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Consumer
Roger Lee, Courtney Chow  |  January 11, 2022
NFTs: The Promise and the Structural Hurdles to Widespread Adoption

In our previous articles, we’ve explored the transformative effects of the blockchain and the rise of social tokens. Non-fungible tokens (NFTs) are the next logical step in Web 3.0’s evolution, allowing unique ownership of digital assets. They have become a multi-billion-dollar asset class with interest from institutions and individuals.

In Q3 2021, NFT trading volume reached $10.67 billion, up 704% from the prior quarter and 38,060% YoY. Singapore-based Three Arrows Capital launched a fund to collect premium NFTs; payments processor Visa acquired an NFT; and clothier Burberry dropped an NFT collection in a blockchain game. We see huge growth opportunities in this arena.

NFTs and How They Work

NFTs, or non-fungible tokens, are unique digital assets that cannot be replaced with something else. They differ from the social tokens described in my earlier article, which are considered “fungible,” identical and interchangeable with one another – like dollars in the real world.

An NFT is best thought of as a digital record assigned to a digital item and stored on the blockchain (like a “blockchain certificate”). Because NFTs are “minted” (or uniquely published) on the blockchain, anybody may access but not change the “certificate”. Thus, NFTs demonstrate digital asset ownership, provenance, and authenticity. Note that the cool image or video the NFT user owns does not actually reside on the blockchain; rather, the record refers to a file that lives elsewhere on the internet (storing content on Ethereum, or most other blockchain networks, is prohibitively expensive!).

Common examples of NFTs are pieces of digital art, like this LeBron James dunk or Beeple’s 5,000 Days, which Sotheby’s sold for $69 million. Other examples include in-game items as in Axie Infinity, a blockchain-based game, digital collectibles like those found on NBA Top Shot, or even music like the new Kings of Leon album released in March.

Catalysts of NFT Growth

NFTs’ popularity stems from several trends:

  • Bitcoin’s momentum (above $60,000 at this writing) despite its volatility.
  • The explosion of the digital collectibles market. Blockchain has enabled digital assets to finally have the same qualities of scarcity, uniqueness, and provenance as their physical (collectibles) counterparts – a market that’s estimated to be $372 billion.
  • The broken and convoluted system for content creators. Social tokens and NFTs have allowed creators and brands to avoid the costs and intermediation of platforms and empower artists to directly interact with their community.
  • The importance of digital identity. People will buy items, such as Zoom backgrounds, to enhance their digital identities. For Gen-Z, “digital identities are an extension of themselves,” fueling demand for items such as sneakers and charms to enhance their avatars.

Celebrities are further raising awareness, such as DJ Steve Aoki with his sci-fi NFTs and Snoop Dogg’s NFT collection. Even an SNL skit about NFTs became an NFT.

Trends We’re Watching

NFTs extend Web 3.0, further disintermediating the internet. While Web 2.0 introduced the participatory web, it gave control of our data, privacy, and monetization to a handful of tech giants. The Web 3.0 model has the ability to redistribute the power, ownership, and reward structure to creators and communities.

As we envision a shift toward a world with decentralized control – further enabled by NFTs and their properties – widespread adoption faces several structural hurdles:

  • Market Access: Despite recent headlines about NFTs, the category remains niche – only 25% of U.S. adults are familiar with NFTs, while only 7% are active users. This is mostly due to barriers around consumer onboarding and participation – merely converting fiat currency to cryptocurrency to purchase NFTs can be daunting in itself! We’re intrigued by companies that help resolve the backend complexities of blockchain and streamline the end user experience.
  • Performance and Scalability: The bulk of NFTs are powered by general Layer-1 blockchains, such as Ethereum; nevertheless, volatile gas fees and high network congestion make the current construct unappealing for most creators. In addition, other factors continue to raise worries about the outlook of NFTs – namely, marketplace fragmentation, overdependence on custodial wallets, and blockchain’s high carbon footprint, among others. To prosper and welcome mass adoption, the NFT ecosystem will require more robust end-to-end solutions and purpose-built networks.
  • Secure Storage: Storing an NFT is complex. Due to the storage limitations of any existing blockchain, most NFTs are held on centralized cloud storage services like Google Cloud and Amazon Web Services, introducing risks around reliability, ownership, and privacy. Through an innovative peer-to-peer file sharing system approach, IPFS (short for “InterPlanetary File System”) seeks to address the shortcomings of the client-server architecture and HTTP web, but network management and stability remain concerns.
  • Cross-Chain Interactions: Today, NFTs usually live in siloed networks. With the growing numbers of chains, marketplaces, and options for creators and collectors, however, NFT interoperability will be a key driver in establishing widespread utility, driving adoption, and providing liquidity. We are excited by cross-chain technology, which enables the seamless transfer of value, data, and information among different blockchain networks.

Moving forward, we believe NFTs are poised to transform the future in ways we can only imagine. We are encouraged by the category’s increasing bias towards utility and the way that NFT valuations are shifting from the speculative to the utilitarian, based on the opportunities they give token holders. As NFTs streamline real estate transactions and medical records, reduce ticket-scalping, enhance charitable activity, and monetize online assets, they are edging into another blockchain-based field, Decentralized Finance (DeFi), that may fundamentally reconfigure the financial world. Our next post will explore this new world.

A version of this article originally appeared on Forbes.

Battery Ventures provides investment advisory services solely to privately offered funds and neither solicits nor makes its services available to the public or other advisory clients. Nothing herein should be construed as investment advice. Content obtained from third-party sources, although believed reliable, has not been independently verified for accuracy or completeness and cannot be guaranteed. * For a full list of all Battery investments and exits, click here.

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