400% growth in NFTs: A revolutionary technology or a bubble about to burst?

Non-fungible tokens (NFTs) are certificates of ownership for digital artwork. The certificates are registered on a blockchain, which is a digital record that cannot be changed or tampered with. People hold NFTs primarily to gain exclusive rights to digital pictures and videos and because they are status symbols. NFTs can then be sold on secondary markets, and—as last year proved—can fetch hefty returns for creators and sellers in the process.  

In March 2021, an NFT sold for USD 69.3 million, setting a record purchase for digital artwork. Last year, the NFT market nearly surpassed the global traditional art market: After starting with a market cap of nearly USD 1 billion at the start of the year, the NFT market swelled to just over USD 41 billion by the end of 2021, according to blockchain analytics firm Chainalysis—although some estimates are more conservative. The unprecedented bull rally will likely continue in the short term. 

That being said, the NFT market does have its downside risks, potentially limiting its scope for future growth. In particular, unlike physical artwork, digital artwork can be easily copied—potentially an infinite number of times. Thus, although an NFT gives the holder exclusive legal rights to the artwork, in practice these rights are difficult to enforce due to the significant costs involved in monitoring and prosecuting NFT copyright infringements. Moreover, roughly 9% of individuals hold around 80% of the total value of NFTs, which makes the market susceptible to swings in macroeconomic conditions, as portfolio adjustments by just a few large investors have an outsized market impact. Unproven and new asset classes in the past have typically performed poorly when large economic shocks take place, such as economic downturns or rapid changes to interest rates. 

When it comes to art, the value is in the eye of the beholder, but fundamentals do play a large role in shaping the market—and most theories would suggest NFT fundamentals are wobbly at best. A strong rise in global interest rates could lead to an unraveling of the NFT market, as seen through the recent correction in traditional asset classes such as equities in response to the Fed’s increasing hawkishness, with our most recent Consensus Forecast projecting three rate hikes by the Fed by the end of this year. This rapid tightening could spell trouble for the NFT market and burn many speculative investors in the process, discouraging future interest in the technology.  

Insights from Our Analyst Network

Commenting on the outlook for NFTs, analysts at Credit Suisse noted: 

“It remains to be seen how persistent this growth proves through the various stages of the business cycle. Also, similar to cryptocurrencies, NFTs bear risks with respect to the identification of owners (KYC) and source of funds in transactions that are yet to be scrutinized or addressed by regulators. However, the variety of tokens and engagement they produce in specific communities of gamers, sports and music fans bodes well for continued expansion.” 

Furthermore, commenting on U.S. monetary policy with respect to equity markets—potentially foreshadowing a correction in the NFT market—analysts at JPMorgan noted:  

“Investors have shed equities at the fastest pace since March 2020 with major indices in correction or outright bear market territory as Fed expectations have quickly and aggressively pivoted. […] The stock market is not only in correction, it is already in bear market territory without a recession in sight.” 

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.

Author: Steven Burke, Economist

Date: February 3, 2022