The Evolving Economics of NFT Summer — How NFT Staking, Dutch Auctions and Fractionalization Are Transforming the Market
NFT summer is sizzling. There’s no disputing it. Take a look at some of these OpenSea statistics below (the primary NFT marketplace). Over $1B in monthly volume in August (only halfway through the month), and over 116,000 unique users/wallets transacting. Data courtesy of dune analytics: https://dune.xyz/rchen8/opensea
This is massive growth, but in comparison to the overall crypto market (Coinbase has 68 million verified users), the NFT user base still pales in comparison. There is still tremendous room for growth.
With that said, the new users entering the NFT space in August 2021 are entering a changed market. New whales have entered and made a huge splash. One whale in particular, @Vince_Van_Dough, has single handedly impacted the Art Blocks market, driving up sales across the board and setting new record highs. Institutions have started to enter the space as well, with Three Arrows Capital (“3AC”), setting the CryptoPunk market on fire by buying 88 punks in a single block, effectively doubling the floor price in a day.
But whale action is not the only factor driving change in the market. There are new financial products offering NFT staking and lending, giving NFT holders more options for generating liquidity. There are new minting structures in place on sites like ArtBlocks changing both initial buying and the secondary market sales. And on top of that we’ve had the launch of Fractional (fractional.art) which may be the single biggest game changer in the market right now.
I’ll elaborate on each of these 3 impact drivers in this piece, along with some predictions for future impacts to the NFT market.
Almost every mistake I’ve made in NFT investing / trading has been selling an NFT too soon. Unfortunately, I don’t have a massive ETH bank to pull from whenever a new opportunity comes up, so up until very recently, I was forced to sell to make new buys. My personal horror stories include 4 Fidenza sales under 3 ETH (current floor at 35) and a Subscape sale at 0.17 (I cringe just typing that).
Thanks to NFTFI (nftfi.com), I am not forced to sell anymore. I can stake my NFTs as collateral for a short-term loan, receive short term liquidity, and still recoup my NFT asset as long as I pay the loan off.
Let me walk through an example. I have been buying up Genesis pieces from Art Blocks as I believe they’re undervalued in the market. I recently wanted some more liquidity for a new purchase and decided to stake one of my Genesis pieces instead of selling. In a matter of a few hours, I received a 3 ETH loan at 20% APY due in 30 days. That’s about a 50% loan to value, which is the standard I’ve seen most commonly (users can set their own terms and lenders can set terms as well).
While 20% APY sounds high, on a 30-day basis it’s not bad and on a 3 ETH loan comes out to only ~.05 ETH. I’m betting I can beat that return on my new buys (if I can’t in this NFT market, I should probably stick to something else). And as long as I pay 3.05 ETH (plus gas) by September 10, I get my NFT back.
This product is a game changer for me personally and I believe for all holders of blue chip NFTs who don’t hold massive ETH reserves. I am now able to extract liquidity from my assets without selling, with quick turnaround times, to move quickly on new opportunities.
In theory you could even turn this into a revolving line of credit. I could stake another Genesis in early September, and assuming I get similar terms, pay this loan off with the proceeds and extend the clock another 30 days. Of course there are risks here and holding costs to consider, so do your own research and analysis, but I like this idea of an NFT-backed line of credit quite a bit.
Right now, the loan terms are pretty favorable to the borrower in my opinion, so we’ll see if that changes as this market evolves (I fear it might). But in the short term, I’m absolutely going to continue using this service and I think we will see an influx of new borrowers and lenders. If adopted more widely, this could lead to supply shortages in some blue chip NFT markets (as traditional sellers are now staking instead), which would drive some prices up in theory. We will see if that plays out.
The influx of whales to the NFT market has brought along with it an influx of speculators and short-term flippers. Flippers have honed in specifically on low-cost minting projects, trying to buy in bulk, flip at 2–3x mint price and move on.
Historically one area that was the most profitable and almost risk free was minting new Art Blocks drops (Curated especially). These mint prices were typically set between 0.1–0.15 ETH, and in the past few months, floor prices would jump close to 1 or higher in the hours post mint. It was a flippers paradise. It was massively +EV (positive expected value) to mint every drop at this price point and speculators figured it out.
This led to increasing competition to mint which caused gas wars (the price to make the transaction), as more competition drove the price of gas to mint higher and higher. We saw upwards of 0.5–0.8 ETH in gas being burned for 0.1 ETH mints. The proceeds for gas go to miners and not the artists, so clearly this is not the optimal situation.
But the wise team at Art Blocks noticed this and came out with the fairest alternative — Dutch auctions. Dutch auctions start at typically a higher price point and reduce the mint price every X minutes until it reaches a bottom price or sells out.
Let’s look at an example from a recent Art Blocks drop, for the Scribbled Boundaries drop taking place on August 17th. Link here https://artblocks.io/project/131. The artist, William Tan, has set his Dutch auction to start at 3 ETH, with price reductions every 5 minutes until it reaches the floor at 0.25. You can see the intermediate mint prices in the screenshot below, as they drop by 0.5 until 1.5 and then by 0.25 until the floor.
We have seen some really interesting dynamics play out from this new structure in the past few weeks. In some instances, the market essentially “holds the line”, where there isn’t much buy action until the mint price drops to a very reasonable level, at which point the bulk of the community decides to buy in. This tends to happen more where there’s a higher supply and a higher starting price.
This worked out beautifully during a recent drop called “Pigment” by Darien Brito, which started at 3 ETH but ended up primarily minting between 1.25–1 ETH. Fortunately for Pigment holders, this collection was very well received and the floor almost immediately raised to 3.5, and thus was massively +EV for minters.
But in other instances of lower supply and lower initial mint price, we have seen collections “mint out” above their fair market value “fmv” and cause short term pain to flippers. An example of this was the recent “Obicera” drop by Alexis Andre. This is not meant to pick on Alexis Andre at all, but at the time of the Obicera drop his Curated collection “720 Minutes” was sitting around a floor of 2 ETH and his first playground collection Void was sitting around 1 ETH. The expected fmv for this new collection in my mind was also around 1 ETH, but people fomo’d in and it minted out at the 2 ETH level.
What happened next is a trend I believe we’ll see more of in this space — the true Dutch auction played out on secondary. There were not many secondary buyers at or above the price of 2, and slowly over the course of the next week, the floor price of Obicera settled around 1 ETH which has proven to be the fmv for “floor” pieces. And I believe it will stay there for a bit until the next rising tide.
To summarize this trend, the Dutch auction structure is removing gas wars and allowing the market to dictate the fair price for mints, which is the best outcome for the artist as they get paid instead of miners. It is no longer automatically +EV to mint every drop, and a savvy trader would need to predict fmv and then watch the Dutch auction play out to determine if and when to mint, and there will be times when the best decision is to sit out the mint (so painful for us who love the minting process). This is because when the market acts irrationally (typically driven by flipper fomo), Dutch auctions play out on secondary with a lot of price undercutting and the true fmv is reached below the mint price.
So what happens next? I believe we’ll see more widespread adoption of this auction format. We will likely see less pure speculating on drops, as they won’t be automatically profitable, leading to more true collector buying (which is better for the market).
This has been one of the biggest recent impacts on the market, but likely second to the single biggest impact — fractionalization.
One of the biggest buzz words in the NFT space since spring has been “fractionalization” — everyone was talking about the concept of buying up pieces of the highest price blue chip NFTs (i.e. CryptoPunks) to participate in the price action without having to front the rising price tags. This was happening in small groups behind the scenes but not on a wide scale.
Well, massive kudos to @andy8052 and the team at Fractional.art for bringing their product to market so rapidly, with a late-July launch. I’m not going to do a full primer on what fractional.art is, as I’m more focused on the impacts. But if you want to read more, check out materials on their site or here https://medium.com/fractional-art
For a very brief description, Fractional is a protocol that allows the owner of an NFT to essentially post their NFT in a vault, tokenize it into fractional pieces and sell those tokens to end users who become fractional owners in the NFT. It is similar to the concept of stock ownership in some ways, but on the blockchain and tied to NFTs instead of companies.
Let’s take a look at an example to see how this works in practice, by looking at Deeze’s (@deezefi) CryptoPunk “Uncle Hoodie” which was the first to be fractionalized. For quick background on Deeze, he is now a community manager at fractional but I’d describe him as a community manager for the entire NFT space, whose Twitter spaces have onboarded thousands of users into new NFT projects and who seems to be just a genuinely good dude who brings great vibes to the space.
Well a few weeks ago Deeze fractionalized his CryptoPunk #7171 and chaos shortly ensued. This is how it went down.
He started by fractionalizing his punk into 10,000 tokens and released 30% of the supply. He set a valuation range between 100–110 ETH (dictating token buy price) and a reserve of 150 ETH (the value at which the punk would be sold).
Well that 30% sold out in just a few hours. So he released another 50% of the token supply into the pool at an increased valuation range, and within hours the valuation range had risen to 126–150 ETH. He had acquired 183 unique holders and over $225k invested, all in a day.
This was just wild, wild movement for a single day. Token holders (“HOODIES”) were all over twitter, using their brand new CryptoPunk avatar. Hoodie punk valuations were skyrocketing across the board, and several were bought up in the chaos that ensued. I believe the floor price for a hoodie punk was over 200 ETH at one point shortly after this chaos, before coming down to earth a bit (155 ETH floor at time of this writing).
During this insane runup, Deeze and the HOODIE gang wisely raised the reserve price (which happens by majority shareholder vote as I understand it), and it currently sits at a reserve of 520 ETH and an implied current valuation of 163 ETH.
So in the 17 days since he fractionalized this CryptoPunk, the valuation is up 60% and the reserve 3x’d.
What drove this action? Well, two primary things. For one, this was all going on while Three Arrows Capital went on their 100 punk buying spree (including the 88 in one block) which set the market on fire. But I believe the single act of fractionalizing this punk also had a big impact in the market.
New investors now see a new means of liquidity in buying ultra-high even NFTs. What used to be illiquid now becomes a bit more liquid via fractionalizing. Buy the punk of your dreams, fractionalize 30–50% and get that amount of your capital back. You’re still the primary owner and you only had to front half the capital.
Well that’s the idea anyway. We will see how it plays out, especially if the market becomes more saturated with investors with the same idea. We have already a 2nd big punk fractionalized, with the new Zombie Party that launched a few weeks ago (valued at almost 1k ETH as of mid-August).
There will be several impacts to the NFT market and community caused by this massive launch of Fractional, but a few trends that I’m focused on and I see playing out are the following:
· The top blue chip NFTs will soar in value. We have seen this with CryptoPunks already and I think top tier 1/1s from the best artists (i.e. Xcopy) will shortly follow, along with the top tier Art Blocks pieces (Fidenzas, Ringers). There is now a new buyer pool for these pieces, backed in theory by potential fractionalization.
· Communities will form around these fractionalized NFTs. We have already seen this with the HOODIE gang and now DEAD gang, and we will surely see more. People love to be in communities — it’s fundamental human nature. Most NFT buyers can’t afford these high-end pieces but want to participate, and this is their entry point.
· Marketplaces will look to bring this functionality in house. I have to imagine the higherups at SuperRare, Foundation, etc., are seeing this play out and want to essentially “cut out the middleman” in this process. Why let investors buy up the top tier pieces, fractionalize it and take fees, when a savvy marketplace could do that themselves. I’m not certain yet if that would be in the marketplaces best interest long term, but I could certainly see this taking place.
In summary, the NFT market is rapidly evolving. There is financialization of NFTs happening in real time before our eyes and new products are transforming the market. It is really fun to watch unfold, and part of my personal mission is to help welcome new NFT entrants and help them better understand the market.
For quick advice, the best way to participate as a new user is to simply enter the space — maybe buy a few cheap NFTs, join a few discord channels, start to follow influences on twitter. And then begin to gravitate to the collections you connect with. Simply being in the space and following along will give anyone an advantage as this market continues to transform.
I for one am here for the NFT ride. You can follow along with my NFT adventure at @tyler_did_it on Twitter. Enjoy!