In grant 1, we propose a Quadratic Voting mechanism to make community voting fairer (https://grant.BNB.one/#/donate). An NFT Auction Model and Mechanism is the second research conducted by DAOeco on BNB Grant. This study will propose a new NFT auction mechanism aiming to solve the problem in the current NFT market to improve the liquidity of NFT trading market and benefit creators and participants through the combination of NFT and DeFi and the release of liquidity in the transaction.
The Introduction to NFT
NFT (Non-Fungible Token) is a unique digital asset with uniqueness, scarcity and non-replicability.
In recent years, NFT has been used widely in digital art, domain names, games, collections and so on. NFT is cast on the blockchain, such as Ethereum, and can be used to verify the ownership of assets. According to the report of NFT data analysis website Nonfungible, in 2020, excluding invalid transactions and dead projects, the total market value of NFT market is about $338,035,012, with an annual growth rate of 299%.
In 2021, the NFT market ushered in explosive growth. According to Nonfungible, the transaction volume of NFT market in 2021 Q2 reached 754 million dollars, with a year-on-year increase of 3453% and a Value of NFT
month-on-month increase of 48%. NFT projects have been launched one after another and some of them are popular. According to Nonfungible, collections are the most popular field of NFT accounting for 66% of sales. Arts account for 14% and sports accounts for 7%.
According to Cryptoslam, the three NFT projects with the highest sales are blockchain game Axie Infinity, NBA Top Shot and Cryptopunk, with sales of $1.04 billion, $670 million and $650 million respectively. In addition, the trading volume of NFT secondary market in 2021 Q2 shows an increasing trend, reflecting the continuous development and maturity of NFT market. The main NFT trading markets include Opensea, the largest comprehensive NFT trading market, and Superrare, which specializes in art.
Value of NFT
The value of NFT can be reflected in many aspects. First and the easiest to understand, the holders can show off NFTs or show people NFT art or music taste; Or in the market, they can earn money with the NFT. In addition, the mapping of real-world assets to the blockchain is also the embodiment of the value of NFT.
We will explore the value of NFT from six dimensions: practicability, ownership history, digital scarcity, supply-demand relationship, future value and liquidity premium. An initial analysis framework for the value of NFT will be proposed combining these dimensions.
The practical value of NFT depends on how NFT is used. Game assets and tickets are two representative use cases with high practical value. A typical example is LAND parcels in the Sandbox virtual world. The value of NFT tickets refers to the price of event tickets. For example, users need to buy tickets to participate in art exhibitions in Decentraland.
Another dimension of practicality is the ability to use the same NFT in different applications. For example, if the same asset can be used in different games across chains and platforms, the practical value of NFT assets will naturally be higher.
However, it is still difficult to realize the above situation. Currently, 90% of NFT players focus on only one game. This requires developers to build a complicated and huge game ecosystem, providing interesting use cases and attracting more users. Dapper Labs and Enjin are now working in this direction.
Another way to increase the practical value of NFT is to establish partnerships with other enterprises to benefit NFT holders. For example, Dapper Labs can cooperate with NFT event organizers to bring discount prices to investors of CryptoKitties. After establishing a cooperative relationship, the event organizers can attract participants more easily, which is a win-win situation for all parties concerned.
The value of ownership history depends on the identity of the NFT issuers and previous owners. NFTs with high historical value are often created or distributed by well-known artists or companies with famous brands.
Take Meebits, which was just released not long ago, as an example. Meebits is created by Larva Labs, which is famous for launching one of the most popular NFT projects CryptoPunks. Meebit has a circulation of 20000, of which 10512 are distributed to the holders of Larva Labs assets (holding CryptoPunks or Autoglyphs). The remaining 9488 are quickly sold out in the form of Dutch auction. The average price of each Meebits reaches 2.5 ETH (about $8500).
There are two ways to increase the value of ownership history.
First, cooperate with companies or individuals with famous brands to issue NFT tokens, which will naturally attract considerable attention and users to the ecosystem.
The second method is to resell NFTs previously held by influencers. At present, due to the anonymity of the blockchain, it is difficult to find who is the previous owner. This valuable historical data remains to be mined. Markets and sellers can provide easy-to-use tracking interfaces to increase the value of NFT. Taking Opensea as an example, the platform can mark the addresses of investors who make the most profits from NFT transactions and list other NFTs they own.
Scarcity is a multiplier for NFT to create value. Like brands, scarcity has three sub criteria: absolute scarcity, relative scarcity and availability. Taking Cryptopunks as an example, Cryptopunks are the first batch of NFTs based on Ethereum and the inspiration of ERC721 protocol, which promotes the vigorous development of most digital art and collectibles industries.
Absolute scarcity refers to how many products a given brand has prepared for consumers to purchase. There will be millions of “Punks” in the market, but only the release quantity is the absolute quantity of supply, which can reflect the absolute scarcity.
Relative scarcity refers to the degree of scarcity of a given item in an absolute set. For example, among the 10000 Crytopunks, there are 6039 male NFTs and 3840 female NFTs, but among the scarce Punks, there are only 88 zombies, 24 apes and 9 aliens, which makes these Punks more valuable because they are fewer.
It is known that scarcity is the main feature of NFT. The buyer knows exactly the number of selected items on the basis of absolute scarcity and relative scarcity. But collectors of physical items such as star cards, cars or shoes will never know exactly how many items are given.
Absolute scarcity and relative scarcity are decided by developers, which may influent the brand. If scarcity is desirable, then greater scarcity will always add value to the brand. However, no brand is welcomed purely because of scarcity, and the brand needs marketing to create initial value.
Absolute scarcity and relative scarcity will ultimately affect availability, that is, how many goods related to a given brand are available for sale at a given time. Higher absolute scarcity means that buyers will have fewer opportunities to collect items from the brand, while a higher relative scarcity means that buyers will have fewer opportunities to complete the specific collection. Higher scarcity means limited supply. With the strong growth of demand, the price of supply assets may rise dynamically.
Relation between Supply and Demand
The relationship between supply and demand should be considered from two aspects. The less the supply, the more likely it will bring digital scarcity. However, it should be noted that the issuer of NFT will not directly bring demand. It is important to make full use of digital scarcity, but at the same time, even if the supply is very scarce, corresponding demand is also necessary.
Meanwhile, the supply-demand relationship of NFT at this stage is also related to the fans economy. Before NFT has entered the mainstream market, those who have a large number of fans on Twitter, Instagram or Youtube and those who are more active in the community are likely to have the opportunity to contact potential customers, enjoying first-mover advantages.
The relationship between supply and demand is a two-way process, not a problem that can be solved only by digital scarcity. Creating demand is the ultimate means to truly realize the value of NFT assets.
The future value of NFT comes from both valuation changes and future cash flow. Valuations are driven by speculation and sometimes may be the determinant of price appreciation.
For example, in December 2017, the price of Cryptokitty #18 soared from 9 ETH to 253 ETH in just three days, equivalent to about $110000 at that time. Some people believe that the price fluctuation caused by valuation may have a negative impact on NFT, but speculation is always the nature of most people and an indispensable part of the current financial system. If a proper balance is reached, it can increase the value of NFT and attract more new users.
Future cash flows are interest or royalties earned by the original owners of NFT. For example, SuperRare allows creators of NFT art to receive a 3% royalty each time their artwork is sold on the secondary market. NFT can be combined with DeFi to give NFT the function of real-world assets. NFT is an asset that can be leased and mortgaged, and can be speculatively resold to create additional cash flow and generate income for creators and holders.
Liquidity Premium refers to the time and cost required to convert an investment asset into cash. If an asset can be converted into cash at a price close to the market price in a short time, it is said that the asset has high liquidity. In the field of NFT, liquidity premium refers to the conversion of high liquidity into higher NFT value.
Liquidity premium is the main reason why tokens created on the chain should have higher value than assets outside the chain. For example, the NFT with ERC standard can easily increase the exposure to people holding ETH in the secondary market and increase the number of potential buyers. Investors prefer to invest in NFT categories with high trading volume, because high liquidity reduces the risk of holding NFT.
NFT designers can make full use of the characteristics of its token economics to encourage users to increase transaction frequency, increase the participation of asset holders and improve the liquidity of NFT. If idle for too long, NFT assets will depreciate accordingly.
Analysis Framework of NFT Value
Based on the above six dimensions, we can conclude:
Value of NFT = Practicability + Ownership History + Digital Scarcity + Supply-Demand Relationship + Future Value + Liquidity Premium
According to the assets represented by NFT, the value weights of these six components are different. Investors can use this framework to evaluate whether NFT is worth investing, and designers can also consider how to improve the value of NFT to attract users and investors according to this framework.
How to Maximize the Value of NFT
Based on the six dimensions of NFT value and the theory of radical market, DAOeco modify the transaction mode of NFT and put forward a new NFT casting and auction mechanism to help maximize the value of NFT.
Under the new auction mechanism, any bidder can obtain ownership of the NFT as long as the bid is 10% higher than the superior bidder. In this way, all NFTs will be given a natural automatic pricing mechanism, and the transaction is compatible but not dependent on the traditional NFT auction platform, so as to improve the liquidity of the asset and maximize the value.
The Theory of Radical Market
Radical market is a new market theory. The main idea of it is to supervise the market with the power of the market itself. The main points include:
- Private ownership brings a monopoly of collectibles and inefficiency of the market. The producer sets the minimum supply price ceiling, which limits the output, and the market cannot reach the balance of supply and demand, resulting in a quadratic deadweight loss between consumer surplus and producer surplus.
- Every item in the radical market will be priced and auctioned, and the auction will be held indefinitely.
- It is difficult to implement the radical market theory in reality, but easy in the blockchain world.
Radical Auction Mechanism
Radical auction is an incentive auction mechanism based on radical market theory. By encouraging bidders to bid, the mechanism makes the price of an auction quickly converge to the reasonable price in the market. The auction price increases monotonically and rapidly according to the joint curve model set by the system, and the bidders who bring price discovery can obtain the income compensation corresponding to the risk.
For NFTs issued based on the fund auction mechanism, the following rules apply:
Assuming that the NFT starts at a fixed price of 1 BNB, each bidder’s bid needs to be 10% higher than the previous bid, X is the auction round, and Y is the final price of the NFT, then,
Y = 0.5 * 1.1^X
The premium of 10% is distributed as follows:
- 50%: creators
- 30%: last bidder
- 18%: the rewarding pool
- 2%: the invitees of the auctioneer (if not, this part will flow into the rewarding pool)
Users can accumulate enthusiasm when participating in the auction. The enthusiasm will be one degree higher for each successful auction. The bonus will be distributed proportionally according to the enthusiasm of users participating in the auction and will be sent to users at the end of the auction. After the bonus is paid, the enthusiasm of users will be cleared.
Creator A created an NFT and put it on the market for auction. The starting price is 1 BNB. Users B, C and D participated in the auction. Assuming that there is no invitation relationship between users, user B finally obtained the NFT after five rounds of auction. The details of each round of auction are as follows:
The radical auction mechanism provides corresponding incentives to the auctioneer’s bid risk, accelerating the process of price discovery of NFT works. This mechanism can effectively maximize the expected income of creators and auctioneers and realize the highest value of NFT works; At the same time, it also gives users (bidders) a fair and just bidding mechanism.