The non-fungible token (NFT) market is growing and many more people are creating, buying, selling and swapping NFTs. There are many challenges in this new market and one of the biggest challenges is the valuation of NFTs.
The valuation of NFTs is a big unknown. There is no case on how the NFT should be evaluated, and its closest analogy to the valuation of the art is rather vague. It is clear that NFTs require a new method of valuation, and maintaining that value requires a better means of managing the digital assets associated with NFTs.
fair market valuation
For tax purposes, the value of the NFT is its fair market value or FMV. Fair market value is the price at which the NFT changes hands between a willing buyer and a willing seller, under no obligation to either buy or sell and both have reasonable knowledge of the relevant facts. This value may include rights over the display and reproduction of a real-world subject of the image as well as the digital image linked to the NFT based on the NFT’s smart contract which is based on contractual obligations between Vendor and Buyers of NFTs.
Fair market value relies heavily on the concept of the “most relevant market” – the market in which such a commodity is sold to the largest number of public. While auction sales may be deemed the “most relevant market” in some circumstances, the specific nature of each NFT, and the use of online marketplaces (eg OpenC) will be used to determine the “most relevant market”.
The analogy is how the artwork is valued. A print published last year is unlikely to hit the auction market. The same would be true for NFTs which are unique and are yet to be auctioned. So, in this case, the “most relevant market” is the asking price for NFTs.
But first, some NFT statistics:
- The most expensive NFT ever sold was “The First 5000 Days” by Beepple for $69.3 million – making it the most expensive virtual item ever sold on any platform in history.
- Between $10 million and $20 million worth of NFTs are sold on the blockchain every week.
- Nonfungible.com surpassed $2 billion in value in 2021.
- The collectibles market is the fastest growing digital market.
- More than a third of sales on OpenSea were less than $100; 53% under $200.
- For most NFTs, prices do not exceed $300.
- Production cost ranges between $70-$150.
- OpenSea and Atomic Markets trade close to each other at just under $90 million every 30 days.
- The total value of all NFT sales in 2020 was $250 million, four times the size of 2019.
- Trading volume was approximately half a billion dollars, with a market cap of more than three hundred and thirty-eight million as of December 31, 2020.
nine factors
The Bankless newsletter has the following factors to consider for evaluating NFTs:
chain protection. It is important for the buyer that the underlying blockchain remains secure. Ethereum, which is the most secure smart contract platform currently in existence, could contribute to the value of NFTs over time.
On-chain or off-chain metadata. On-chain is defined as the direct incorporation of metadata into the smart contract that represents the token, while off-chain representation means hosting the metadata separately, due to the storage limitations of the Ethereum blockchain.
On-chain metadata makes NFTs more valuable; partly because metadata is included in the token, allowing NFTs to last forever (or as long as Ethereum exists); And, partly because on-chain tokens have to meet certain Ethereum standards, giving them a premium liquidity and ease of trading.
When determining whether an NFT is on-chain or off-chain, the main question is where the NFT is hosted, that is, the Digital Asset Management System (DAMS) used.
Age. Since NFTs are very new, NFTs created before 2020 can be considered a “digital artifact” with higher value.
Creator and community. The broad marketability and recognition of a celebrity artist will affect the value of their NFTs compared to that of another, less well-known artist. Few NFT creators in the games industry have realized this and have partnered with notable artists to produce digital-first, one-of-a-kind content. These NFTs are attractive to buyers and are distinct and distinct from the types of physical goods available to buy.
scarcity and authenticity. Some NFT platforms such as SuperRare only support unique, single-edition digital artwork. Some marketplaces also break down their NFT offerings due to scarcity, for example, the NBA’s Top Shot ranks its NFTs in the “Normal,” “Rare,” “Legendary” and “Ultimate” tiers. Those listed in the higher tier tend to have significantly more value than their counterparts in the “Normal” tier.
Authenticity goes hand in hand with scarcity—for example, the Uffizi gallery in Florence has created an NFT of Botticelli owned by him, which is worth more than an NFT made from an iPhone image of a tourist. However, verifying the authenticity of the vendor over the Internet, and managing the intellectual property associated with NFTs, is difficult, if not impossible, without access to DAMS.
The lack of valuation of gaming NFTs is also a big factor, as such NTFs can only be obtained in very specific ways.
ReleasePace. The speed of release, or how many of these NFTs the producer mined overall, affect the value of the NFTs. A project that offers unlimited mints of NFTs at a nominal cost is generally not as tempting as buying NFTs from an artist who commits to making a limited edition of 25 NFTs.
Property. Prosperity is related to the additional features of an NFT. An audio component can add value as it can: 1) showcase a known artist, or 2) create an addictive loop for the audience. An NFT that combines a digital asset with access to a real-world asset or experience has an even greater value. This happened most recently when the Golden State Warriors auctioned off the NFTs of their previous championship rings and included a tangible benefit for the buyer, who could have had the experience of a VIP basketball game or a fake physical of a ring with custom name engraving. Could have been the version. One of these NFTs sold for over $800,000.
On the experience side, purchasers of the New Jersey Devils NFT had the opportunity to watch the 2021–22 season play in the New Jersey Devils Alumni Suite, featuring a Devils legend from a championship year. This NFT sold for $3,000; Whereas, some of the digital-only NFTs on the site are selling for only $100.28.
destruction of work. One approach that some manufacturers are using to increase the value is destroying the original work, either at the time of the transfer of the NFT to the buyer, or even before the sale takes place. Perhaps the most famous destruction event was the planned auction of a Basquiat NFT in late April. Auction sponsor DAYstrom advertised that the sale would include all relevant IP and copyright, and the highest bidder could choose to “deconstruct” (i.e. destroy) the physical drawing if they wish. The auction did not end, as Basquiat’s assets pulled NFTs from OpenC and clarified that the assets would retain the license and rights to the drawings.
Destruction may confer status on NFTs as a special digital asset; However, once the NFT is cast on the Internet, the destruction of the original does not prevent anyone from viewing, downloading, sharing and copying the image, unless there are enforceable restrictions on IP rights.
Origin Protocol recently auctioned off the “Charlie Bit My Finger” video to NFT, which was once the most viewed video on YouTube. Origin said it plans to remove the original video from YouTube so that the content can be memorialized on the blockchain. YouTube hasn’t taken down the clip yet, but the video has now added “Waiting on NFT decision” with the title.
contractual restrictions. Instead of destroying the original deed or giving the buyer the option to destroy it, the creator can always create an NFT of the physical item and retain the item. One place in which this happens is the art world: for example, art historian Ben Lewis created an NFT of Salvator Mundi by Leonardo da Vinci, with some minor modifications, without destroying da Vinci’s original work. It appears that the NFT is still listed on OpenSea and is not sold yet. Likewise, as noted above, the Golden State Warriors became the first professional team to launch the NFT Collection, in which the Warriors’ six NBA Championship rings were digitally reproduced as NFTs. Initial sales took place in early May and did not include the destruction of the original championship rings.
The manufacturer may add a motion to contractually restrict the performance of the original. Buyer would have potential breach of contract and copyright infringement claims against the creator if the creator were to publicly display or use the work. Again, the issue with this is how to manage the IP rights to the digital image associated with the display, or even the sale, of the original image.
Conclusion
As the NFT market roars, expect valuations to become higher, not less confusing. However, valuation is important, as the tax impact of buying, selling, trading and gifting NFTs will depend on whether the correct valuation is used to determine the relative value of exchanged NFTs, or to determine the cost basis. What. A charitable contribution and the value of a gift or property. What will also be important is how NFTs are handled in the underlying DAMS, and the methodology adopted by the IRS and ultimately the courts. Moving forward on both issues will be critically important as the NFT market continues to grow.
Matthew Erskine is the Managing Partner at Erskine & Erskine (www.erskineco.com).
