Recent innovation in the NFT space has unlocked more growth potential by introducing utility. These NFT 2.0 projects are distinguished by their team-led initiatives to grant users deliverables, including yield generation, merchandise, private yacht parties, exclusive access to Michelin-starred omakase, coffee beans, membership to alpha groups, play-to-earn video games, musical compositions, meetups with celebrities, and IRL events and parties. Where NFT 1.0 projects like CryptoPunks and Art Blocks triumphed by building gated cliques around their digital collectibles, NFT 2.0 teams instead focus on storytelling and worldbuilding using the Web3 tech stack, creating positive system dynamics. NFT 2.0 teams try to build a socio-cultural milieu—a belief system—that lends itself to organically forming Web3 lifestyle brands that are collectively and decentrally owned and governed.
This development has made the space more difficult to navigate. As such, this piece aims to help the reader identify quality projects. As someone who’s been embedded in the NFT space for several years, I present a methodology for appraising NFTs, particularly avatar or “metaverse” NFTs on Ethereum as they account for the vast majority of today’s volume.
Evaluating NFTs
Whereas NFT 1.0 projects were appraised as art, NFT 2.0 projects can be appraised as ventures. Namely, the life of a project hinges on smart monetary resource allocation that will produce long-term holder benefits that, in turn, feed back into increased demand for the underlying NFT. As business sustainability is a precondition for long-term value generation, identifying successful NFT collections becomes analogous to identifying successful growth companies with sound business models.
Through this lens, early-stage (floor price less than 2 ETH) and growth-stage NFTs should be evaluated differently. Early-stage projects are more focused on narratives, storytelling, and experimentation, while later-stage projects focus more on granting utility to holders and generating revenue through sound treasury management. Accordingly, NFT appraisal should be approached using both fundamental and technical analysis, looking specifically at innovation potential, management, community strength, on-chain metrics, and macroeconomics.
Innovation Potential
Does the NFT project have a unique way of pushing the space forward? Does it have some sort of distinctive edge? Broadly speaking, innovation can come in many forms:
- Technological: Space Doodles (non-dilutive, or non-airdrop, value additions and re-customization of NFTs)
- Artistic: Cyberbrokers (fully on-chain art composed of compressed SVGs)
- Financial: Nanopass (each pass will generate a weekly BlackBox of loot funded by the community vault)
- Ideological: Loot (decentralized and composable world-building), $ASH ecosystem by Pak (burn Pak NFTs for $ASH through burn.art)
- Social: Proof Collective (token-gated alpha group)
Gaining a competitive edge comes from finding projects that are pushing the space forward, not merely extensions of past trends or, worse, copycats of existing projects. The next Bored Ape Yacht Club will not be the Bored Monkey Jet-Ski Club. Although Yuga Labs sent anxious trend-chasers scrambling for “the next big profile-pic NFT series,” the truth is hard to stomach. According to a Chainanalysis report, while flipping NFTs on the secondary market results in a profit 65% of the time, “only 29% of sales of NFTs bought when they were brand new resulted in a profit.” A recent Nansen report further cautions that “on average, one in three NFTs minted go on to become a dead collection with little or no trade activity” and another one in three also has “a trading floor price below the mint costs.” Clumsily chasing after fads is a negative expected value play, and sure enough, the copycat trend has cannibalized itself with an unsustainable incentive structure. Understanding how a project is trying to change the space and holding a part of that project for the long term is the path to success.
Management
NFTs are not primarily technical innovations, but fiscal and cultural innovations. They are a new medium of social communication and organization. Thus, storytelling is one of the most underrated but important metrics when it comes to evaluating an NFT project. Good management knows how to control the narrative, meaning they under-promise and over-deliver and drive expectations by inciting hype and FOMO using deliverables. For example, airdrops are new NFTs that are freely delivered to current NFT holders and have proven to reflexively provide positive-sum gains for BAYC, CloneX, and Azuki. When done right, airdrops have increased capital flow into the entire NFT ecosystem by attracting priced-out holders, anchoring higher floor prices, and galvanizing the community. Airdrops are but one of many value-add deliverables and management of such deliverables could make or break a project.
Furthermore, it is important to spend time on due diligence on the team. Who is the founder, are they doxxed, and can they lead, grow, and push the space forward? Do they have a good balance of artists, community moderators, and engineers? Although the MekaVerse collection had great art and was launched long before some of the current top projects, the management proved to be incompetent when it came to sustained growth and poorly handled the fraud scandal and Discord hack. The collection has since faded into obscurity, falling from an 8-9 ETH floor price to 0.4 ETH.
The Doodles team is an example of a strong team with good balance. Evan Keast, known as Tulip in the community, is a product marketer and NFT consultant who comes from Kabam Games (Net Marble), Dapper Labs, and CryptoKitties. Poopie (Jordan Castro), another co-founder, was also known for directing the CryptoKitties team at Dapper Labs. The artist—Scott Martin, who works under the alias Burnt Toast—has a distinctive art style that is instantly recognizable in the NFT space and beyond. His past clients include WhatsApp, Google, Snapchat, and more.
While decentralization is a core principle of Web3, most NFT projects, at least initially, require the leadership of a strong, centralized team. While you’re investing in a project, it’s important to remember that you’re also investing in people: make sure to spend time understanding who’s working behind the scenes.
Community Strength
As a natural follow-up to the previous point, the strength of a community depends on the team. More specifically, a team must be driven by mission, value, and vision, and the leadership must effectively mobilize resources within the community. MekaVerse became famous after this Forbes article for getting over 100k Discord members, yet the members did not translate into long-term believers in the project. In contrast, Azuki and BAYC both have strong core values that they build on, and relying on them helped founders weather storms and adhere to their roadmaps. Teams with these elements find that after healthy retracements, speculators are washed out and replaced by firm believers. Teams without such value-based conviction find the opposite.
With that said, there are simple ways of gauging a community’s strength. Check their Discord and read the chats. Check Twitter: what are people saying about it? How many followers do they have? What’s the engagement/followers ratio? Is there engagement artificially inflated through tactics like giveaways? Are people trying really hard to get on the whitelist? Check Google search statistics. Check other Discords channel’s alpha chats: are they talking about it? Perhaps most importantly, are big whales involved? One big whale following a project is worth more than 1000 anonymous followers. Of course, beware of whales who are paid by projects to advertise, and exercise discretion.
It is also important to gauge community strength by thinking from the founder’s perspective. In my opinion, there are two approaches teams can take with community building: top-down and bottom-up. Good teams beget good communities because the holders can grow with the brand (many BAYC members became influencers through their NFT). Doodles launched the Doodlebank in October, allowing the community to pitch ideas to the team that will be built by the community and funded from the treasury that accrues from the royalty fees. Azuki intends to do the same for its holders with the “Azuki Grants” initiative. It could be simple Twitter posts retweeting artists’ fan art, or it could be community moderators chatting with holders in the Discord, but look for teams that are actively reaching out because their communities will grow stronger.
The other approach for community building is bottom-up. Web3 is ultimately about decentralized ownership and the increased liberation of creators. This leads to memes—a whole lot of memes. If there are great memes and derivatives being spun off of a project, the community will grow stronger as well. For example, the Mfers by Sartoshi collection has no centralized team whatsoever and makes no promises of value-adds to its holders, yet has seen tremendous growth. Mfers are also CC0, so anybody can do with the NFTs what they please. This freedom has resulted in an explosion of Mfers’ cultural influence that embodies the genesis of the Mfer utopia where all holders vibe in a state of harmony. “Begone with the Apollonian babble,” says the cigar-smoking, sovereign Mfer draped in a black hoodie: “let us drink to Dionysus!” As Sartoshi himself wrote: “I didn’t know what that would ultimately look like--and that was the point…nobody does. … my view of what is most valuable for me to offer to mfer holders is to amplify the best of their ideas and creations to reach vastly greater audiences.”
On-Chain Indicators
Tracking volume, floor price, and sales are table stakes; to elevate your NFT analysis, I recommend a few additional strategies. In particular, it is crucial to track “whales,” or ultra-wealthy traders, since so much of the NFT market is determined by them. These whales usually have group chats where they can sharpen their edge in the market by sharing exclusive information, organizing floor sweeps, or collectively dumping. By looking at NFTGo, you can track what whales are minting, buying, and selling; act accordingly.
To demonstrate basic quantitative metrics analysis, we will look at the Degen Toonz Collection which launched last month.
First, look at the data for the number of NFTs listed in view of the floor price. The lower the number of listings, the thinner the floor, and the lesser the selling pressure and thus the greater the potential for upside. When there is more listed, it means that people are more willing to sell and the floor will either drop (due to undercutting) or will at best stay consistent. The graphs below show a strong inverse correlation between the number listed and floor price. A handy proxy for diamond hands is the following formula: (collection-number - listings) / collection number. For Degen Toonz that would mean (8888-984)/8888 = 88.9%. Not too shabby for a burgeoning project.
Next, we turn to the holding distribution. Degen Toonz has comparably many diamond-handed owners due to the number of people who never sold since buying.
At the same time, we can analyze the holding amount distribution; we see that individual holders control 64.71% of Degen Toonz NFTs, meaning that it is more or less resistant to whale dumping. Furthermore, as 65% of holders have only one Toonz, they are less inclined to sell because of their inability to fractionalize their holdings, meaning that psychologically, they are afraid that they might miss the run-up and the additional utility (airdrops, for example) in the future. This leaves less room for flippers who are immune to this mentality and exert sell pressure because they hold many.
Lastly, it is also important to check the mutual holders’ list. Although it is promising that 167 Mutant Ape owners also own 450 Toonz, it is not a good sign that Bored Ape, Punk, Doodles, and Azuki holders have not taken major positions in the collection, so I would argue that Toonz so far does not have the necessary backing to see explosive growth.
These metrics must be studied holistically and do not give a definitive picture of the collection. Yet, if at least three or four of the aforementioned metrics are bullish, as is the case, it could be a good buy even as the floor hovers above 0.3 ETH.
Recommended tools: CryptoSlam!, NFTGo, Coniun, Origins, NFTNerds, Flips, and Nansen.
Macroeconomics
Crypto remains highly correlated with the performance of the public markets, and NFTs are crypto assets. If broader markets are fragile, NFTs may crash. In our current moment—with the Russo-Ukrainian war, the rising inflation, and panics in public markets—NFTs should only be bought with disposable income and with extreme caution.
As fear, uncertainty, and doubt ease, however, blue-chip NFTs—loosely defined as collections with a floor price of over 2 ETH and trading volume of over 10k ETH—will recover first. Further, they are less volatile because the price of small-cap growth projects will be adversely affected due to high gas fees. This is because as ETH price gains momentum, traders move to buy altcoins on DEXes which will clog up the network. This makes trading NFTs prohibitively expensive, and thus eliminates a big chunk of investors. The prices of blue-chip NFTs have also corrected with the sharp drop in the currency market. But because of large buy-side pressure, NFTs experience quick rebounds when the price of ETH stabilizes. Overall, when ETH rallies or dumps, NFTs are negatively impacted because they reside at the end of the asset class risk curve. Notably, during downturns, the perception of blue-chip NFTs is more likely to be USD-based rather than ETH-based. Lastly, volume in the NFT market is an important indicator of the demand for NFTs in the market and lower volume usually signals a bear market. Overall, although the impact of macroeconomics on NFT prices remains disputed, and legitimate concerns signal a risk-off environment for the foreseeable future, the long-term dynamism in the space warrants an optimistic outlook.
Intraproject Appraisal
Once you’ve decided to invest in a particular project, it’s sometimes a challenge to pick the correct rarity of the NFT within the collection. Usually, floors (the most common NFTs in a collection) give better value per NFT due to potential deliverables for a lower base fee. For example, CloneX clones have yielded 3 drops worth 2-3x their public sale price, and Bored Apes have given holders Mutant Apes, Kennels, and APE coins. Buying 5 floors instead of a single rare one could mean 5 times the deliverables. Floors also offer superior liquidity over rares and are more sensitive to price fluctuations because floor NFTs are de facto fungible (when it comes to value) and most PFP collections follow a lognormal distribution of prices (whereas rarity is distributed on a bell curve) where most NFTs trade at floor value. Thus, for most investors, floors are the best choice.
Although mid-tier rares suffer from low comparative per-basis value, poor price discovery, and illiquidity, super rares may be an attractive option for long-term investors. They hold value better and can outperform floors in raw returns due to their ability to capture long-tail gains. At the top end of a collection, NFTs take on more properties of fine art because whales will come together and collude to anchor the floor price of the rares (of course, if there is low volume, fire sales can still happen). These grails can trade at 5x-25x floor: however, for mature collections like CryptoPunks, that multiple could be as high as 120x (the 8000 ETH alien punk for example). Some collectors derive very high utility from owning the very best.
Furthermore, there is a Web3 native reason to own grails: whales are incentivized to keep the community robust. Whereas owning many shares of General Electric does not compromise the integrity of the firm, one more NFT for a whale who already has a hundred means one less available to purchase for someone who truly associates with the identity of the brand but can only afford one. At one point, Pranksy owned over 1200 Bored Apes. This directly translates to 1200 fewer potential BAYC members who could’ve better promoted the community and strengthened the brand. An erratic billionaire could have bought the entire BAYC collection for a measly 800ETH back in April. Contemplating this counterfactual, Yuga Labs would be done with. Thus, the positive-sum strategy for whales who are bullish on a particular collection is to buy grails. The cherry on top is that grail PFPs can be strategically utilized because having a Golden Ape or Alien Punk bestows an ipso facto aura of legitimacy. If you are in here for the long run and have spending power, super rares are your best bet.
Liquidity Sourcing
An avid investor sources liquidity from multiple avenues. There are marketplaces that allow users to find buyers and sellers of NFTs via order books, the most popular being OpenSea, though LooksRare and X2Y2 have gained some traction with their novel incentive designs. However, most markets end up being illiquid for the long tail of assets. Thus, it is common practice for traders to source liquidity ad hoc by approaching buyers to do OTC deals. Complex trades involving a combination of NFTs from multiple collections and fungible tokens are common. Yet, this method of trading is inherently very risky. Stay away unless you are tech-savvy and comfortable with what you are doing. I only recommend using NFTTrader, an audited escrow service, if you must. NFTs can also be purchased through aggregators like Gem as liquidity is better because they pool liquidity from all marketplaces.
Lastly, the increasing DeFi-ification of NFTs has provided novel solutions to liquidity sourcing. P2P lending protocols like NFTfi are being augmented by P2Pool lending platforms like Pine and Bend that offer instantaneous time-to-liquidity based on machine learning and algorithmic valuation. 0xmons has even developed an AMM NFT DEX for Sudoswap. Although an in-depth analysis of these new forms of liquidity sourcing is beyond the scope of this article, the trends seem to point to increasing fractionalization, collateralized loans, yield-bearing protocols like Gradient, and NFT derivatives, contracts, and other exotic structured products like Abacus. In particular, I am looking forward to trading floor perpetuals via NFTures and Injective Pro. In any event, exchange-backed NFT marketplaces will introduce sidelined capital into the space and make NFT trading more accessible, while better front-end design and integration with SocialFi will ease price discovery and ignite the next surge of NFT adoption.
Conclusion
As NFT 2.0 projects should be most closely evaluated as businesses, a successful investor must leverage intuition, market conditions, technical, and fundamental analysis to form a thesis into why they believe the project will return value in the future through deliverables. On a high level, however, when appraising a PFP NFT, I suggest asking yourself if you would use it as your profile picture. Philosopher Walter Benjamin wrote that “ownership is the most intimate relationship” one can have with an object; would you want this JPEG to represent you in the Web3.0 space? Furthermore, always remember that it is impossible to lose by being liquid; there will always be more investment opportunities. Resist the urge to trade every day and adopt a more long-term view.
I leave the reader with a lingering thought: should one buy NFTs only for their exchange value? Contemporary artist Damien Hirst laments: “I used to give a lot of art away to people,” but “they’d always sell it after a lot less time than I thought they would … they’d sell it to buy handbags. And I’d be like, ‘Damn, I hate that!’” Hirst is interested in discovering where the line between collecting and profiteering can be drawn, and if it can be drawn at all. Every NFT investor should also have this on their mind when they hover their mouse over the buy button.
About the author: Andy Zeng (Boba Epicure) is a rising junior at Harvard College studying Philosophy from Shanghai, China. He is a voting member of Harvard Blockchain, a previous Community Ambassador for Axie Infinity, and an investor at Dragonfly Capital Partners. He is an Azuki maxi and likes to read about ancient Rome and the Romance of the Three Kingdoms in his free time. He has previously authored The End of History and the Philosophy of Crypto and Looking Onward for Crypto Gaming. He can be reached here.
Special thanks to Haseeb Qureshi and Ashwin Ramachandran for their thorough edits, and thanks to Jihoz and DeeZe for their guidance and thoughtful feedback in the production of this piece.
Disclaimer: Harvard Blockchain and the author of this piece are not financial advisors. Nothing contained in this research piece should be construed as investment advice.