Looking Beyond NFT From Million Dollar JPEG Energy Hogs To Its Value Proposition

The value of digital content can be captured in NFT (Non-Fungible Token), a type of cryptocurrency that is stored on the Ethereum blockchain. This allows anyone to create a token or tokens for their digital content and sell it in an open decentralized marketplace. The NFT industry emerged in 2020, as prices of minted tokens soared based on their demand. NFT include drawings, songs, music, gaming rewards, video clips, tickets, novelty items, and just about anything digital or physical that can be tokenized. The NFT is not the content itself, but it is what gives access and ownership to the content.

NFT falls under the category of rare collectible items that are unique and thus “non-fungible”. That means you cannot easily replace one item with another because they are not the same. Money is fungible because you can use any $20 bill to pay for an item. A non-fungible item cannot be substituted for another item. There can only be one type of that item. It is like a genuine authentic Picasso painting, which if lost or stolen cannot be replaced by another painting. Willing buyers have paid as much as $69M for digital art (a file created by artist Beeple) so this shows there is a market out there for NFT.

A Ridiculous Market

Some critics have described some NFT as nothing more than overpriced JPEG or GIF files. Others are video clips of NBA highlight reels or memorable moments like Jack Dorsey’s first tweet (the very first tweet on Twitter). The expectation is that the NFT gives exclusive access and rights to its holder. A digital artist may hold the original file, but they can still make copies of it. Once the image is rendered on a browser over the Internet, viewers can download the file. If there are restrictions to downloading the file, viewers can take a screenshot or use screen capture tools to take a picture of the image. There are so many ways around the restriction, even using a smartphone camera is possible.

There are other critics who call it a hype because many people are just FOMOing into NFT due to popularity. Public influencers, celebrities, athletes and social media creators join digital artists in launching their NFT. The vast amount of money that is coming into the space is certainly attracting a lot of attention. Some artists, while acknowledging the significance of NFT in the art world, also see it as potentially harmful to an emerging industry. With valuations going into the millions for art work like that from Beeple, it could be a bubble that is about to burst.

The speculative nature of the NFT market does not seem to make sense. Why are people willing to pay millions for a JPEG image? What an NFT allows is for the tokenization of content for establishing ownership that is verified on a blockchain like Ethereum. The owner can then sell it in a decentralized marketplace, either directly or through a platform. The NFT can be a one-of-a-kind digital asset that no one else owns, much like a limited edition car or vintage baseball card. This has an appeal to collectors and dealers who value rare items. Many questions still arise as to whether it can implement copyright laws, prevent others from copying the content, or if NFT is a new way for artists to sell their content directly.

It seems vague if NFT doesn’t have any purpose other than establishing “digital bragging rights”. What the creator of an NFT owns is actually just metadata that describes the content. The promises of valuation could be empty for all we know. A comparison can be made with businesses that experienced a boost in capital investment without much explanation during the Dotcom Bubble of the 90’s. Many dotcom businesses were born with novel ideas, but many later failed to materialize. That surge of investment had plenty to do with the popularity of the Internet at that time. Perhaps NFT is different, but explaining their valuation is going to be the hard part.

Energy Waster And Harmful To The Environment

While the news of NFT has been circulating in the art world, many artists seem open to the idea but there are also those who are not. Some artists have put attention to how the creation of NFT are harming the environment. This is coming from the narrative that cryptocurrency requires a large amount of energy to produce, so this leads to more carbon emissions per token. There is a reason why plenty of energy is required for cryptocurrency like Bitcoin. Opponents of cryptocurrency have long made the argument that cryptocurrency, specifically Bitcoin, is an ecological disaster that wastes a lot of energy. Ethereum, although similar to the Bitcoin blockchain’s consensus, does not consume as much energy.

The electricity required to create a coin or token is based on the Proof-of-Work consensus mechanism algorithm. When creating cryptocurrency like Bitcoin, a network of computers called nodes compete with one another to validate a block of transactions. The purpose of this system is to help secure the transactions and protect the network, by creating a puzzle that nodes must solve to produce a block. The node that solves the puzzle first becomes the validator and receives a reward for providing their computing resources, in the form of the cryptocurrency (e.g. BTC for Bitcoin or ETH for Ethereum).

The problem is that over time, as more nodes join the network, the Proof-of-Work algorithm makes solving the puzzle much harder by adjusting what is called a difficulty target. This is to ensure a form of fairness among participants. This increases the difficulty of solving the puzzle, since the nodes have to expend more computing power to try to solve it. The nodes calculate large sets of numbers using their computer’s hash power (measured in hash rate or hashes/second). Plenty of electricity is consumed by these nodes in order to crunch the numbers to solve the puzzle.

According to indicators, the Ethereum network’s (the main blockchain of NFT) hash rate activity is 493.93 TH/s (as of 4/3/21). That means 493.93 TH (TeraHashes) of calculations occur every second to try and solve the puzzle. The higher the number, the more energy is required to perform calculations. Specialized computers are now used for this process which is called mining. The nodes or miners can use many computers, ranging from desktop rigs to data centers that use computer cards called a GPU for crunching the numbers. It can be an expensive investment for an individual setup, but fortunately, there are mining pools available to join. The criticism here is that due to the increase in difficulty from more nodes participating in the network, the energy consumption is averaging about 68.87 kWh per transaction (source taken from the Ethereum Energy Consumption Index). That is the equivalent energy consumed by a single US household in 2.33 days.

The Value Of NFT

The demand for NFT has grown, in part due to endorsements from popular celebrities and public figures. If these personalities see value in making an NFT, doesn’t that mean it is legitimate? Depending on perspective, perhaps we should ask who is buying the NFT. You can download images and other content for free from the Internet. You can even copy the content of an NFT, so why bother paying for it? It is individuals like collectors who have a motivation to pay for that content. They see value in rare and unique items. Perhaps it was due to nostalgia or as mentioned earlier “digital bragging rights” to own an item that no one else has. You can copy the content, but you are not its actual owner. NFT can establish who has rights on who owns that content.

Is it still correct to call this a “bubble” when it is not based on implausible or inconsistent views, but rather on the personal preference of an individual? To make my point, take as an example the buyer who paid $69M for an NFT. Either the buyer regrets it now, but more likely enjoyed making the purchase. That is because the value of owning the NFT is the very motivation to make a bid for it that ran up that high. This was not based on mere speculation, but on what the buyer was willing to pay for. We can speculate on the price of gold or BTC to go up in value in the future as an investment or hedge, but pay for it according to the market price. When it comes to NFT the buyer is willing to pay based on what they want to give it value for.

The value is still market driven because biddings are allowed on platforms that sell the NFT (e.g. Rarible, OpenSea). No one has to purchase an NFT based on the given price. If a buyer wants to outbid another buyer, they can double up the price. They can also lower the bid. This can go on until there are no more bids made, and the last bidder gets the NFT. I don’t see it as a bubble in that case. As long as there are people willing to pay for an NFT, then it is not a bubble. These collectors may not even care about selling since most like to keep the items.

Think about the value of having the actual baseball that Babe Ruth hit for his last home run. Whoever owns it knows its value for all its worth. Likewise someone who owns a special NFT would hold on to it as well. They can always sell it in the future, but better yet they can monetize on the item without having to sell it through other ways (e.g. exhibits, promotions, copyrights, licensing, etc.). An NFT makes it easier to prove ownership in order to make monetization or promotion happen.

I was looking at the value from the buyer’s perspective for the most part. Now how about the creator of the NFT? What do they get out of its value? The benefits are clear. It allows creators like artists and musicians to establish their ownership of content with verification on the blockchain. This can help them make claims to copyright or intellectual property, but that also requires some legal backing. They can also earn on their NFT when it is sold, like a copyright fee.

Addressing The Issues

So what is the end game for NFT? There are those who say it is a bubble that is going to collapse. Others don’t see it as solving the problems of enforcing property rights and claims of authorship or authenticity. There are also artists and creatives who believe that it is harming the environment. It could be that those assumptions made against NFT are based on the high expectations people have for it. What is frustrating about knowing the benefits NFT can bring as a disruption, are those ideas against it.

I don’t think that the NFT market is like a cottage industry or the real estate market. Despite being speculative, it is based more on an individual’s preferences rather than mass appeal. This is a market that deals with a new asset class that is based on technology that establishes digital ownership. The uniqueness and scarcity of the content or property is what makes having an NFT desirable for some people. What is important to me is the aspect of being able to make a claim as the owner of a rarity and prove it with the help of the blockchain. Critics say since NFT is just metadata, that it won’t help if links to digital content are deleted or updated. Data stored on the blockchain is supposed to be immutable, so if the NFT points to an expired link then it does not establish anything for the owner.

When these problems are pointed out, this is where the community comes together to develop solutions. The cryptocurrency space is full of great minds, and that is not an overstatement. There are developers and engineers who work in the space who identify problems and propose solutions that require consensus from the community for deployment. NFT metadata on the blockchain can survive and never expire in order to establish the version of the truth that exists. A new file system called IPFS implements content rather than link addressing of files with an NFT, and a new blockchain-based naming service like ENS can help maintain access to content for NFT. These are also scalable decentralized solutions as well, so they aim to provide a high level of availability for digital content.

Others will say that NFT cannot enforce any legal means of ownership, even if it exists on a blockchain. This is a slippery slope regarding digital rights and ownership of content, but NFT can actually help. It is true that other people can make counter claims, and the blockchain does not prevent that. What is important here is to put the claim in legalese terms. If there is a clear protocol for creators of digital content to establish digital ownership of their content, then let there be an actual contract that is verified by law. This is where a digitally signed and encrypted legal document can be integrated with an NFT and by consensus on a blockchain establish the ownership claims.

While energy consumption is a function of economic activity, it doesn’t always directly relate to the burning of fossil fuels for emissions. This is because energy emissions are really dependent on the source regarding emissions. For Ethereum and other cryptocurrency like Bitcoin, the incentive to move to cheaper, cleaner and greener energy sources makes more sense than using expensive energy from the grid that burns fossil fuels. Many renewable energy sources like hydro, solar, wind and nuclear have less emissions, so if these were being used by the network it has less of an impact on the environment.

Compared to other industries, the carbon footprint of cryptocurrency is actually smaller. The carbon emissions can also be coming from other parts of the NFT minting process. This can be from the user, who uses their home computer or laptop that charged from the grid. Reports have come out that attempt to compute the amount of energy “wasted” by minting an NFT, but I don’t think those numbers are accurate. We cannot determine the accuracy because all people don’t use the same grid as everybody else and the Ethereum nodes that process the NFT may be using various energy sources.

It is also important to point out that when transactions are processed on the Ethereum network, energy consumed is not wasted but is based on total demand and for providing security. The busier the network, the more energy is consumed. The energy consumption increases as a requirement to maintain consensus and helps to secure the network by making attacks more energy-intensive than is possible. At the moment it may be inefficient on the Ethereum network, but that energy is not really being wasted. It is like how an internal combustion engine is inefficient in converting energy to work, by producing more heat when burning fuel. While it is wasteful, the mechanism is just not efficient in converting to useful energy. The Ethereum blockchain is also moving toward a new consensus algorithm that aims to be more efficient and to use less energy, which can help reduce their carbon footprint.

Synopsis

Since NFT are new, there are still many possibilities to explore to see how this asset class evolves. I don’t believe you should shut something down when the benefits can outweigh the disadvantages. It is like saying we should not fly on airplanes since it consumes too much fuel and has high carbon emissions. The airline industry eventually adopted guidelines and standards to reduce emissions and prevent air pollution. Awareness of the harmful effects led to action that has found a tradeoff between what is good and bad. Likewise, this is also true with NFT and cryptocurrency.

For some people, like creators and artists, this can be an opportunity to monetize more content. They can now do so in a verifiable manner with the use of a blockchain to record their ownership as well. It also simplifies their access to more markets where they can sell their NFT and connect with their fans. I understand those who do not accept NFT because of what they read or heard, but it should be something to consider. Such concerns are going to be addressed by the community since the blockchain is decentralized and not under the control of a single group or organization. Many different viewpoints are involved in the development of the blockchain, so it is about creating solutions that address the issues.

The system is in place and there needs to be more improvements to push for further adoption. There needs to be more clarity for NFT in establishing ownership, authenticity, property rights, content storage, and efficient use of energy. It is near impossible to come up with a perfect system the first time out. There will be flaws, glitches, and unintended consequences along the way. If NFT had no practical use or purpose, then the market would decide. There are people willing to buy NFT and that shows that it doesn’t require everybody to approve of an NFT. Its uniqueness and scarcity are what give it value.