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Let’s do a thought experiment around NFTs that I think will be eye opening for many people. It’s not so critical you know the specifics of what an NFT (non-fungible token) is for this, but it is important that you know that one of the most popular current experiments around NFTs is NBA Top Shot, where you can become the exclusive “owner” of moments from the NBA. Those moments have generated hundreds of millions of dollars in sales so far.
Ok ready? Now I want you to imagine how much money you end up with at the end of this sequence of events.
You’re watching a Lakers game. Lebron hustles back up court, catching up with a breakaway just in time to absolutely stuff the ball off of the backboard. The block of the year. You’re sure it is going to be “a thing” so you whip out your phone and buy ownership of the NFT on Top Shot for $100. Over the next week it goes absolutely viral on social media, generating millions of dollars for Twitter and Facebook via advertising. Several Hollywood movies and TV shows use it in one form or another. It becomes fertile ground for hundreds of memes over the next decade — pretty much any time somebody is getting rejected the clip surfaces in some way or another. Several digital artists even build it into their art, which they also mint as NFTs. Some of those NFTs sell for more than $100k.
So, how much money did your NFT generate through all of that additional activity? The answer: nothing. Now we can maybe assume that ownership of the NFT has increased in value — you did pick a winner! But the point is that all of the revenue that was generated from the clip you now “own” doesn’t flow back to you. In fact in this example the biggest difference between now and the world before NFTs is that the NBA has an extra $100.
Compare this with music, where from 1985 to 2017 every time you played a Beatles song, you were giving money to Michael Jackson’s estate. Whether on Spotify or in a movie, Lennon singing “Let it Be” sounds like a whole lot “ca-ching!” to whoever owns the rights to the Beatles music. MJ bought the rights for 47M in 1985 and his estate sold them after his death for 750M.
The contrast is stark, but it’s not black and white. Of course, it’s fairly easy to find a way to play The Beatles without paying for it in any way. That was what made Napster so bad for musicians, and why Spotify can position itself as music’s white knight. Spotify’s model isn’t perfect and others are experimenting with potential improvements, which I’ll touch on later. The point is that generally speaking if you own the rights to a song, the more it is played, the more you get paid.
Ultimately this is about attribution; how well can you attribute the value that content generates back to its creators and owners. You can essentially put different industries on a scale from zero attribution to perfect attribution. Music during Napster was pretty bad, now it’s better. Digital art before NFTs was essentially zero, now it’s a bit better. But it’s still not great.
The good news is that many of the biggest challenges to overcome in having better attribution of value to digital artists are technical in nature. And NFTs do already use royalties — the term for the money MJ got when you played a Beatles song — in a way that is in many ways leagues better than what you find in physical art. That’s why I think the moderate view of the erupting NFT experiments is the right one; the current implementation could be much improved, but these new developments constitute an important building block to allowing creators and curators of digital content to capture more of the value they create.
An ownership pump fake
It’s worth reading Top Shot’s terms of service. Not only do you not get royalties when the moment you own is used, you are expressly prohibited from modifying the moment “in any way.” You cannot “sell, distribute for commercial gain or otherwise commercialize merchandise that includes, contains, or consists” the moment you now “own.” The NBA very clearly lays out the fact that “you own the NFT” and as a result you are granted a “license to use, copy, and display the Art.” In other words, you’re acting much more like someone who includes that NBA clip in their movie and has to pay the NBA for it than the rights owner of a Beatles song.
The fair counterpoint to this is that Top Shot NFTs are much more like baseball cards — Kushaan Shah referred to them as a “virtual trading card market” — than ownership in music, not to mention the obvious counterpart that integrating copyright seems incredibly complicated. In other words the value of the NFT comes from what it represents and from the fact that it is scarce, and the low barrier to entry is actually a feature rather than a bug. They are collectors items to display in your virtual binder, not contracts which grant you legal ground to take a cut of the value of the object they represent.
When people talk about the importance of better digital ownership, they are referring to decentralization of value — the fact that so much of the value of our digital content is captured by a few platforms. So you can see how Top Shot is a step in the right direction. Millionaires are indeed being made via ownership of digital art. But it’s not because Top Shot is capturing value; Top Shot is creating new value, and the value of a Top Shot NFT in the future will depend entirely on whether it’s cool to have them. If you buy low on a player you think will explode, and they do explode, your bet is only going to pay off if Top Shot itself continues to grow in popularity. The moments you buy via Top Shot are timeliness, but will the platform be?
The power of NFT royalties
One of the core advantages of NFTs is that you can program royalties directly into the smart contract. For example let’s say you can decide that 10% of every sale of an NFT should go back to the creator. So if I buy the NFT from a creator for 1$, they get $1. Then if I sell it to you for $2, they get $.20 of that too. If it gets sold 1,000 times, they get paid 1,000 times. It’s a much more creator-centric model, and one reason that many digital creators are so excited about NFTs.
Others are experimenting with more creator-centric royalty models as well. Soundcloud for example is now experimenting with a model they call “fan powered royalties” where musicians are paid based on their actual listeners, and how much those listeners pay to SoundCloud. It’s a subtle change from the previous model where Soundcloud pooled all the revenue from subscriptions, and then split it up based on the number of listeners an artist had. The idea is that smaller artists may have fewer listeners but a higher proportion of which are highly dedicated subscribers, which means that the artist would essentially make more per listener than a bigger artist. The “1,000 true fans” theory, in business model form.
The challenge with virality
That “NFTs allow you to invest in memes” is sort of a meme in and of itself at this point. It’s catchy because it’s so obvious how much cultural value memes deliver to the world; it feels only right that they should be financially valuable assets as well. But true to their “viral” nature, memes tend to grow exponentially and then fade away, cured by the next meme that comes along to distract the host.
Knowing that, will NFTs hold their value long-term? If a Spotify song goes viral for a month but then fades away, the value to the artist is the area under the graph. If an NFT value has a similar spike, the value to the owner is just the difference between the before and after. So for memes that only have a brief but brilliant dance across the stage, long-term ownership seems like a fairly inefficient way to realize their cultural value.
There are many different ways to improve on this model. One obvious one is to more tightly connect social capital to the NFTs that you own. When the Top Shot moment you own goes viral, you should get some credit! That’s the insight behind NFT social networks like Alex Masmej’s Showtime, and it seems inevitable that a whole wave of products to allow you to showcase and share your ownership of digital art will flourish.
You can imagine the holy grail for NFT royalties looks something like an API. Many APIs simply charge a fee based on how much you use or “ping” them. For example we use one which provides us information on URLs. We send it the URL, it sends us information, we pay the service a few cents. Imagine if Top Shot moments worked like that. If a movie wants to feature the clip, it pings your NFT and pays a usage fee. The more people that watch, the more the movie producer would pay you. Clearly this isn’t how the NBA has imagined it so far, and in their defense it seems totally reasonable to chalk it up to the complexity and total lack of infrastructure to support that kind of vision. But as we move towards better attribution of digital value to digital ownership, you can start to see how NFTs are an initial but exciting step along what will be a long path.