If you are wondering about

• Why an Azuki is worth over $30k
• How to value NFTs
• Or which NFT project to ape into

Read on.

Part 1 of this article provides a quick answer to why some NFTs are worth a sh*t ton of money. Part 2 outlines our valuation framework for NFTs. Part 3 lists the top 10 NFT projects that are worth consideration.

NFT is a broad concept. NFTs are classified into nine categories on Opensea. Covering everything in a single article is not a good idea either for our sanity or yours. While our valuation framework can be applied to different types of NFTs, we focus on digital collectibles in this article, specifically profile picture projects ("PFPs") such as CryptoPunks and Bored Ape Yacht Club.

There are NFT projects that are more art than PFPs, for example, The First 5000 Days by Beeple and Fidenza by Tyler Hobbs. There are gaming NFTs like Axies, Skyweaver cards and RaidParty Heroes. Then there is digital real estate like Sandbox and NFT Worlds.

There's also been a trend of NFTfi, allowing NFTs to be staked and generate yields (mostly in the native currency of that particular project). NFTfi behaves very much like stock with dividends. The ceiling of NFTfi projects might be lower than collectible NFTs, because one can apply some sort of DCF model to NFTfi and arrive at a probable valuation, which tends to be more realistic (a.k.a. lower) than the valuation of a brand (more on brand in part 1).

Even within collectibles, there are innovations beyond PFPs. For example, we are observing an emerging demand for banner NFTs such as Midnight Breeze.

This article also only targets NFTs on Ethereum, leaving out some very interesting projects on other chains, for example, Smol Brains on Arbitrum.

We will save all those topics for future discussions and keep this article focused on Ethereum PFPs.

Part 1: Why are Some NFTs Bewilderingly Expensive?

Let's all be honest upfront. NFTs have little, if any, intrinsic value or inherent utility, especially PFPs. For the purpose of being used as profile pictures on social networks, Azukis are no more valuable than right-click-and-saved images from a free anime character library. Why are Azukis worth $30k each then?

The trick is that PFPs are brands. There are always premiums paid for brands. An Hermès handbag provides no more utility than your local grocery store's free shopping bag. A Lamborgini Gallardo takes you to your destination no better than a Honda Civic.

Why are there brand premiums? Some argue for love for design or emotional connection with brand. That is bullshit. People pay premiums because there are premiums. They buy luxury items to communicate about themselves, mainly showing off their social and economic status.

Luxury brands are perfect examples of Veblen goods, whose demand increases as price increases. Hermès handbags will not be sought after, if they are $500 a piece. Sales of luxury brands will tank during tough times, but their price is unlikely to drop much.

The mint price for a Supreme x Louis Vuitton t-shirt was $485. A little pricey for a white t-shirt, but it has got a Supreme logo on it! Of course something Supreme (pun intended) is not selling for $15 like those ordinary stuff in JCPenney. What about the floor price after mint? $2000-$2500. We wonder what would happen, if Supreme allowed fans to grind in their discord for a whitelist.

Source: StockX

A branded item must not be judged on its utility. Its value is driven by the brand narrative and the market, i.e., supply and demand. Brand and market are the two most important factors for valuing luxury items as well as PFPs (more detailed analysis in part 2).

Supreme has built up its reputation as a top street-wear fashion brand. At the same time, Supreme is pretty good at playing around scarcity. "It’s not like when we’re making something, we make only six of them. But if we can sell 600, I make 400," says James Jebbia, founder of Supreme, during an interview.

CryptoPunks is telling the story of being the OG PFP and a pioneer in pixel art. And there are only 10,000 punks.

More importantly, PFPs are a total upgrade to physical brands like Supreme, not only because authenticity and scarcity become easily verifiable on chain but also because humans are migrating from the physical world to the digital world. PFPs are an integral part of people's digital identity in the metaverse.

The global collectibles market is $372 billion in 2020. Opensea's total volume is $14 billion in 2021. Pre-owned luxury watches sales hit $18 billion in 2019. Pre-owned CryptoPunks sales are roughly $2 billion in 2021. Nowadays, how often do other people see your profile picture as compared to your watch?

On the demand side, there are 7.7 billion people in this world. All of them will need a digital profile picture at some point. On the supply side, 100 successful 10k PFPs (1 million profile pictures) can satisfy the demand of 1 million people, or 0.013% of the world's population. As a reference, 800k new Rolexes get made every year. The potential in PFPs is obvious.

You are probably already a believer in NFTs since you are reading this, so let's turn to valuation frameworks. For doubters, we highly recommend Ben Yu's masterpiece NFTs 101 (you need to block 2 hours to read it!). It is a much more detailed explanation on why NFTs are going to make it.

Part 2: How to Value NFTs?

It is hard to value NFTs. Most of the discussions on this topic remain qualitative. We attempt to establish a quantitative framework for valuing NFTs in this part. Of course, everything is tentative and experimental in nature. We welcome all kinds of feedback and criticism.

As alluded to in part 1, the two pillars of our NFT valuation framework are 1) brand (40%) and 2) market (60%).

Brand (40%)

In the "brand" segment of our framework, the total weight is divided into floor price (20%), average price over the last 30 days (10%), twitter followers (5%), and age (a.k.a., days since first mint, 5%).

Floor Price (20%) & Average Price over the Last 30 Days (10%)

When we talk about a brand, we concentrate on the brand's mimetic power. When people own the brand, they want to show it; when other people see it, those people want to own it.

In the restaurant business, there has been an increasing trend to make food not only tasty but also instagram-able. Food must look delicious when photographed, so that it can be shared via Instagram to attract new diners. Brands work in the same way. Lamborghini will not be a thing if its owners do not drive them around.

Originally we considered measuring PFPs' brand power based on their perceived artsy-ness or coolness, such as conducting surveys among a large and diverse group of individuals. However, we are afraid that no groups are qualified to be NFT tastemakers.

Instead, floor price is a simple yet very good proxy for determining whether a brand is desirable or not. Chanel is more expensive than Coach primarily because Chanel is perceived to be more worthy. We would not be able to judge the artistic difference between an Azuki and a Divine Anarchy. But the market clearly shows that the former is much more attractive.

So floor price as the proxy for brand takes up 20% weight in our framework, with average price another 10%. Average price better accounts for large sales of rare pieces and fluctuations in a volatile market.

Twitter Followers (5%) and Age (5%)

Twitter followers is another good proxy for measuring a brand's mimetic power. We would love to monitor activities on any social network. Unfortunately, while almost all PFPs are on Twitter, not many have presence on Instagram or TikTok, which is kinda absurd. Anyways, we had to settle for twitter followers.

Twitter followers is further divided between total number of followers (3%) and new followers over the last 30 days (2%) to account for what is trending at the moment.

Age (5%) is an interesting metric inspired by Nassim Taleb's elaboration on the Copernican Principle. We share Taleb's belief that the longer something lives, the longer it is expected to live. In the wise man's own words:

If a book has been in print for forty years, I can expect it to be in print for another forty years. But, and that is the main difference, if it survives another decade, then it will be expected to be in print another fifty years. This, simply, as a rule, tells you why things that have been around for a long time are not “aging” like persons, but “aging” in reverse. Every year that passes without extinction doubles the additional life expectancy. This is an indicator of some robustness. The robustness of an item is proportional to its life!

Our investing philosophy in NFTs is straightforward. Buy into projects that are least likely to go to zero. The older PFPs that are still relevant today, are more likely to survive longer. They represent better investment opportunities.

CryptoPunks is over 5 years old now. It is probably going to live longer than all the other popular PFPs at the moment. In fact, none of the other ones have celebrated an anniversary yet. It is remarkable that CryptoPunks is capable of maintaining similar trading volumes as these young guns. This is strong evidence of punk's mimetic power.

Market (60%)

In the "market" segment of our framework, the weight is divided among volume over the last 30 days (40%), the number of items listed (10%), percentage of unique holders (7.5%), and percentage of top 10 holders' supply (2.5%).

Volume (40%)

As we are considering PFPs as investment opportunities, not as personal collectibles. It requires that liquidity is our top priority. Cash is king after all. Floor price does not mean sh*t, if there is no volume. When you check rankings on Opensea or any other NFT marketplace, the default criteria is always volume.

We believe giving trading volume the largest weight (40%) needs no further explanation.

Number of Items Listed (10%), Percentage of Unique Holders (7.5%), Percentage of Top 10 Holders' Supply (2.5%)

Recently some very good-looking projects faded into oblivion. Pure supply and demand mechanism was the main culprit. When 20-30% of a project is listed for sale, it creates enormous pressure on its floor price. As floor price decreases, more holders try to sell and buyers are less willing to bid. Falling floor prices are also disastrous for maintaining the project's brand image. Then everything starts going down in a death spiral.

The more prominent PFPs typically have around 8-15% of their total supply listed, a healthy percentage that ensures stable volume without triggering death spiral.

Percentage of unique holders (7.5%) and percentage of top 10 holders' supply (2.5%) are helpful proxies for estimating future listings. During bear markets, the mentality and action of owning 100 apes is very different from owning only 1. Supply is more stable when there are more unique holders and the top holders do not own much.

Bored Ape Yacht Club has 6313 unique holders at the time of writing. CryptoPunks only has 3285. It is interesting to see how the market will react when big punk hodlers decide to cash out.

Other Considerations

Many other factors unfortunately do not make it into our framework, mostly because their effect on NFT projects is uncertain. We are going to go over some of them below.

Doxxed Team

It is argued that doxxed teams are less likely to rug. This argument has merits. But doxxed teams are like public companies. Their every move is put under greater scrutiny. This may not be ideal for projects in their early stages.

Anonymous teams are like private companies. They can freely evolve by trial and error. Bored Ape Yacht Club founders were anonymous. Azuki team was semi-anonymous. Only the artist was doxxed. But no one seems to worry about BAYC or Azuki rugging. Unexpectedly, the Pudgy Penguins team, who made it to the New York Times, rugged.

Satoshi Nakamoto was not ever doxxed. Bitcoin did just all right after Satoshi disappeared. It is not clear whether anonymous teams consistently under-deliver.

Influencer Involvement

It is bad when influencers pump and dump. But it is difficult to distinguish between genuine and ill-hearted shilling. Influencer marketing is something to consider but cannot be included in the framework.

High Mint Price

High mint price is another element that is inconclusive. The argument is that high mint prices lead to a huge one-time windfall, incentivizing teams to rug. There are expensive projects that do well; there are also cheap projects that rug. 300E (10000 pieces for 0.03E each) is still a significant sum to just walk away with.

We recommend aping more cautiously if the mint/auction/sale price is high, but we don't believe high mint price is a definitive red flag.

Part 3: Some Worthy Projects

We evaluated over 50 popular PFPs according to our valuation framework. And the following made to the top 10. It's easy to see Bored Ape Yacht Club's dominance in this space. All three clubs made the list.

Most other projects are well-known winners. Mfers is the trending project right now. Its no roadmap approach is very interesting. Whether Mfers can stay on this list after the initial hype is something to keep an eye on. Cryptoadz was the meme NFT project not too long ago.

There are also several projects that unfortunately didn't make the list, including World of Women, CyberKongz, VeeFriends, Adidas Originals: Into the Metaverse, etc. It was close towards the end of the list. They could get in at anytime.

(You may check the full breakdown here.)

Some of you (like myself) might have been priced out of the projects above. That's why fractionalization is a key step to allow more people a share in these projects' success. It's easy to buy 0.5 btc, but it's hard to buy one half of a bored ape. Azuki is experimenting with fractionalizing Bobu (Azuki #40). We are closely monitoring the developments on this front.

It is much more risky to invest in cheaper projects that are not yet battle-tested. But if you are brave enough, checking Opensea rankings for projects with over 50E daily volume and increasing yet affordable floor price is a good start.

Closing Thoughts

We'd like to end with a word of caution. Ryan Selkis compared the recent NFT boom to the 2013 bitcoin bubble in his annual crypto review (it's a 165-page must read if you haven't already done so). He predicted that "the digital art / NFT market crash will eventually be even more nauseating than the 2015 bitcoin bear market (because these are highly illiquid assets by definition), but the 10 year trajectory of the overall market will be the same: 100x+." By the way, Bitcoin crashed 80%+ in 2014.

NFTs are in many ways very similar to 2013 bitcoin. Bitcoin in 2013 was a gigantic brand. The valuation was not based on intrinsic value, but on narrative and people's willingness to pay. Even today, fees generated by the bitcoin network are negligible if compared to bitcoin price. It could also be argued that Cardano ($ADA) maintains its top 10 spot not as a blockchain, but as a brand. But let's have this discussion on a different day.

Prominent NFT projects are unlikely to crash 80%+, exactly because they are highly illiquid assets. If you only own one bored ape which you bought for 100E, you will probably not sell it at 30E, unless you are desperate for liquidity. However, if you are desperate for liquidity, why are you selling your ape instead of your more liquid assets?

The US home prices fell by a record 18% in 2008. The more liquid Nasdaq dropped 40% during the same period.

But in a bear market, the less blue-chip NFT projects will not just dip. They will probably disappear. There is definitely irrational hype in the NFT market today. Apparently apes whose special features are floating necklaces and hats with holes for ears are worth tens of thousands of dollars.

Any up-and-coming market is a Wild West. As illustrated in Gartner's Hype Cycle, it will experience a trough of disillusionment.

Source: Wikipedia

There will be market-wide corrections, a.k.a., crashes. Ryan Carson predicts that it will happen 6 months after Coinbase NFT launch. We are not fortune tellers so we are not gonna pick a date. But we are observing decreasing trading volume and falling floor prices across the board. Whether this is transitory remains to be seen. Again, NFT is an exciting yet dangerous playground. Volatility is sacrificed for outsized returns. It is never wrong to only invest what you can afford to lose.

But when that crash hits, when trading volume dips 80%+, it will be the best time to ape into any surviving NFT projects for maximum gain.