NFTs Are In Their First Crypto Winter

What Happened

Although NFTs held out longer than mainstream crypto assets earlier this year, market participation has fallen dramatically and even blue chip assets and collections such as the Bored Ape Yacht Club have seen their prices crash.

Although perhaps inevitable, some investors hoped or believed that NFTs might fare better given a few reasons:

  1. They represent a different segment of the market comprising committed community members that often attach sentimental value to the NFTs they hold. Much of what confers value to NFTs is the sense of community and the ability for NFT owners to engage with other holders within the collection.
  2. Unlike assets like bitcoin and ether, institutional money has not yet flowed into the space. Although celebrated for driving the price of bitcoin up to almost $70,000 last year, mainstream investors have also led to crypto forming a tight correlation with risk assets such as tech stocks.
  3. Buying an NFT also comes with more friction than purchasing bitcoin on a prominent exchange. Most assets are priced in other digital assets, such as ETH or SOL, not fiat, requiring would-be purchasers to acquire these assets first.

Now, as the NFT market prepares to go through its first bearish cycle, investors are trying to determine how they are going to perform in the second half of the year.

Broader Context

Although NFTs are sometimes dismissed as easily-replicable digital images, they convey a sense of community and belonging that harkens back to the early days of bitcoin. In the profile picture (PFP) avatar segment of the market, making up most of the value of the NFT space, holders post their NFTs on their social media pages as the face of their digital identity. Additionally, relative illiquidity and the social pressure of supporting a community by tethering a members online identity to her NFT portfolio may contribute to a mentality of longer term holding.

Certain NFT holders can also gain access rights to private chat channels, tickets to live and virtual events, and other forms of utility. These rights are authenticated through services such as Collab Land that directly integrate with Discord (the primary communication app leveraged by NFT communities) to verify a user possesses the necessary NFT in her Web3 wallet, such as Metamask or Rainbow Wallet.

Still, weakness in the equities market has had a spillover effect into the crypto markets, largely induced by the Feds emphasis on lowering interest rates and reducing the size of their balance sheet to combat historically high inflation.

The crypto markets shed $2 trillion in value since their 2021 peak in November. Although small capitalization assets were hit the hardest, with some losing 99% of their value, the crypto majors such as bitcoin and ether were not immune, shedding 74% and 79% from peak to trough, respectively. The total crypto market cap declined from $2.97 trillion to a recent low of $792 billion, representing a drawdown of 73%.

Key Figure

The market cap of all collections listed on data aggregation platform NFTGo dropped 40% from $37.2 billion to $22.2 billion from peak to trough. Daily trading volume amongst these collections has declined precipitously by 95% from its peak of ~$800 billion in January to ~$40 billion now.

Outlook and Implications

Even amongst the top performers of all NFT collections, the floor price of these collections has drawn down to a slightly greater degree than ETH (-79%). This relative underperformance suggests NFTs serve as a risky high beta play on the crypto markets, outperforming to the upside and underperforming to the downside. Of course, the opposite was true throughout the bullish period that just ended.

While Bitcoin is currently undergoing its third major market cycle, NFTs are a relatively new segment of the market that are going through their first such period. Still it appears that the trajectory for both classes within crypto will depend on how the broader market performs. As it stands with the current tightening environment and growing fears of a recession, it is hard to imagine a significant rebound before 2023, unless the Fed significantly changes its course.

Decision Points

Given the challenging environment, investors should be careful to purchase NFTs that are relatively more liquid and backed by established teams and developers. One metric worth paying attention to in particular is trading volume. Although it has been anemic as of late across the entire sector, an increase in volume could signal greater interest and attention from investors and users as they enter the space.

Additionally, investors who denominate their portfolios in the native crypto asset and place less emphasis on the currency fluctuations of the underlying ETH may be able to stomach the volatility of the NFT markets more easily. Top collections (as determined by floor price, volume, and community size) have been more likely to retain their value in ETH terms, and thus they are better positioned to appreciate in value when the market flips bullish.

From peak to trough, the Bored Ape Yacht Club (BAYC) is down 52% when denominated in ETH but down 80% when denominated in USD, the Mutant Ape Yacht Club (MAYC) is down 65% in ETH but down 86% in USD, and Moonbirds are down 58% in ETH but down 85% in USD.