As the world moves towards a more digital future, the rise of Non-Fungible Tokens (NFTs) has been one of the most talked-about trends in recent years. NFTs are unique digital assets that are authenticated using blockchain technology, making them scarce and valuable. The value of an NFT is determined by several factors, with rarity being a key driver of Fair Market Value (FMV).
In this article, we will delve into the concept of scarcity and how it affects the valuation of NFTs. We will also explore the methods used to assess the rarity of an NFT and how it can be used to maximize investment returns.
What is Scarcity in the Context of NFTs?
Scarcity in the context of NFTs refers to the limited number of tokens available for a particular NFT. NFTs are unique and irreplaceable, making them scarce by design. Each NFT is created with a specific set of traits, such as hair color, weapons, jewelry, etc. These traits are what make the NFT valuable, and the rarer the trait, the more valuable the NFT.
One of the most famous examples of how rarity affects the Fair Market Value of an NFT is the CryptoPunks collection. CryptoPunks are 10,000 unique 8-bit characters, each with its own specific traits such as hats, glasses, and facial expressions. Some of these traits are rarer than others, and as a result, certain CryptoPunks are worth significantly more than others. The CryptoPunk collection is widely referred to as the original NFTs.
The most valuable CryptoPunk is the one with the attribute "Alien". There are only nine CryptoPunks that have this attribute, making them incredibly rare. In 2021, one of these Alien CryptoPunks sold for a whopping $23 million at an auction.
On the other hand, the least valuable CryptoPunks are the ones with common attributes such as beanie hats or regular glasses. These are relatively common and can be purchased for a few thousand dollars.
This demonstrates how rarity can have a significant impact on the Fair Market Value of an NFT. Even within the same collection, certain NFTs can be worth much more than others due to their rarity.
Assessing NFT Rarity
The rarity of an NFT can be assessed using various methods. One such method is calculating the statistical rarity of each trait in an NFT by multiplying the individual traits' rarity scores. This approach is particularly useful when assessing the rarity of multiple traits in a single NFT. By assigning a rarity score to each trait, an NFT's overall rarity score can be determined, which in turn can be used to determine its value.
Another method for assessing rarity is by relying on several basic indicators, such as rarity rank. Rarity rank is a measure of how rare an NFT is compared to other NFTs in the same collection. The rarer an NFT is, the higher its rarity rank, and the more valuable it becomes.
Marketability and Recognition
The marketability and recognition of a celebrity artist can also increase the value of their NFT over that of another, less well-known artist. For example, an NFT created by a famous musician will likely be more valuable than an NFT created by a relatively unknown artist. The fame of the celebrity artist adds to the uniqueness of the NFT, making it more valuable.
One of the best known examples of how marketability and recognition impact the value of an NFT is the Beeple "Everydays: The First 5000 Days" NFT artwork. Beeple is a famous digital artist who has been creating and sharing his art online for over a decade. He has a large following on social media and is well-known within the digital art community.
When Beeple's "Everydays: The First 5000 Days" artwork was released as an NFT, it quickly became one of the most talked-about NFTs of all time. This was due in part to the marketability and recognition of Beeple as an artist. His name and reputation added to the uniqueness and value of the NFT.
Edgar Degas famous said “Art is not what you see, but what you make others see.” Many of have called Beeple’s artwork itself impressive and unique. "Everydays: The First 5000 Days" is a collage of 5,000 digital images that Beeple created over a period of 13 years. This made the artwork one-of-a-kind and highly sought after. The marketability and recognition of Beeple as an artist, combined with the uniqueness of the artwork, made "Everydays: The First 5000 Days" one of the most valuable NFTs ever sold. It was auctioned off by Christie's in March 2021 for $69 million, making it one of the most expensive NFTs ever sold. Clearly, people must see a lot in Beeple’s "Everydays: The First 5000 Days"!
This example demonstrates how marketability and recognition can significantly impact the value of an NFT. When assessing the value of an NFT, it is important to consider not only its rarity but also the reputation of the artist and the demand for their work.
Assessing Rarity through Price
Rarity can also be analyzed by assessing the price at which an NFT changes hands from a buyer to a seller (i.e., market prices). The prices at which NFTs are sold can give insights into the perceived value and rarity of the asset, as well as the current state of the market. The distribution of actual prices is similar to that of rarity scores, with high-end assets fetching a very high premium, while most assets are reasonably priced. The prices at which NFTs are sold can give insights into the perceived value and rarity of the asset, as well as the current state of the market.
For example, let's say there is an NFT collection of 10,000 unique digital assets, with each asset having its own set of traits that make it unique. If the NFTs with rarer traits or attributes are selling for significantly higher prices than those with more common traits, it is an indication that rarity is a driving factor in the value of the NFT. Furthermore, if the price of an NFT is significantly higher than the average price of other similar assets in the collection, it can be an indication that the particular NFT is considered rare or highly desirable by the market. Similarly, if the price of an NFT is lower than the average price of other similar assets in the collection, it can be an indication that the particular NFT is less rare or less desirable by the market.
"CryptoKitty #1" NFT is example of the sale price of NFT can indicate its rarity. The CryptoKitties collection is a popular NFT collection where each kitty has a unique set of traits and characteristics. The first CryptoKitty ever created is considered to be the rarest of them all. In 2017, the "CryptoKitty #1" NFT was sold for 246.9255 ETH, which was equivalent to approximately $117,000 at the time. This sale price was significantly higher than the price of any other CryptoKitty, demonstrating the rarity of the first CryptoKitty. Hence, it is reasonable to assume the rarity of an NFT as seen through its sale price may be an effective method for determining its value. When an NFT is sold for a significantly higher price than other NFTs in the same collection, it is an indication that the NFT is rare and highly sought after.
Why is Understanding the Fair Market Value of an NFT Important?
Just as with any asset, it is useful to understand the fair market value of an NFT for many reasons:
Transactional Reasons: Having an estimate of the fair market value of an NFT is important when buying or selling it. Estimates of fair market value helps both buyers and sellers to make informed decisions about the price of the NFT.
Collector and Investor Purposes: Understanding the fair market value of an NFT is important for collectors and investors who want to make informed decisions about buying or selling NFTs. The fair market value helps them to determine whether the NFT is overpriced or underpriced and whether it is a good investment.
Insurance Purposes: NFTs can be insured like other valuable assets. The fair market value of the NFT can be used to determine the insurance coverage needed and the premiums to be paid.
Financial Reporting Compliance: Increasingly, it appears likely that companies that own NFTs may need to report them as assets under “fair value” rubrics on their financial statements. The fair market value of the NFT may be used to determine the value of the asset, which is important for financial reporting purposes.
Tax Compliance: When you sell or exchange an NFT, you may be required to report the transaction on your tax return and pay taxes on any gains. The fair market value of the NFT is used to determine the amount of gain or loss you have incurred. Failing to accurately determine the fair market value could result in underreporting of gains, which may lead to penalties and interest.
How can Eton help?
At Eton Venture Services, we were founded by veteran Silicon Valley lawyers and include a team of CFAs who were trained by the Big Four. Our singular focus on valuation, lack of conflicts, and thousands of valuations under our belt, make us the valuation provider of choice for private companies, venture capital firms, and their advisors. With our extensive experience with Web3 companies and all types of crypto assets and related transactions, we can help you assess the rarity of any NFT and how that trait may affect the NFT’s fair market value through a detailed quantitative analysis of your NFT’s value. Contact Eton today.