Analysing NFT Market Dynamics: A Burst or A Shift in Trends?

Key Takeaways:

• The NFT market is currently experiencing a substantial downturn, marked by significantly reduced trading activity compared to the levels observed a year ago.
• The era of speculative trading for profit in NFTs appears to be waning, particularly in the market for profile picture collectibles with limited utility, which has seen a decline.
• Industry executives are shifting their focus towards NFTs with practical applications, such as alternatives for ticketing and gaming-related assets.

Introduction 

The NFT boom set the course for a wide variety of possibilities for digital creators. This led to the NFT surge of 2022, when the creators were creating sold-out collections. However, these multi-million dollar assets have experienced a significant decline in popularity over the past year, leading many to question the reasons behind the crash in the non-fungible token market, when a recovery might occur, and what initially caused the downturn.

Some experts are also of the opinion that this downtrend is to cause an end to the creation of the ‘dumb NFTs’.

Several key factors contributed to the NFT crash, encompassing the psychology of economic bubbles, NFT wash trading, the volatility of the broader crypto market, and overall macroeconomic conditions. Below, we delve into these aspects to provide a comprehensive understanding.

To trace the roots, the NFT industry emerged with the introduction of the Ethereum ERC-721 token standard in 2017 and peaked in the spring of 2022. However, recent trends show a substantial drop in prices and trading volumes. Let’s dive deep to understand where the NFT space is standing in today’s time.

Additional Read: How to Create an NFT for Free?

What is an NFT Bubble?

In short, an NFT bubble emerges when the market value of non-fungible tokens undergoes rapid and unsustainable growth due to an increase in excitement and speculative trading.

Characterized by an industry-wide surge in NFT prices fueled by widespread enthusiasm and an inflow of speculative investments, these bubbles form when NFT market values surpass their intrinsic worth on a broad scale.

“Bubbles” are not exclusive to any particular sector; they occur when prices climb excessively beyond reasonable or historical levels. Notably, such conditions are often filled with speculative hypotheses, similar to that of the dot-com bubble of the 1990s and the unregulated lending contributing to the housing bubble that precipitated the Great Recession.

Ultimately, demand sees a decrease, leading to market downturns and the subsequent collapse of the NFT market. Solo Ceesay, CEO and co-founder of Calaxy, a blockchain-driven social marketplace, described NFT bubbles as a manifestation of market euphoria, noting that during bullish periods, prices can reach irrational levels as investors become overly optimistic.

When Did the NFT Bubble Begin?

If we look back and analyze the whole scenario and take a look through the initial phase of the NFT market, it had been marked by the sale of digitized “art” at exorbitant prices. That is often considered to be the starting point of the NFT bubble. Participants were entering a space that was like a form of “gold fever,” and those with a futuristic outlook recognized the inherent unsustainability of the situation.

As per the report published by Nonfungible.com in its 2021 edition, in January 2022, the onset of the NFT bubble was marked by a surge in trading volume, reaching $17.6 billion and exhibiting a staggering 21,000 percent increase compared to the previous year.

The report revealed a dynamic market scenario with significant growth in various metrics. The count of active users, determined by the registered crypto wallets, skyrocketed from 89,000 to 2.5 million. The number of buyers experienced an almost 3,000 percent surge, while sellers saw an impressive increase of 3,700 percent.

Source: Nonfungible.com

Bubbles are integral components of market cycles, according to Ceesay, the CEO and co-founder at Calaxy. She also commented that the bubbles only serve as catalysts for corrections. The current state of the NFT market suggests a potential future crash, depending on one’s perspective. However, Michel Caspers, co-founder of Unity Network, a software development company, views this as a sign of the market making an attempt to understand NFTs better rather than an imminent collapse. Despite concerns, Caspers sees unrealized potential that may prevent a sudden halt to the NFT market’s growth.

Factors Contributing to NFT boom

While the NFT space saw a rise with the introduction of the Ethereum blockchain and the ERC token standard, the limited collection of digital assets reached its saturation till the crypto market was running its bullish course in 2021. The numerous collaborations of artists and their collection of NFTs to connect better with their communities saw a rise during the same period, propelled by the infamous Beeple NFT.

However, the diminished value of the NFTs, being correlated with the crypto assets, saw a similar trajectory thereon. More on the crypto prices and the NFT crash below.

Correlation Between NFT Crash and Crypto Prices

The close connection between the crypto and NFT markets is evident, and while their prices don’t align in a 1:1 ratio, the crypto market significantly influences NFTs. Although the crypto market reached its peak in November 2021, with Bitcoin price hitting nearly $70,000 and a total market cap exceeding $3 trillion, the subsequent decline to $1.632 trillion in late January 2022 did not immediately impact NFT prices.

Source: CoinGecko

The 2022 NFT crash can be attributed to various factors related to NFTs and the broader crypto landscape. Both crypto and NFTs are subject to broader market forces. When the COVID-19 pandemic hit in 2020, and part of 2021, substantial financial support was provided to individuals, especially in the United States, which resulted in increased consumer purchasing power. This influx of funds bolstered the e-commerce industry and allowed people to invest in riskier assets like crypto and NFTs.

Federal Reserve data indicates that U.S. households accumulated around $2.3 trillion in savings beyond normal levels in 2020 and through the summer of 2021. However, savings rates declined significantly by mid-2022, leading to reduced disposable income and shifts in consumer behavior.

Fluctuations in savings rates, coupled with artificially low-interest rates and a significant rise in the stock market throughout 2021, influenced consumer financial dynamics. The S&P 500, for instance, soared by 206% from March 2020 to the end of December 2021 but experienced a 23% loss of those gains from the end of 2021 to June 2022.

Global inflation, reaching a staggering 8.3% in April 2022 and peaking at 9.1% in June 2022, also contributed to financial strain. Many individuals likely sold their NFTs in response to rising consumer prices, coinciding with the collapse of the NFT market.

In a broader economic context, bull markets prompt increased investments in high-risk assets like crypto and NFTs by individuals and institutions. Conversely, economic scarcity conditions, particularly when government stimulus ends and savings decline, lead to the gradual divestment of high-risk assets like NFTs. Therefore, overall economic conditions played a pivotal role in the 2022 NFT crash.

Additional Read: Non-Fungible Tokens vs Crypto Assets

What’s Causing the NFT Bubble to Burst?

Declines in prices, low trade volumes, and decreasing media coverage are clear indicators for investors that the impending collapse of the NFT market is on the horizon.

Reports from Reuters began highlighting signs of an NFT crash as early as April 2022, with more comprehensive reports emerging later in the same year. Although there is a general consensus that the NFT market did experience a crash in the final quarter of 2022, Forbes raised questions about how a market could be deemed “collapsed” when its benchmark, the Bored Ape Yacht Club, continued to command prices exceeding $100,000.

On the other hand, experts like Caspers assert that an NFT crash has indeed taken place. Caspers stated, “Yes, the bubble has burst,” framing it as a positive development. Fintech regulatory attorney Felix Shipkevich contends that the NFT market has collapsed, yet he attributes it to a combination of factors rather than a singular cause.

However, here are some of the reasons that caused the NFT bubble to burst:

1. Prices decline with minimal trading activity: Reports from DappRadar showed that OpenSea, a leading marketplace, experienced a substantial 97 percent decrease in trading volume from January 2022 to September 2022.
2. Lack of long-term value: Questions were raised about the rationale behind paying $25 million for a pixelated avatar, deemed an unsound investment. While the NFT market created diverse opportunities, from “get-rich-quick” schemes to legitimate pursuits like NFT art collections, the struggle to retain long-term value is evident.
3. A decline in public interest: Active wallets have nearly halved since the peak of the market in January 2022, indicating a significant loss in consumer confidence. Also, the decline in Google searches may indicate that many first-time investors lacked a deep understanding of NFTs, contributing to associated risks and potential disasters.

Read More: Legal Challenges & Risks Around NFTs

Source: Startup Daily

Future of NFT

Despite the NFT crash in 2022 and the overall volatility in NFT prices, the outlook for non-fungible assets is exceedingly optimistic. According to data from Grandview Research, the global NFT market could potentially reach $211 billion by 2030, surpassing the current size of the video gaming market and the market capitalization of numerous Fortune 500 companies.

Source: Grandview Research

Moreover, NFTs in the GameFi sector are gaining traction, with an increasing number of developers creating blockchain-based games centered around NFTs and major gaming studios exploring the integration of NFTs into their existing products. While these GameFi NFTs may be more abundant and affordable compared to current gaming NFTs, they have the potential to significantly boost the overall market capitalization and sales volume of NFTs in the years to come. The growth of the ERC-1155 dynamic NFT standard, allowing NFTs to evolve over time and enabling large-scale batch minting and transfers, is expected to contribute to this expansion, providing substantial gas savings for game developers and players. Additionally, the incorporation of in-built NFT royalties for both art and GameFi NFTs ensures that the original creator or owner receives a percentage of royalties with each NFT sale or trade.

NFTs could go beyond gaming, entertainment, and digital art to become part of daily life. Less glamorous but potentially transformative, commonplace items like driver’s licenses, event tickets, and property deeds might become NFTs. Real estate startups in the crypto space have already tokenized traditional properties, often using fractionalized NFTs—dividing NFTs into pieces distributed among different owners.

While Ethereum presently dominates the NFT market, the ascent of Layer-2 solutions like Polygon, Arbitrum, and Optimism, along with the rapid growth of Layer-1 blockchains such as Solana, Sui, and Aptos, may introduce NFTs with added utility and features. This diversity could contribute to a more stable pricing environment in the NFT market.

In conclusion, the NFT market collapse is just one phase in a broader cycle, and similar patterns are anticipated in the future. Predicting when NFT prices will rise is challenging. Despite the positive outlook, it’s essential to recognize that investing in individual NFTs, such as BAYCs or CryptoPunks, remains a high-risk venture. Individuals and groups should only invest in NFTs with funds they can afford to lose. The market is likely to witness further booms and crashes in the next few years until it matures, prices stabilize, and NFTs and other digital assets gain broader acceptance.