The meteoric rise and fall of NFTs

At the beginning of 2021, in the middle of the global COVID-19 pandemic, barely anyone knew what a non-fungible token (NFT) was. By December, around 40 billion US dollars had been spent on these blockchain-recorded, digitally-produced pieces of art. 

While drinking an espresso and sitting in front of his laptop camera in early 2021, Andrea was digitally catching up with a colleague he had not been able to connect with for a while. The colleague soon relayed to Andrea that he had spent a significant portion of his COVID-19 lockdown time getting to know the specifics of an emerging asset that registered digital art on blockchain. Curiosity grabbed a hold of him and Andrea quickly learned about this emerging asset class. He discovered that NFTs allowed digital artists to sell their works in a marketplace, where they would be protected and where consumers could not just simply copy and paste images that they liked. This new emerging digital market simply did not exist before. 

Shy to admit it, the colleague mentioned that trading these assets online was bringing in a significant amount of income. He said, "Andrea, you should get into this before it’s too late."

Andrea was intrigued with the idea. As a finance professor and a consultant of large trading firms like Blackrock and Barclays, he was comfortable with the idea of trading… trading gold, wheat or in this case digital art. He also wondered if these so-called NFTs would develop as other asset classes. The researcher in him was intrigued. As an expert in new ways the banking and the ways the investment sector was evolving, he wondered if getting involved at an early stage would also provide a financial opportunity.  

He started to investigate the details. His curiosity had him developing his own pieces of digital art, realised by an algorithm he wrote. Andrea then created a collection of generative art, by writing a simple computer code to produce geometric images inspired by shapes that can be found in nature. After only a few days, his collection turned into a great success, with thousands of NFTs being sold out in the primary market. 

Following the adage "a rising tide lifts all boats" the Italian academic saw individual pieces of his own art collection rise in value on the secondary market. "At that point, I was sure that the sale price I chose for the primary market was suboptimal. But maybe I was wrong. Recently, I read a theoretical paper modelling NFT sales, from fellow researchers at the University of Chicago. I thus realised, ex-post, that setting a suboptimal sale price (relative to the expected demand) is actually the best strategy to achieve a sold-out."

After the surprising rise of the value of his art collection, Andrea noticed the decrease in trading… and then in the price. Noticing this drop in the number of transactions and the value of his own collection, Andrea foresaw the inevitable collapse of the value of his NFT collection and perhaps the global NFT market... and quickly realised that this destiny will be shared with many other digital artists.

Over the next few months, Andrea saw this digital asset class fold just like many other asset bubbles in banking history. Realising that this could be a research idea, he quickly brought the topic to Angelo Ranaldo. 

Convinced that the NFT crash had academic value, the two quickly gathered data and wrote a book chapter together. The chapter, which focused on NFTs, explained how they worked from a technical perspective and their economic implications. It also went on to explain how the markets functioned, organised themselves and what the economic implications of the entire asset class was.   

As they delved deeper into the subject, they noticed a few things. Firstly, they found thousands of cases - all similar - of people making and losing money. What caught their attention was that they were able to identify some sophisticated traders who gained more than the average trader, and even when the market was about to collapse, they managed to adapt. This trend is similar to hedge fund traders, for example, who are able to follow the market, make a profit and get out at the right time.

This type of market sophistication has always been an area of interest, especially in relation to bubbles and crashes. Already in 1901, the Puck Magazine published a picture with J. P. Morgan depicted as a bull, blowing soap bubbles for eager investors. Several of the bubbles are labeled, "Inflated values". 

Now in the aftermath, there is much to be learnt. Some NFTs, a minority, did not crash to zero. A certain cartoon penguin, for example, has continued to be profitable… but the model has changed. Those responsible for it, use NTFs as a way to share profits from the generation of toys. There also has been sustained interest in NFTs representing popular art or artists. Whether interest in NFTs will rise to the levels found in 2021, no one can be sure… But one thing is clear: Professor Barbon has harnessed personal experience to create award-winning academic research. His paper, co-authored with Angelo Ranaldo, won the Best Paper Award at the Cryptocurrency Research Conference in Monaco. This journey from practice to academia provides a unique, complementary perspective to the HSG slogan "From Insight to Impact." 

In collaboration with colleagues at the School of Finance, Andrea will deliver a public lecture on market bubbles, extending beyond just NFTs, in the upcoming academic year.

HSG at a glance