“There’s something apocalyptic about it,” someone told me this week.
We weren’t talking about the war. Or the pandemic. Rather, we were sharing an incredulous chuckle at a series of announcements by Yuga Labs, the company behind NFT sensation Bored Ape Yacht Club. Over the past month, Yuga made a barrage of eyebrow-raising power moves. In a matter of weeks, they acquired CryptoPunks, launched a currency, closed a $450 million seed round and released a feature-film quality trailer for a major metaverse launch.
The CryptoPunks acquisition wasn’t cheap. The currency launch minted dozens of new millionaires overnight. The funding round valued Yuga at $4 billion. The metaverse project, dubbed “OtherSide,” was billed as an effort to construct a “media empire,” and I’d note that if Yuga paid to license “Break On Through” for the trailer, that probably wasn’t cheap either.
10,000 jpeg images of monkeys dressed in different outfits morphed into a multi-billion dollar company in the space of 12 months. A rough measure of Yuga’s NFT market cap (using the combined floor price for Bored Apes and two spinoff projects) equates to around 1.5% of Ethereum’s entire market value.
In short: A single “base” cartoon of a disinterested ape appears to be taking over the world. This world, yes, but also a digital world still marked “under construction,” like so many single-family homes in America.
On Saturday, when “gas” (the fee you pay to transact on Ethereum) was low, I took the opportunity to exit the vast majority of my crypto positions. I kept some Bitcoin, and left a few thousand dollars scattered across a few tokens. I also kept the handful of NFTs I bought, mostly because there’s no liquidity for them. My three-month experiment in Web3 is, for all intents and purposes, over.
A few readers were surprised at my foray into crypto, which began in earnest in January. Ultimately, I no longer felt comfortable having no Bitcoin, and more importantly, I couldn’t countenance my own willful ignorance. I knew more about crypto than the next person, but considering how few people are actually invested in the space, and the extent to which those who are mostly confine their activity to centralized exchanges and thus have no experience with DeFi (decentralized finance) and NFTs, that wasn’t saying much. So, I deployed some play money on-chain and dabbled in everything I could possibly dabble in, from DEXs (decentralized exchanges) to DAO (decentralized autonomous organization) tokens to photography NFTs.
At first, I was enamored with it, especially the DeFi aspect. But my infatuation quickly gave way to skepticism and, eventually, something like disdain. I can sum up the main problem in a single sentence: It’s a hopelessly self-referential system that assumes perpetual appreciation against the dollar (or the euro, etc.). When the appreciation stops, it sows the seeds for an existential crisis.
With that in mind, I wanted to share a few things I learned since January. If nothing else, I think this can serve as a useful CliffsNotes for anyone considering a foray into something most people don’t understand. If you get bogged down, keep trudging along. I’ve endeavored to make this accessible and the NFT discussion is important. I saved it for last, prone as I am to burying the lede.
Lucrative, as long as…
Let’s start with decentralized exchanges. On DEXs, you can “stake” various tokens (including those created by the exchange itself) for “rewards” or, euphemistically and interchangeably, “interest.” The rewards are based on any number of things. You can collect a portion of trading fees on a given platform, for example. The interest rates are exorbitant, sometimes to the point of absurdity. This is a very lucrative setup as long as the underlying tokens are appreciating.
Although there are a variety of platforms on which you can collect interest on deposited USD-pegged stablecoins paid out in USD-pegged stablecoins at higher rates than you’d receive in an FDIC-insured bank account, the highest rates are generally associated with the staking of something other than stablecoins. Those rewards are typically denominated in that coin or, at best, that chain’s native token.
Of course, if the coins are depreciating rapidly against the dollar, both your principal (your staked deposit) and your interest are depreciating too. The only way you don’t lose money is if the rate of token interest (i.e., the rate at which you’re receiving depreciating coins) exceeds the scope of the selloff in the tokens relative to the dollar.
Ponzi meets hyperinflation
Getting involved in a DAO can be a recipe for losing your entire investment depending, of course, on the DAO’s structure, objectives and your own experience level.
There are dozens of social media influencers (many of whom use Bored Ape or CryptoPunk avatars as profile pictures as a way to legitimize themselves to prospective followers) who purport to analyze the “tokenomics” associated with various projects and the developers behind them. “I don’t bet on coins, I bet on teams,” is one common refrain.
In some cases, the setups are a fusion of Ponzi dynamics and hyperinflation carried out over a very short window. If you get in early, you can receive emissions at wild rates (e.g., 60,000%). The bet, in essence, is that you’ll receive enough free tokens to outrun the hyperinflation.
That may or may not work, though. In adverse market conditions (e.g., if crypto is selling off alongside stocks and other risk assets), these tokens can sell off even harder than, say, Bitcoin or Ethereum. That’s especially true of projects built on other projects, where, for example, a team issues a token and uses the proceeds to acquire other tokens in an effort to gain outsized control over some utility those tokens confer upon the holder.
Ultimately, the odds of losing everything in such structures appear disproportionately high, even relative to other high-risk corners of DeFi.
You too can be Drift
NFTs are perhaps the most lamentable corner of Web3, precisely because, based on my experience, the majority of the artists and creators are honest people intent on creating real value for collectors. That includes, by the way, Yuga Labs. One think you can’t say about Bored Ape Yacht Club is that it didn’t create wealth for its investors.
To be sure, NFTs are full of inspiring stories, the most astounding of which belongs to Isaac Wright, better known as “Drift,” whose work first landed the Army veteran in a jail cell before ultimately vaulting him to semi-stardom on the way to Sotheby’s. Another, longer-running, success story is the London-based “XCOPY” who, on Thursday, sold more than $20 million of his signature, flickering Mad Max-esque NFTs in a dramatic 10-minute open edition offering. That impressive haul doesn’t count what he sold in a trio of more limited auctions carried out just an hour previous.
Success stories aside, the problems in the space are myriad and endemic. Most obviously, Wright is the exception, not the rule. In fact, he may be the sole exception. I’ve spent months researching the major artists in the space and I wasn’t able to find a single example (again, with the exception of Wright) of a previously unknown artist whose work would garner anything like the prices it garners as NFTs.
Wright’s work would’ve made him a millionaire regardless. It was just a matter of time. And there are some established artists in the NFT space who had preexisting careers. But for the most part, it all rests on a (very) shaky foundation: The mere act of tokenizing the work and denominating it in Ethereum confers a novelty premium that likely wouldn’t exist outside of blockchain.
It’s obvious why someone would pay $50,000 for one of Wright’s photos, assuming the work comes with some authenticating trait, be it the NFT provenance or, for a physical print, his signature. He embarks on death-defying climbs to capture surreal panoramas. Often, the work is compositionally flawless, although I’m not sure even he realizes it. It’s possible the work is still undervalued, even after a 12-month run more dizzying than one of the balancing acts that made him famous. On the other hand, it’s not obvious why anyone would pay $5,000 for a picture some random person took of a palm tree (and yes, I’m referring to a real collection there, but since I’m suggesting it’s overvalued, I won’t mention the artist).
Further (and this speaks to the self-referential points made above), too many NFT artists and collectors have trained their minds to think only in terms of Ethereum. That’s very dangerous. When Wright sells an NFT for 50 ETH, it’s likely that both he and the buyer think “50” first, rather than the dollar equivalent, which, as of this writing, is roughly $155,000.
That tendency could be ruinous in the longer run for a variety of reasons, not least of which is that it you make a sale for $150,000 today, convert half to dollars but leave half in Ethereum, then spend the $75,000 you converted, you’re effectively betting your good standing with the IRS that the portion you kept in Ethereum doesn’t depreciate by more than, say, 50%. If it does, the dollar value of the remaining Ethereum at tax time won’t be sufficient to cover the bill on the $75,000 you removed and spent.
The risk associated with that scenario grows materially the more one sells. Although I imagine someone like Wright has incorporated himself in order to (legally) minimize the tax bill, most artists likely haven’t. That means the tax burden on proceeds moved off chain could be very onerous if the artist doesn’t understand how those proceeds will be treated and how much to put aside to cover the bill.
Let me offer another word of caution. Wright, XCOPY and other wildly successful artists are fond of delivering inspirational messages to their followers, many of whom are artists too. Those messages are genuine and well-meaning. However, everyone with a camera isn’t Wright. And everyone with Photoshop isn’t XCOPY. It’s not as simple as “Never quit.” Indeed, telling legions of artists with good-paying day jobs to “never quit” (because if only they dedicate enough time and energy, they too can sell at a prestigious auction house or make $20 million in 10 minutes), is a good way to ensure those people do, in fact, quit. Not on their dreams, but rather on their real jobs. That’s a bet. And it’s one most people will lose.
Finally, and relatedly, quitting one’s job to pursue a dream isn’t necessarily a bad idea, but anyone who’s inclined to take such a step in the context of NFTs needs to understand this: Even if you succeed beyond your expectations, the whole endeavor could still go awry in the event Ethereum depreciates substantially.
It may be wholly viable (indeed, it might be wholly advisable) for someone with a sizable following to quit a $40,000 per year day job to sell photography NFTs with Ethereum at $3,000. After all, you only have to sell 15 of them in a year at 1 ETH each (not easy, but not terribly difficult either) to be financially better off. If you incorporate yourself, you’ll get better tax treatment too, and you’ll be able to deduct your cameras, film, etc. If Ethereum goes from $3,000 to $10,000, you’re a genius. If it goes to $60,000, like Bitcoin did, you’re a visionary. If, however, it goes to $300, you’re broke. You’ll be selling your work for 10 times less and demand will crater as sentiment for crypto assets deteriorates. You’ll also owe taxes, in dollars, for any Ethereum proceeds you cashed in to pay your bills. Again: It’s all dangerously self-referential.
I put off a crash course in Web3 for as long as I could. I stuck assiduously to some version of a script that said crypto wasn’t a “real asset,” that NFTs were a fad and that the metaverse would be more “Wrath of the Gods” than Inception. By December of 2021, I was convinced those assumptions were wrong.
Unfortunately, I’m now compelled to say I was mostly correct. Blockchain isn’t the future, and there’s no such thing as “Web3.” That’s just a buzzword for any webpage with a “Connect Your Wallet” button in the upper right-hand corner. The metaverse isn’t The Matrix. It’s just Grand Theft Auto, only not as fun, and rebranded as a blockchain-based “revolution.”
Frankly, I expected more. I thought this was the beginning of the end — the early stages of a transitional phase from reality as we know it today to a dystopian world of personalized digital money. I expected a revolution. I’m not quite sure what I found, but it wasn’t that.