anecdotal data, an item’s perceived rarity can also be impacted by it’s previous owner(s). This attribute mirrors the concept of “provenance” in the traditional art investing world — essentially, who owned a piece previously, where it may have been shown or displayed, and how that in turn impacts its value. There are a host of interesting implications here when it comes to NFTs, especially as ownership is inherently transparent via the blockchain. The“tastemakers” of NFTs currently seem to be the Gary Vee’s of the world, endorsing projects on Twitter and the likes. However, there could be interesting implications around the concept of curation as the sector evolves. Who will be the curators of NFTs?

Holding Ratio:

In addition to evaluating a project’s community from a qualitative standpoint, project “health” can also be evaluated by examining the ratio of NFT owners to total project size. In other words, for a project with 10,000 items, is the ratio of owners to items 20:500, or 2:5,000? Projects with owner:item ratios of 50%+ are generally deemed “healthy”, as it indicates that an engaged group of users love and believe in the project, rather than just a select few.

Looking at Bored Apes Yacht Club again as an example, you can see the project currently has 10,000 items and nearly 6,000 owners — a very healthy holding ratio of ~60%.

Price and Trading Volume:

Tracking a project’s price, and trading volume, can also be indicative of vitality. Opensea shares data on price floor, as well as average price. I personally find price floor to be more informative, as a few high priced outliers can skew average price data. There are no hard or set rules around optimal value or growth rate for floor prices. (This is especially true because in the early days of a project — when it often makes sense to buy — there is little historical data to observe.) That said, looking at pricing data and trends in the first days or weeks of a project, and whether or not there seems to be steady growth on both fronts, can be helpful.

In conjunction with price, trading volume data can help indicate the potential success of a project. Importantly, Opensea trading volume is represented in total value (# of NFTs traded x price). Accordingly, make sure to assess if the number of trades is slowing, steady, or growing, rather than just the price of NFTs. This can also be teased out by looking at the time log for each trade. Generally, the higher the trading frequency, the better (e.g. in minutes, not days or weeks).

Again, while these attributes are important to inspect, given the limited amount of data available around price and trade volume in the early stages of a project, they cannot be examined in isolation. A project’s qualitative attributes, such as health of the community, are equally, if not more important.

What’s Next?

Overall, the NFT market is still a massive “unknown” and in the earliest stages of development. In many ways, investing in NFTs is a lot like investing in seed stage startups. With limited historical data, investors must make decisions based on team and vision. But, as we’ve seen over and over again at Flybridge, an engaged and passionate community can be a great indicator, and tool, for growth.

As a parting thought, something I’m still thinking through, and watching closely, is what exactly it is that binds the most successful NFTs communities together at the onset. Investing in NFTs is still rare, relatively speaking. So, to some extent, investors are bound together just by participating at all. But, for projects centered around specific interests, are all NFT holders actually invested in the causes that seemingly make the communities so strong? Or, are investors piggybacking on the strength of those communities to hopefully turn a profit? And, as those communities scale, how does that potential impurity impact the projects vitality?

I’m excited to see how things continue to unfold over the coming months. More to come…

If you’re building in this space, I’d love to chat. You can find me at julia@flybridge.com.

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Early Stage Investor @ Flybridge & X-Factor Ventures | GP @ The MBA Fund | Previously @ Underscore VC, WeWork, and Plum Alley Investments | Wharton MBA

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Julia Maltby

Julia Maltby

Early Stage Investor @ Flybridge & X-Factor Ventures | GP @ The MBA Fund | Previously @ Underscore VC, WeWork, and Plum Alley Investments | Wharton MBA