There has been a lot of hype around non-fungible tokens (NFTs) lately, and a lot of confusion, so I thought I had better address it.  As it happens, I am involved in my spare time with electronic music production, and that is where a lot of interesting discussions are happening.  I’m going to outline the issues as they stand, and link to a lot of places where you can learn more.

Why Music is a Good Place to Start

Why focus on music production?  Well, there has long been a problem in the professional music community around ownership and distribution of income.  Since the advent of streaming via Spotify and others, many recording artists have seen their licensing revenues drop to a pittance.  CD sales have declined to the point where only the most popular artists are earning a living wage from album releases, and most need to tour to sustain themselves.  Obviously, that has been a huge problem in the last year.  So, there is a critical problem that NFTs may be able to solve.

The Problems with the Current NFT Market

A lot of focus has been on art NFTs, beginning with the sale of a digital artwork by Beeple for $69 million on March 11, 2021.  That eye-popping figure led to a lot of artists jumping on the hype train, as well as a lot of journalists.  Yet, when you look more closely, the more this seems like an anomaly.

It Is Hard to Value NFTs When Cryptocurrency Prices Are So Unstable

Figure 1 shows just how much the price of Ethereum (ETH) has changed over the past year.  From $231 a year ago, ETH rose to $2,560 a year later, for a 1,008% increase.  To put it mildly, this is not how currencies are supposed to behave.  We can also see that the dollar-denominated value of ETH was extremely volatile, increasing as much as 26.7% decreasing as much as 21.4% in a single day.  The average daily shift was 3.8% in either direction.

The chart shows the price and day-to-day change in Ether over the Past Year.

Source: Coindesk, 6/15/2021.

On March 11, the value of one unit of Ethereum (ETH) was $1,826, so the sale was for about 38,000 ETH. However, just two months later, on May 11, the value of ETH was $4,384. The same auction, for the same amount in US dollars, would have only cost 15,816 ETH, or half as much.  Admittedly, that was the peak of the cryptocurrency boom; since then, the price has gone back down, although it still would cost less ETH to do it today.

Let’s say the buyer obtained their ETH on January 1, 2021, just a few months beforehand.  At that point, ETH was trading at $731.  Let’s do the same analysis in reverse.  Accounting for the rise in ETH’s value from January 1 to March 11, the buyer would have spent 38,000 ETH at $731, or $27,778 million.  Still a lot of money, but much less impressive than $69 million.

How Much Was the Beeple Worth, anyway?

So, was the Beeple worth $69 million, $28 million, or something else?  Without a stable currency value, it’s hard to say.  The January 1 date was chosen arbitrarily; I could easily have picked another date, such as October 19, 2020, when ETH was worth half as much.  Since we don’t really know when the buyer obtained their ETH, we don’t know how much the NFT really cost them.  Note that you won’t read articles saying the Beeple sold for 38,000 ETH, because nobody knows what that means.  The US dollar, on the other hand, does have a stable value, and thus all the headlines we read are denominated in that currency.

This has serious implications for artists attempting to make a living from NFTs.  Depending on when they sell, and whether they hold the proceeds in cryptocurrency, they could be leaving money on the table.  Since the crash in ETH began on May 12, Coinbase (the source for all these values) has sent me alerts of a greater than 5% change in value almost every day.  If making rent depends on making enough money in token sales, you would want some assurance that you would get the amount of money that you thought you were getting.

Inflated Prices Have Led to Disillusionment, Harming the NFT Market

Indeed, we are now seeing reports that the NFT market is crashing.  A June 2, 2021 article on Gizmodo found that NFT sales had dropped 90% since the peak, to $19.4 million from $170 million.  Part of this is surely because ETH and other cryptos are not worth as much now as they were then, but the number of active NFT wallets has also dropped, from 12,000 to 3,900, nearly 70% less.

Toward a Better Kind of NFT

In contrast to the collectibles market, which is based more on psychology than utility, most of the debate in the music community has centered on practical concerns.  How can NFTs improve the life of a typical musician?

A prominent YouTube personality and professional musician named Benn Jordan posted an influential video on April 7, 2021, in which he pointed out many problems with NFTs as they existed at the time and urged musicians to wait for better options.

Climate Change is Becoming an Issue with Bitcoin and Ethereum

Jordan highlighted the environmental implications of “proof of work” cryptocurrencies like Bitcoin and Ethereum, which require enormous amounts of electricity to power the computers that solve the mathematical problems necessary to mine these currencies.  He points out that proof of work is not necessary to NFT production, and that proof of stake is just as good, and more environmentally sustainable.

Proof of stake relies only on one’s ownership of a certain amount of cryptocurrency and involves a governing body to enforce rules and create standards.  Proof of work cryptos are useful in trustless environments, but music is not one of these; there is already an elaborate network of contracts and trust-based relationships, not least between the artist and the listener.  The focus here is on creating new governance models that work better for artists than the current system of major labels and licensing agencies negotiating deals that have impoverished most working musicians.

Proof of Work Cryptocurrencies Cost a Lot to Use for NFTs

Another obstacle is the cost of creating an NFT. One article found the minimum cost to be $70, due to the cost of proof of work.  This means that NFTs must be at least $100 apiece, which puts them out of reach of the casual listener.  Single tracks can cost $15, which is hard to swallow at a time when an entire CD can be had for about the same price, and without having to join an exchange or purchase cryptocurrency.

A month later, Benn Jordan was back with a follow-up video, in which he described a startup called Orica.  Orica addresses several of the problems with the current NFT marketplaces, among them the cost of minting NFTs and the dependence on Bitcoin and Ethereum.  Orica has a native cryptocurrency, the ORI, which can be bought and sold with fiat currency and traditional payment methods.  As a result of this, the minting fees are much lower than on Ethereum-based marketplaces.  Benn describes a lot of possibilities that are not yet evident on the Orica site (which, to be honest, is not particularly good), but which are plausible avenues for development.  Note that Orica is only just getting started; actual “initial NFT offerings” are not scheduled until the third quarter of 2021, and the roadmap does not extend beyond the end of the year.

Bitcoin and Ethereum dominate NFTs, as they do other forms of commerce, because they are widely available now and are effectively the only game in town.  As better solutions develop, NFTs will detach themselves from the underlying medium of exchange and become a boring part of market-facing solutions. Just like payments!

Broadening the Audience

So far, I have been writing about a small community; most music fans are completely unaware that any of this is going on.  Getting them on board will require much more than utopian visions.

Adding Value to NFTs

At present, most NFTs suffer in comparison to existing music distribution models.  If the desire is to get back to the model of physical ownership of an artifact such as a CD or a vinyl record, then producers need to think about what is valuable about those artifacts.

In my view, the missing piece of streaming audio is the liner notes.  With CDs and vinyl records, these would often be an opportunity to provide lyrics, background information on the recording, artwork, and photos.  An analogous example from the world of DVDs is behind-the-scenes documentaries and commentaries.  Without the limitations of a physical medium, NFTs could grant access to a wealth of added content for people who want to go beyond the music itself.  It is already possible to provide private links to videos and other content, or codes to unlock content for download and consumption.

At present, most NFTs are like buying a t-shirt at a concert; they serve as a form of social currency, showing your support for an artist.  The t-shirt has some utility, but that is not the primary driver of the purchase.

Expanding the Market

Another problem is that the market at present revolves around uniqueness.  Due to the cost of minting, generally an artist will mint only one NFT for a given digital asset.  This appeals to collectors, but severely limits the size of the market.  Even traditional collectibles usually have runs in the hundreds or low thousands.

It is easy to see how an artist could mint any amount of NFTs, if the costs were low enough to support a mass market price point.  These NFTs could be linked to the added content mentioned above, and only those people who owned an NFT could access it.  Since the blockchain prevents duplication of tokens, anyone else who wanted to access that content would have to buy an NFT from the artist, or from someone who had previously purchased it.

Creating a Recurring Revenue Stream for Artists

This reintroduces the concept of resale value, which has been lost in an era of subscription services and licensed content.  Using smart contracts on a blockchain, it would be possible for the artist to get a small percentage of every NFT sale, so that they would have a recurring stream of royalties similar to what they get from radio or streaming.  From the consumer’s point of view, it would be an incentive to get rid of NFTs they were no longer using, to use the proceeds to buy something else.  This could mean that the number of NFTs minted for an asset could be much lower than for a physical release.

Initial NFT offerings, as envisioned by Orica, are a way for fans to help fund the production of music while maintaining a share of ownership and the royalties that come with that.  As with an initial stock offering, an INO is a way for popular artists to keep more of the value that they generate, while providing NFT owners with a recurring revenue stream like a dividend.

A Promising Future

In short, I see a lot of exciting possibilities for NFTs, across all digital asset classes such as art, video, writing, research, games, and many others.  I encourage interested readers to ask questions of NFT advocates such as:

  1. What can NFTs do better than anything else?
  2. What are the true costs of NFTs, considering transaction fees, commissions, and environmental impacts?
  3. How can buyers reduce market risk, given that the value of cryptocurrencies can fluctuate dramatically? What role could stablecoins or central bank digital currencies play in the future?
  4. What steps can we, as buyers and market participants, take to help development proceed in a way that maximizes the benefits and minimizes the costs to all stakeholders?

Since I do believe that NFTs are going to play a significant role in the digital economy, it is important that those of us with experience in payment systems and marketplaces get involved early, when we can have the greatest impact.  Using the faddish or cultish aspects of the current NFT marketplace as an excuse to ignore it would be a mistake.