TL;DR

Nonfungible tokens (NFTs) are priced differently from their fungible counterparts like Bitcoin (BTC) and Ether (ETH). The value of NFTs varies depending on their category, design, and in some instances financial rights or utility. As more and more people are starting to learn about NFTs the question that still remains unanswered is,

How do NFTs derive their value?

The reality is there is no exact science behind it, and there is no black or white answer - it’s mostly, if not always, gray. But unlike physical non-fungible objects, like a Mona Lisa or Jackson Pollock’s artwork, NFTs have some unique digitally traceable characteristics that can be valued objectively. And I think, these characteristics or value multipliers should be taken into account when valuing an NFT. These value multipliers can be classified into:

1. Technical Value Multipliers: Chain Security, Level of Decentralization, and Scarcity
2. Functional Value Multipliers: Utility and Liquidity
3. Hedonic Value Multipliers: Desirability and Creator + Community

1. Technical Value Multipliers

Chain security

The entire point of NFTs is that they’re immutable and guaranteed digital assets—as long as their underlying blockchain infrastructure stays immutable and guaranteed, that is. As such, Ethereum is the reigning NFT network in no small part thanks to the fact that it’s easily the most secure smart contract platform running today, and that dominance is poised to continue for the foreseeable future.

In other words, the chain an NFT is minted on contributes to and secures, its value over time. This is why NFTs minted on Ethereum are currently more valuable than NFTs minted elsewhere.

Scarcity

It is a major underlying cause for value, similar to the total supply of a fungible token. Rarity factors are the most powerful things that are added to an NFT collection. The rarest NFTs in a collection will typically be the most valuable ones in the marketplace. The CryptoPunks example below, while a simple depiction of the rarity and sale price in action (report here), provides an insight into what the market values - and quick math that validates the market valuation.

This is not to say that if the math works for CryptoPunks, it will work for other NFT projects too - they had a limited set of traits and attributes. NFT creators programmatically adjust the supply of NFTs to impact rarity; for example, minting 1,000 base collectibles and only 10 gold tier collectibles. In other words, if all variables are held constant except rareness, scarcer NFTs are priced higher. This forms the basis of valuation models for collectible NFTs based on the statistical rarity of attributes.

Level of Decentralization

NFTs minted totally on-chain, like Avastars, Aavegotchis, and Art Blocks drops, only rely on their respective Ethereum smart contracts to exist. This means they’ll be around for as long as Ethereum exists, which will probably be a very long time.

On the flip side, some NFT projects opt for ease and flexibility by making their NFTs rely on external, off-chain providers like AWS. This introduces a dimension of trust, so you have to hope that the project will stick around and keep its servers running. Otherwise, you might effectively have a blank NFT within a few years. As such, the more on-chain an NFT is, the more raw self-evident value it has — it proves itself and can prove itself at any time.

2. Functional Value Multipliers

Utility

This is perhaps the most open-ended aspect of an NFT. The utility of an NFT describes its functional and financial value.

• The NFT holder has rights to a functional good, service, or asset. For example, software access via NFT licensing, intellectual property rights, or insurance coverage.
• The NFT holder has rights to future cash flows, which can be valued according to discounted cash flow models. Examples include resale royalties, digital real estate, and yield-bearing NFTs.

For example, one of the more novel concepts is NFT staking or farming. This refers to staking NFTs to a protocol to earn a yield. It gives NFTs passive yield-generating utility, and can be thought of as decentralized finance (DeFi) meets NFTs.

Onessus Blockchain Systems is a blockchain game and NFT publisher based in the United States. Its WhenStaking platform has proven the growing popularity of the idea of yield-earning NFTs.

Another form of NFT utility that is growing in popularity is redeemability. Redeemable NFTs allow the holder to exchange the NFT for either a physical or digital good. While not new, their prominence is gaining ground. NiftyVille, for instance, is furthering the exploration of redeemable NFTs. This redeemability element of the game creates a metaverse-real-world crossover entertainment platform, linking gaming and real life.

Liquidity

This is what attracts premiums from investors. Blockchain-based collectibles offer a higher liquidity value compared to “off-chain” collectibles. Investors may value NFTs issued on Ethereum, considering their ease of sale and volumes. However, there are several other blockchains (image below) that are creeping up on Ethereum’s market dominance.

3. Hedonic Value

Desirability

This pertains to the experience an NFT brings to its buyer. As they say,

Beauty is in the eye of the beholder.

• The perceived sociocultural value such as the relation to an artist, group, event, or cultural niche. This also includes the social benefits of owning an NFT — e.g., accessing exclusive digital communities, identifying with a group, or receiving respect and praise.
• A personal, sentimental, or aesthetic tie between the purchaser and NFT.
• This hedonic value can simply be the enjoyment of hunting rare items or completing a collection.

Creator + Community

If a person with no following and no history of creating drops an NFT on OpenSea or Rarible and doesn’t announce it, will it sell? Some, yes - but will require a lot more leg work to gain traction with the community. That’s why an NFT published by a major artist or creator gives it value. It’s stamped with the magic of the issuer’s digital fingerprint—no different than an autograph. The key to remember is that having engaged communities creates demand. Naturally, the more popular the creator, the bigger the community, the more valuable the NFT is — and this dynamic is basically true for any market.

And the community to a large extent resides on Twitter, Discord, and/or Telegram forums. Promising NFT collections are marked by enthusiastic communities that are garnering new members on a daily basis. So it is important to be aware of the following:

• The number of users in the Discord and/or Telegram group for that NFT.
• The number of Twitter followers.
• Growth over time in the number of Discord/Telegram users and Twitter followers. If the Discord is dead or the Telegram is full of bots, that is a big red flag.
• Are there any benefits that the NFT unlocks, such as exclusive content or chat rooms?

Conclusion

When it comes to NFTs, put your money where your mouth is. We’re all still figuring out how to accurately value them, and there’s certainly no right answer yet. And the speed at which the space evolves, it’s highly likely we’ll value them differently now than we do even in a year’s time. The bottom line is we have to tackle valuing an NFT from multiple angles. But if you can build a model, you’re way ahead of the curve.