“Hey John, what's our QR code strategy?” - Disney President (2011)
The “what’s our strategy for X?” questions haven’t stopped since. From Vine to Vessel, Go90 to Google Glass, iTunes Ping to Periscope. Bosses, advisory clients and fellow execs have always come my way to (1) develop an early mover advantage, (2) drive near term, opportunistic revenue, and (3) “innovation signal” as a thought leader.
Well, NFT’s have now entered the chat.
After quadrupling in market size in 2020 to $250M, only to then surge to $2B in Q1 of this year, NFTs have of course piqued the interest of yours truly (bad habits) and our clients alike. 7 weeks, 28 conversations, 6 deal proposals and loads of reading have led to more questions than answers. That said, I'm unpacking it all best I can in a streamlined brand cheat sheet below covering the main value drivers, reasons to exercise caution, and our view on how brands should think about the space.
Let’s start by level setting on just WTF an NFT is.
Short form below. For a mid form explainer go read, Explain it like I am 5: NFTs.
NFTs are unique and indivisible crypto assets that can represent a variety of goods such as art, video, music, real estate, news stories, tweets (Dorsey’s 1st tweet, "Just setting up my twttr,” sold for $2.9M or $120K per character if you're counting) and other oddities (a NYC film director sold a NFT Fart for $85), are all just a few among them.
NFT ownership is verifiable through a public blockchain like Ethereum, which makes assets difficult to forge without complicating authentication.
2 Main Value Drivers
Digital Scarcity - In a world where digital content is infinitely sharable and replicable without “permission” or renumeration, the effective value of that content is close to zero. The more unique and scarce an item, the more perceived value it has. Bitcoin fixing supply at 21M bitcoins is the prime example.
The "Solution in Search of a Problem", Finally Found its First Problem to Solve - Crypto is for all intents and purposes a hermetically sealed economy. Ridiculous crypto-wealth is sloshing around with nowhere to go. It can’t be readily put to use in the less speculative asset classes such as real estate so why not funnel it into the only thing crypto billionaires can currently buy - crypto "art".
Reasons to Exercise Caution
Mega Volume, Minuscule Buyer Pool — Insane levels of volume in Q1 (up 25x from December 2020) came from a very small pool of buyers and resellers. Said differently, NFT demand is consolidated around only a few “active wallets". Here’s a startling stat… According to Nonfungible.com's “real time” tracker (which leverages a methodology I am admittedly ill equipped to vet) there are only 2,963 Unique Daily Active Wallets buying or selling NFT assets. Granted, we expect this number to bounce around in what is a wildly speculative new market. That said, as cryptocurrcency continues to garner mainstream awareness/interest through increasingly lowered barriers to entry, NFT participation is sure to follow suit.
Speaking of Mainstreaming — Companies selling toilet paper and light beer are tailgating on NFTs’ newfound popularity. Disingenuous commercialism could be one interpretation. Harmless fun is another. Either way, the exclusive, insider, early adopter feel of it all will undoubtedly give way to various modes of mainstream exploitation and particularly off-the-mark executions will slowly erode whatever "cool factor" remains.
Ownership & Vulnerabilities — When someone buys an NFT, they’re not buying the actual digital artwork; they’re buying a link to it. Or worse, they’re buying a link that, in many cases, lives on the website of a new start-up that’s likely to fail within a few years. Decades from now, how will anyone verify whether the linked artwork is the original? And, if continually resold how might the original asset creator share on the promise of their perpetual claim to future rev share? Herein lies another 'broken promises' aspect of NFTs with royalties. Currently royalties don't crossover to other platforms. If I am a creator and mint my NFT on Rarible and sell it, I can collect a royalty every time that NFT is sold within Rarible. But if a new owner takes it over to OpenSea, my royalty doesn’t survive. A proposed EIP to address this is in process (get wonky and read the proposal here). Seems for now vulnerabilities are being glossed over with the market moving as fast as it can to catch up.
Environmental Cost — Like Bitcoin, “mining” Ethereum requires computers to handle the computations and those computers require considerable energy. An analysis from Cambridge University found mining for Bitcoin consumed more energy than the entire country of Argentina. A vastly scaled NFT ecosystem could layer additional environmental consequences onto the mounting Bitcoin mining concern. Some discussions in crypto circles have taken place on this topic but no immediate solution is on the horizon.
Legal “Gray” Areas — Money transmitter (Crypto <> USD) licenses, “know your customer” requirements, income tax consequences, and anti-money laundering regulations are but a few areas that have yet to be properly explored legally. Good high level summary here.
How Brands Should Approach the Space
Overall, get in the game at your pace. "We're in the gold rush phase of NFTs, with parabolic upside and downside," says Seth Shapiro, CEO of Artaku NFT. "Brands and talent approaching the space should do their research and avoid feeling rushed."
Yes, there’s definitely a valuation bubble particularly around the most high-profile items, but we believe the future of the NFT business is affordable, sustainable and inclusive. This outlook may fly in the face of digital scarcity, but we see hype cycle evolution coming here.
For those that aren’t in pure observation mode, there are 3 main ways we’re seeing and helping NFT forward-thinking businesses explore right now: DIY, Agency, JV-type model.
DIY - If you have the capabilities to conceive and create digital assets, own a DTC audience and know how to mobilize them, and can stitch together the right NFT ecosystem partners – then DIY is an option. Be warned however – DIY is high risk, high reward. Low barriers to entry breed speed to market and speed to learning but Partner diligence will be complex and murky to navigate.
Agency - Consider an agency if you are a more passive licensor and/or want to outsource risk and lean on experts and OPM to get into the space. The agency route is lower risk, lower upside. Higher barriers to entry as the few top agencies are being bombarded with supply-side interest. Partner diligence still complex and murky to navigate.
JV or Virtually Vertical - An option if you see NFT as a key area of growth and are looking to build your own O&O branded solution or a niche marketplace. Highest risk, highest reward. High barriers to entry but its possible to claim a significant first mover advantage. Partner diligence will still be complex and murky to navigate, but all the more critical.
And I’ll even throw out some tactical thought starters for your consideration:
Dazzle at the Point of Purchase - Digital commerce data suggests that the moment of purchase now creates more of a rush than when the actual item arrives (obviously shifts from buying groceries to a rare sneaker). So, if more pleasure is generated by the act of purchasing than holding a sneaker in your hand, why even bother with the real thing? Find ways to make that digital point of purchase and post buying experience magical.
Build Hybrid-Scarcity with Physical x Digital Product Bundles - Let your biggest physical collectible customers, build / trade / sell their digital shelf with matching digital replicas that may be able to come to life in the meta verse. Funko primed to be a first-mover here.
Tradeable, Recurring Experiences - Building on the previous O2O (online to offline) point but adding in a live experiential element, Kings of Leon dropped an NFT album making a quick $2M bundling in LE digital art as well as front row tickets to future concerts - for life. This is a right that can be sold or traded once you’ve had your fill. This hints at the path to the O2O rainbow NFT might bring about for brands."
For now, we at illum remain diligent but optimistic from a brand standpoint and have opted for the "Agency" model for 2 of our clients. We always thrive in finding the opportunities amidst unc