What could explain the mind-blowing NFT craze in 2021 and some stats for thought.
by Chia Sheng Yeong
In this article we aim to provide some insights on how you can become successful in NFT trading.
Some Stats for Thought
Before we begin, let’s take a look at some stats.
The stats in this section below mainly comes from Chainalysis. It focuses on NFT trades in OpenSea platform. The stats are a collection of data from around 23,000 user addresses who have flipped 10 or more NFTs on OpenSea. At the time of writing, all data shown in this section are sourced from the Ethereum mainchain. The user addresses are broken into five quintiles. Group 1 being the most successful quantile accounting for 85% of the total profits while Group 5 being the least successful quantile.
Figure 1 below shows that the successful quintile, Group 1, flipped the most NFTs at an average of 105 times. There seems to be a direct correlation between the number of flips and being successful in NFT trading. However, the correlation stops with Group 5 where even though Group 5 flips more than Group 4, they are the least successful group.
Figure 2 shows that on average, Group 1 is willing to pay the most for NFTs. The willingness to pay then drops for every subsequent group until Group 5. Group 5 has a tendency to pay more than Groups 2, 3 and 4, but still performs the worst. Figure 2 indicates that cheaper NFTs aren’t necessarily going to have the most potential. At the same time, practising good judgement in picking the right NFTs while paying a premium is also essential.
This is especially more evident in Figure 3 where the top 5% pays around 3 times more than the bottom 95%. The top 5% has the willingness and capacity to pay more for NFTs while demonstrating the capability to pick top performing NFTs.
In Figure 4, it shows that trading a diversified set of NFTs correlates to better NFT flipping performance.
Having said that, in 2021, there are a total of 2,000 NFT collections with 94% of all NFT flips concentrated in the top 500 NFT collections. Therefore, the performance gains from diversification is only limited to the top NFT collections.
Figure 6 shows how the Groups fare between each other when flipping NFTs for a profit. Curiously, Group 1’s ability to flip NFTs that results in a profit (72%) is not meaningfully better than Groups 2 (70%), 3 (69%) and 4 (66%).
In this case, how can we explain why Group 1 deserves to be on the top spot? Taking a look at Figure 7, we can see that even though Group 1 is no better than Groups 2, 3 and 4 in picking profitable NFTs. Group 1’s NFT flips tend to result in higher return on investment.
Looking at Figure 7 again, other than Group 5, does it mean that most NFT traders are profitable because their return on investment multiples are more than 1x? This may not be the case. The data in the figure doesn’t account for unrealised losses that NFT traders may suffer as NFT traders have a tendency to flip their NFTs only when there is a profit.
In summary, is it safe to say anyone can profitably trade NFTs so long as they have a lot of money, able to hold out on NFTs until they can flip it for a profit, have the willingness to pay premium prices for good picks, diversify into the top 500 NFT collections and actively practice flipping NFTs? Not exactly, in the next section of this article I will share more insights that might explain the rise of NFTs in 2021.
What could explain the NFT craze in 2021?
Massive growth then massive interest
Prior to 2021, NFT trading volume was already growing at a breakneck pace from 1.3 million in 2018 to 85.7 million in 2020. Starting from 2021, NFT trading volume went berserk. It grew from 85.7 million in 2020 to 19.6 billion in 2021. This represents a 22,770% growth. According to some reports, NFT trading volume in 2021 is even higher at $40 billion or 400x from 2020. What could explain this massive growth?
Massive growth cryptocurrency market cap
Bitcoin’s May 2020 halving kickstarted of the new cryptocurrency market rally. The price of Bitcoin went from around $8,000 in May 2020 to a peak of $64,000 in April 2021. That translates to a 800% return in one year alone. Looking at Ethereum, the second cryptocurrency by market cap, the price of Ethereum went from $200 in May of 2020 to a peak of $4,100 in May of 2021. That translates to a 20.5 times return on investment. Therefore it is likely that we are seeing wealthy cryptocurrency native users looking for new ways to spend their new found wealth. This could also explain why Beeple’s Everydays: The First 5000 Dayswas sold to a cryptocurrency user for $69 million in March 2021.
Launching NFTs have never been easier
When Larvalabs first created their Cryptopunks back in June 2017, the ERC-721 standard which most Ethereum based NFT follows had not been launched. ERC-721 standard was only launched in January 2018. So this means that Larvalabs had to write their own code to create the now famous Cryptopunks. But not all was smooth sailing because the first version of Cryptopunks had a code glitch and Larvalabs had to reissue the Cryptopunks again. It is this reissued Cryptopunk that the public recognise. Since then launching NFTs has become a lot easier. NFT platforms like OpenSea makes it easy for artists to create their own NFTs without writing code. On top of that, the coming of age for tools like Metamask makes it easier for web developers to build applications and interact with the Ethereum blockchain.
The entire cryptocurrency community and its offshoot – NFTs – is fuelled by meme culture. Take Dogecoin for example, it was initially created as a joke, a parody of Bitcoin. Since then it has captured the public’s imagination and has many copycats. It also doesn’t help that famous public persons and celebrities also propagate the memes. Therefore, when an NFT is created to carry that narrative, it helps to kickstart a conversation about that NFT, allowing it to spread like wildfire. Take the now famous Bored Ape Yacht Club (BAYC), it was designed as a meme of people getting rich from speculating on stocks and cryptocurrencies by “aping” into trades together, after which they are bored and like all bored rich people, they join a yacht club.
New found wealth, tools for accessibility, viral narratives and of course to a certain extent, lockdowns from Covid-19 all contributed to the rise of NFTs in 2021. Figure 9 below shows NFT as a search term on Google reaching its highest score of 100 by the end of the 2021.
NFT traders are wash trading to scam other traders
What about wash trading stories in the NFT market? According to Chainalysis, about 262 addresses – as compared with 23,000 addresses mentioned at the beginning of this article – are categorised as actively engaged with wash trading due to these addresses selling to addresses that are self funded for more than 25 times. At first glance, it seems like wash trading is a small issue. But, traditionally wash trading has been hard to detect. As the technical sophistication and threshold needed to meet the definition is difficult to pin down. In any case, we can get a feel for it through another NFT trading platform called LooksRare.
Looking at Figure 10, we can see that when LooksRare first launched in January of 2022, it was 2 times more successful than OpenSea in terms of daily trade volume.
However, by looking at the daily active users, we can see some troubling signs. LooksRare daily active users are 20 to 40 times much smaller than OpenSea. This suggests that wash trading could be a severe problem in LooksRare.
So why is wash trading so much more obvious in LooksRare than in OpenSea? It boils down to incentives. LooksRare tries to differentiate from OpenSea by providing users with rewards in the form of LOOKS token for flipping NFTs on the platform. However, the inadvertent effect is that wash trading is more rampant. LooksRare recognised this problem and have implemented safeguards. It is not yet clear if the safeguards are effective.
Going back to OpenSea, although not all wash traders are in the black, wash trading is still profitable as a whole.
As the NFT industry matures and with regulations kicking in, we will have better tools to detect, investigate and prove malicious behaviours like these with more avenues to take action against them.
NFTs are scams because money launderers are pumping the price
To answer that question, we have to first look at the illicit value received by NFT platforms.
The chart above shows that in 2021, less than $3 to $4 million of NFT trades are sourced from illicit funds. This accounts for roughly 0.01% to 0.02% of the entire NFT market in 2021. This shows that money laundering does exist in the NFT market and is growing; still it is much less than the overall NFT trading volume.
Sources of fund reveal a lot more
Finally, taking a look at Figure 14, we can see that 5% of user addresses on OpenSea account for 80% of the profits from NFT trading.
So what makes the top NFT traders stand out? Referring to Figure 15, we can see that the sources of funds from the top quintile also known as Group 1 discussed in the first section of this article.
From it, we can see that only 15.1% of them source their funds from conventional centralised exchanges like Coinbase or Binance. The balance of the funding is sourced from places like decentralised exchanges, smart contracts etc. This indicates that successful NFT traders are technically sophisticated. This makes sense because of the open and permissionless nature of public blockchains like Ethereum, technically capable cryptonatives with new found wealth will be able to gain an outsized advantage by employing their coding skills.
For example, Punk #9998 was bought for around 125,000 ETH or around $500 million. This makes it the most expensive NFT ever sold. But the community is very quickly able to investigate that the trade wasn’t legitimate because the buying and selling addresses are deemed to be owned by the same person. The buying address borrowed the funds through a flash loan to purchase the NFT at an exorbitant price, then the selling address used the proceeds to pay back the flash loan.
Another example is the “sniping” of a BAYC NFT for $3,000 instead of the original price of $300,000. What happened here is that the original owner of that BAYC accidentally input the wrong price. Before he could cancel instruction, a bot that was created to scan the entire NFT market for bargain prices immediately purchased the NFT before the instruction was cancelled.
The points above seems to indicate that in addition to having a lot of money to trade, willingness to pay more, having enough trading experience, stare down unprofitable trades and own NFTs across top collections, to be in the top 5%, chances are you have to be technically savvy with smart contracts, able to code up bots, exploit loopholes, and use DeFi to fund your transactions. Separately, there is very little evidence that money laundering is the main driving force behind NFT trades. And more research is required to identify and ascertain the effects of wash trading. Having said that, 2021 was an exceptional year for NFTs. It grew by at least 200x. In such a market condition, it is hard not to be lucky and profitable.
Additionally, there is growing evidence that NFT users might be a different class of its own. The reason is because since the cryptocurrency market correction at the end of 2021 to the beginning of 2022, the NFT trading volume didn’t follow suit. It has been resilient, with some NFT prices reaching all time highs. This shows that maybe NFT users are strong believers or have strong attachments for their NFTs. They may also price their NFTs in dollar terms, thereby adjusting their NFT prices up whenever the price of the denominated tokens like ETH drops relative to the dollar.
The NFT industry is barely a couple of years old, at a trading volume of $20 billion to $40 billion, it is barely 1% to 2% of the $2 trillion dollar cryptocurrency market. Give it a few more years to mature, then maybe the success factors will solidify with more opportunities for everyone to win.
Disclaimer: The opinions expressed in this article are unqualified opinions of the author. It is meant for informational purposes only. It is not meant to serve as financial or investment advice. Please consult with your financial advisor.