The Million Dollar JPEG
Why are NFTs valuable?
Originally published at https://brainflow.substack.com on March 7, 2022.
Having been building in the NFT space for almost a year now, I deeply understand why NFTs are valuable, but I also appreciate why people on the outside have a hard time understanding NFTs.
“Like why would anyone spend millions of dollars on a picture of a cartoon ape? I can just right-click, save it to my desktop and I have a copy myself. It doesn’t make sense.”
I get that.
I was there myself about a year ago.
It’s a weird world where value is seemingly created out of thin air.
Personally, I find that incredibly exciting because it allows NFT creators to create value where previously there was none.
And I admit that kinda sounds like a scam. How can somebody create value out of nothing?
TL;DR: it all boils down to social currency and collective belief.
And today I hope to pull back the curtain on this a bit, give some insight into how this works, and show that this method of value creation is not just relevant to NFTs but also clothing, money, limited liability companies, and many other things we consider valuable.
For me it took a leap of faith to go from NFT-agnostic to NFT-believer.
It wasn’t really a continuous process, I pushed myself to read a few articles and watch a couple of videos, then, suddenly, it all *clicked* and I understood it.
I hope after reading this article you’ll be one step closer to understanding NFTs.
Here’s the thing:
The value of an asset is whatever somebody is willing to pay for it.
Value is not some absolute scale upon which all things can be referenced. It changes from person to person. And if somebody believes buying an NFT of an ape is worth $1 million then that’s what it’s worth to them.
People were already spending large sums of money on luxury items before NFTs came along.
Just think about luxury brands like Rolex, Bugatti, and Louis Vuitton. Each of these brands provide something beyond function, they have a certain status and social currency.
How often have you seen people posting pics on IG of a Rolex on their wrist while casually holding the steering wheel of a Mercedes?
People share photos like this because they want to display to the world that they’re successful and, because of their success, can afford to buy the finer things in life.
And they use brands like those shown above (Mercedes, Audi, and Rolex, to name a few) to convey this message of success.
Now, I could take a photo of myself wearing a Swatch and holding the steering wheel of a Toyota but it wouldn’t convey the same message. Some might even see it as satire.
Why is that?
The photo is still functionally the same.
I’m in a car, wearing a watch.
But it’s about more than just a generic car and watch, it’s about the specific brands involved and the associations we make with those brands.
Those associations and feelings we have about a brand make up social currency.
On Wikipedia, social currency is defined as:
… an action made by a company or stance of being, to which consumers feel a sense of value when associating with your brand, while the humanization of your brand generates loyalty and “word of mouth” virality for the organization.
The key part of this definition is that social currency is “a sense of value consumers feel when associating with your brand”.
And that value can be monetary, status, value-for-money, moral, and whole host of other things that people believe in.
Let’s illustrate this point further by comparing and contrasting two brands: Walmart and Ferrari.
What comes to mind when you think of Walmart?
For me, I think of words like: good value, cheap, large selection, McDonalds, discount, low-quality etc.
Now, what about Ferrari?
I think of things like: red, fast, powerful, luxury, desirable, cool, sunshine etc.
These are very different associations because Ferrari and Walmart are very different brands and each have a different kind of social currency.
This social currency has been built over time through out interactions with the brands: where, when, and how we’ve seen the brands throughout our lives, and the experiences and emotions we associate with those experiences and thus the brands.
So the value we associate with these brands is derived from our own beliefs, which ties back to a modified version of the opening statement of this section:
The value of a brand is whatever somebody is willing to pay for it.
An individual’s beliefs give things value in their mind.
And if enough people share the same belief then that thing becomes culturally accepted as “valuable”.
So our collective beliefs define what is and what is not valuable.
How does social currency relate to NFTs?
NFTs are assets like supercars and watches, just they’re digital.
And, like watches and cars, they too have social currency.
In June 2021, Jay-Z bought a CryptoPunk NFT and set it as his profile picture on Twitter.
He spent 55 ETH on it, about $126,000 at the time, which seems like a good deal because the cheapest CryptoPunk for sale right now is 72.69 ETH ($208,934.33).
When Jay-Z bought the Punk, CryptoPunks as a brand gained a lot of social currency.
Like holy shit, imagine if you created a fashion brand and Jay-Z was spotted wearing your gear. That’s the level we’re on.
CryptoPunks were already popular at the time, which makes sense because Jay-Z wouldn’t have bought a no-name collection.
Here we see social currency at play.
Whatever NFT Jay-Z buys and displays on his Twitter is going to receive a boost from Jay’s own social currency, and on the flip-side he’s only going to buy and display an NFT that’ll boost his own social currency.
See how that works?
So NFTs like CryptoPunks are becoming a kind of digital Rolex.
A digital flex.
A status symbol.
And people value status symbols.
If you need evidence of that then just go to IG and search for “luxury lifestyle”.
There are thousands of photos of people with their luxury belongings, showing off their status to the world.
By buying an NFT and displaying it to the world on Twitter, Jay-Z is saying, “Look how much I spent on this profile picture. I can afford it because I’m successful.”
Now Jay-Z’s brand becomes associated with CryptoPunks as cool, edgy, luxury, and relevant.
And CryptoPunks become associated with Jay-Z as important, popular, and successful.
The 2 sets of values intermingle and become tied to each other.
But I’m not a famous rapper…
Right, so how does this relate to the majority of the population?
You don’t have to be Jay-Z to make use of social currency.
In fact it can be more beneficial for less famous people to use social currency because you stand to gain a lot more from the social currency you associate yourself with and you have a lot less to lose.
If Jay-Z hadn’t been informed about the NFT space and just picked any random NFT there’s a big risk that his brand would’ve been associated with a bad project that could’ve hurt his brand.
And there are many, many projects out there that could do this.
But for most of us, that problem is much less of an issue.
My 372 Twitter followers probably even don’t care what my profile picture is, let alone inform their own thinking based off of my pfp choice.
So I can set my pfp as whatever I want without people writing articles about it and scrutinising my decision to the nth-detail.
Before Bored Ape Yacht Club (BAYC) many of the current BAYC owners were relatively unknown.
After the rise in popularity of the Apes there’s a certain status associated with those people who have BAYC pfps on Twitter.
When they tweet, people listen.
It’s obvious now because the floor is 98 ETH, but even last year when the floor was 15 ETH the Ape-holders held court and were people you listened to on Twitter.
Those individuals became influential because of the social currency provided by owning a BAYC.
And BAYC became a brand that provides social currency (at least in the NFT space) by building it over time, through the actions they took on social media, through the partnerships they made, and through the associations they created with other brands.
The BAYC team grew their brand’s social currency from nothing and look where that got them.
It’s human nature
If you still don’t buy in to what I said above you might be thinking it’s a conspiracy.
And that’s fine, I got a scientific explanation for ya.
Let’s dive deeper and go back a few thousand years to a time where humans, that is Homo Sapiens, were beginning to emerge in Eastern Africa.
Up until this time no mammal on the planet was able gather and coordinate in groups as large as Homo Sapiens.
Take chimpanzees for example (how fitting), our closest living relatives live in extended family groups of 20–120 individuals.
While these groups may seem large, they spend the majority of time in smaller groups that break off from the main group and periodically come back together.
In order for a chimpanzee to trust and coordinate with another chimpanzee they have to know each other intimately.
They must spend an extended amount of time together, watching each other, and go through various experiences together before they can both truly trust one another and coordinate.
This may be part of the reason why chimps stay in “extended family” groups because each chimp has known the others from birth and has built up trust over their whole lifetime.
But the point is chimps can only coordinate with a limited number of individuals because their trust is based on evidence from their physical senses and there’s a cognitive limit to the number of individuals they can do this for.
In contrast, Homo Sapiens are able to coordinate in much larger groups.
Just look at companies like Amazon and Walmart with workforces in the millions.
Essentially millions of people coordinate for the benefit of a single cause.
How?
In the human brain, the neocortex gives us our ability for intellectual creativity.
All mammals have a neocortex, but in humans it takes up a much larger portion of our brain and has more “cortical areas” which has allowed us to develop the mental abilities that differentiate us from our ancestors and other animal species.
Our intellectual creativity is key because it has allowed us to create fiction, that is, imaginary things that don’t physically exist.
Much of our success as a species is attributed to this characteristic.
In his book, Sapiens, Yuval Noah Harari says
Fiction has enabled us not merely to imagine things, but to do so collectively. We can weave common myths such as the biblical creation story, the Dreamtime myths of Aboriginal Australians, and the nationalist myths of modern states. Such myths give Sapiens the unprecedented ability to cooperate flexibly in large numbers.
Some fictions you might be familiar with are money, religion, and limited liability companies.
They are all things that people collectively believe in to one extent or another and they don’t physically exist.
Yes, we have physical coins and banknotes but they are just representations of money much like a statue of Jesus or Buddha is a representation of a god.
Money is an idea invented by humans to facilitate trade and commerce.
Before we had money people traded in a barter economy where people traded the goods and services they produced for other goods and services.
There was no money.
Money was invented to make trading easier.
It’s kinda hard to lug 2 cows, 3 sheep, and 6 jars of honey around all day when you could just carry a purse of coins.
Imagine if somebody in the street, let’s call them Dave, handed you some coins with their face stamped on them. From the Bank of Dave.
That would have no value to me personally. I don’t know Dave. Nobody is going to accept my Bank of Dave coins.
Like if I tried to pay for my McDonalds with Bank of Dave coins they’d think I’m crazy.
But that’s what we do, it’s just that we’ve all accepted the belief that US Dollars, and British Pounds, and Japanese Yen are valuable and can be exchanged for goods and services in their respective countries.
And instead of the Dave’s face being printed or stamped on the money it’s Benjamin Franklin, and the Queen of England, and Fukuzawa Yukichi.
Over time we’ve (the human race) created this collective belief, this collective fiction, that money is valuable.
We invented it.
Give 10 dollars to a monkey and see what happens.
He’s not going to open a savings account and store it away for a rainy day, is he.
He might try to eat it.
Because monkeys don’t, and physically can’t, share in our collective beliefs.
What about religion?
The same thing applies.
I’m not here to say whether religion is good or bad, right or wrong, just that it is a great example of a collective belief.
Religion does not physically exist, it’s in the minds of believers.
Destroying a place of worship or religious artifact does not destroy a religion.
Burning holy books or even worshippers does not destroy a religion because, just like money, it’s an idea, it’s a collective belief.
The same goes for limited liability companies.
Look at Apple.
They have physical offices, but is a single office Apple?
No.
Apple is a collective belief held by employees, shareholders, and consumers all around the world.
They believe that Apple produces great products and will continue to do so.
Apple is a collective belief, a fiction, that doesn’t physically exist.
You could destroy all of their offices around the world, all iPhones, iPads, and MacBooks, and fire all their employees, but Apple would still exist because it’s an idea.
You could wipe every trace of Apple off the face of the Earth and you still wouldn’t have destroyed it.
Because it’s a collective belief.
Thousands of people contribute to Apple every day, they operate the company, design new iPhones, and build new software because they believe in the idea of Apple.
Because they believe it will continue to exist and be successful and provide value to them and you know whatever else it is that people think about limited liability companies.
The key point here is that money, religion, and limited liability companies are collective beliefs and it’s our shared belief that gives these things value.
When a critical mass of individuals believe in something it comes to life.
NFTs are a collective belief
Now you might’ve already gone there but the same applies to NFTs and crypto in general.
They’re collective beliefs too.
A growing number of people believe NFTs are valuable, and that’s what makes them valuable just like USD and Apple.
And this goes back to something I said in the introduction:
The value of an asset is whatever somebody is willing to pay for it.
Value is not physical nor tangible. There is no absolute scale of value, it only exists in our minds and is unique to each individual.
So if enough people believe NFTs are valuable then it becomes so.
It’s a self-fulfilling prophecy.
They don’t need utility or backing by a physical asset. That’s kinda just a crutch for NFTs.
To say that an NFT is backed by gold reserves or something is just taking a nascent collective belief (NFTs) and propping it up with a well-established collective belief (gold).
I guess that’s a good differentiation between the stages of collective belief.
Like people will buy gold because they believe it’s valuable. That’s been established over many millennia.
You don’t need to establish the reputation of gold by saying “Come buy my gold, it’s backed by $1 billion USD”.
Because gold already holds value in our minds and it doesn’t need to rely on another asset class.
Gold has proven it’s worth over time and continues to do so.
NFTs are new and have not proven their value to anywhere near the same level as gold so some creators are using established sources of value to increase the perceived value of their NFTs.
I see it as a scale of perceived value or asset reputation:
This is not an absolute scale and definitely represents some of my biases, which is kinda the point because each person will have a different view on each assets reputation.
These views have been influenced by their social circles, their upbringing, their education, and a whole host of other factors that I can’t even begin to discuss.
If you took the scale from everyone on Earth and created an average scale that describes the mean reputation of every asset class, I expect NFTs would be very low on the scale and gold would be very high.
As more and more people start to view NFTs as valuable their position will start to rise and our collective belief will begin to accept NFTs as a valuable asset class, much like the journey Bitcoin has taken over the last 14 years.
Similarly, if more and more people start to view NFTs as worthless then they may fall lower down the scale and disappear into obscurity.
Value is subjective
The main takeaway from this is that value is subjective and defined by collective beliefs.
Individuals ascribe value to assets because of their beliefs and these beliefs contribute to our collective beliefs about what is and what is not valuable.
And in all that there is no adjudicator, there is no independent-third-party-review, it’s just human nature at play.
Remember that, once upon a time, Rolex, Versace, and Ferrari were unknown brands, they had to prove their worth to society, and their worth has been defined by our experiences with those brands, by their social currency.
And NFTs are on the same journey.
Personally I’m excited to see how far we can go, what people will use NFTs for next.
Forget all the rug pulls and scams, they will fall into obscurity.
Only the projects providing real value to society, and building genuine social currency, will win and stand the test of time.
Only the projects that we collectively believe are valuable will win.
Originally published at https://brainflow.substack.com on March 7, 2022.
