Mental model for NFTs

NFTs are the most familiar concept for most crypto curious people in Web3.

In this deep-dive, I’m going to provide a mental model for assessing NFTs. The scope of this piece is limited to NFT collections. It will not cover NFT technology in general for use cases like ticketing or property.

Let’s dive in.

Skip if you know what an NFT is.

NFTs (non-fungible tokens) help identify ownership of an asset. The asset is non-fungible.

A dollar is fungible because I can trade my dollar for your dollar.

On the other hand, if I hold an NFT from the Bored Ape Yacht Club (BAYC) collection, it’s non-fungible. The picture below references BAYC #9. There are other NFTs in the BAYC collection, but #9 is unique because it has specific attributes (see second picture).

Depending on who you ask, people buy NFTs for a variety of reasons. But the reasons can be boiled down to:

To make money

People buy NFTs because they believe the price tomorrow will be higher than the price today. They may buy an NFT because it gives them commercial rights to something or a share of future revenue.

For utility

Some NFTs carry utility of some kind. This could be membership in a community or access to specific content.

Believe in a cause

When the war in Ukraine broke out, the government in Ukraine issued NFTs to raise funds for its military and its citizens. You may choose to buy an NFT simply because you support the cause.

I love mental models. I’ve been thinking about NFTs, and wanted a frame a mental model to assess an NFT project. I’m going to call this the CAHUT framework:

Let’s dive into each one.

NFTs buy you membership in a community. It’s useful to ask what value you can derive from the membership in the community.

Proof Collective is a private community of 1,000 NFT collectors and artists. If you are an artist or plan to collect NFTs, the conversation in the community and the network might benefit you.

Community creates long-term value for an NFT collection if that community can be maintained. If I’m buying an NFT for the community, I’m less hesitant to sell based on price fluctuations.

NFTs may derive their value entirely from art. The most famous example of this is Beeple’s NFT piece that sold for $69 million. Beeple created a piece of art every day consecutively for 5,000 days, including on his wedding day and the birth of his children. The NFT derives its value from this.

It’s important to assess the market sentiment or ‘hype’ of an NFT. Like any other asset, it helps inform the best time to buy. But more importantly, it can help you avoid losing money. A few questions that can help with this:

Recently, Goblin towns launched using hype. The project’s website explicitly calls out that there is no roadmap, utility or discord (community). It launched and continues to increase in price purely based on hype. The floor price (cheapest NFT in the collection) is 5 ETH ($9.5K based on today’s price).

NFTs can offer utility to owners.

Trends.vc is newsletter that Dru Riley started and scaled to 50,000 subscribers. Every issue is accompanied by an NFT. Instead of paying the annual subscription fee, users could choose to buy the NFT to gain lifetime access. This NFT derives its value from giving you life time access to Trend.vc’s content.

The team behind an NFT project is critical. An NFT holder is reliant on them for all of the above. Community requires active nurturing and this is the responsibility of the team. Art requires responsibility. For example, what if the founding team decides to replicate the art in a different project? The founding team needs to ensure that utility continues for holders of the NFT.

Questions worth asking:

In the case of the Proof collective, a large part of the demand for the project was due to Kevin Rose. He’s the founder of Digg and a general partner at Google Ventures.

It’s impossible to provide a definitive view on how to weight all of the above. Instead, I’d like to like to leave you with the following:

Start with the team. It remains the most critical from my point of view. The last thing you want is for the team to run away with the money (called a ‘rug-pull’).

Community, art and utility provide long-term value. If your risk appetite is low, focus on projects that provide one or more of these. Ideally more than one. All the NFT projects I’ve bought into have followed this logic.

Treat hype as a feature, not a bug. The best traders in the world use fundamental analysis and supplement it with the best time to buy an asset. The same goes for NFTs. Timing your purchase is important.

If you’re buying NFTs, only invest what you can afford to lose. Contrary to what you might hear from others, it remains a risky investment. There are people who’ve made millions and others who have lost everything. I’m rooting for the projects that have true value using the CAHUT framework.