All digital creations are NFTs. We just don’t know it yet.

If you follow non-fungible token (NFT) news, you may have noticed that the market has recently been coming to terms with the harsh reality that NFTs are possibly not as good for artists as the creative community first thought.

As NBC News’ Kevin Collier noted only a couple of weeks ago, creators are discovering rapid growth in the NFT space has opened the door to rampant piracy and fraud in the creative sector.

On most NFT platforms including OpenSea, by far the largest NFT marketplace, people can create an account and start selling whatever digital images they want to upload.

Not only does that mean there’s no guarantee you’re buying a copyright claim with an NFT purchase, it follows that there’s no guarantee you’re even buying an authentic creator-approved NFT.

A good example of this is that even Melania Trump’s collection, the crème de la crème of NFT issues which launched at the end of December on the Solana platform, is already being duplicated unofficially on OpenSea, a competing platform.

Unless you are a discerning digital collector who understands digital signatures, chances are you won’t be able to tell the difference between an authentic Melania and a fake. All the more so if Solana, the Trumps’ preferred NFT blockchain platform, goes down, as it did at the weekend when it suffered an instability setback, becoming inaccessible for large periods of time due to transaction congestion.

Garbage-in, garbage-out

The relationship between NFTs and copyright has always been a murky and unclear one. Nonetheless, there was at the peak of the mania an assumption that some sort of value was being assigned to someone in the process of an NFT transaction. This, however, has started to unravel as it’s become increasingly obvious blockchains do not solve the Garbage In Garbage Out (GIGO) problem.

The GIGO vulnerability means that while it’s still incredibly difficult to counterfeit or hack a token once it’s been created, there’s no guarantee the token itself was created legitimately. (A bit like self-reporting a QR code associated with a self-administered lateral flow test. You still need to trust that the originator, or test-taker, truly reports the correct result.)

The irony, for a supposedly highly innovative market like the NFT one, is that centralised platforms like YouTube solved this GIGO problem long ago by actively policing content for copyright abuse at the origination point.

According to Collier, while NFT platforms (especially those with identifiable management structures) are becoming increasingly responsive to takedown requests from artists who flag copyright breaches, the burden of policing fakes still falls on creators not the platforms.

This reveals two important issues about the market. Firstly, that it is incredibly sensitive to becoming embroiled in any high profile copyright dispute and, secondly, the benefits of its decentralised state in giving creators more power have been massively exaggerated.

The centralisation problem

Awareness of these two points is giving way to another important realisation: that the presence of a blockchain makes very little material difference to anything.

When the Solana blockchain network became inaccessible during the peak of the weekend’s crypto rout, we wondered out loud what might happen to NFTs if the value of the blockchain they reside on goes to zero. Or if the miners who usually support the network head for the exit?

Do such NFTs become internet ghosts? Are they resigned for all perpetuity to the Wayback Machine? Who continues to fund their verification and hosting?

According to the Twitter feedback (somewhat skewed towards crypto interests) the answer is no, none of this would necessarily be problematic. The chain would likely still continue to be validated by the originating entity, meaning the only negative consequence would be more centralised control of the system. In the worst-case scenario, NFTs could be transferred to more functional blockchains.

What it also means, however, is that NFT platforms, like banks, are highly vulnerable to runs.

To use banking parlance (JARGON ALERT), NFT platforms are mostly capital-light facilitators of open-source origination of zero-coupon perpetual assets that draw funding exclusively from capital markets, and whose performance depends on continuing positive mark-to-market valuations in highly illiquid markets.

If and when their mark-to-market valuation falls to zero, and the market for new origination closes, they too will have no incentive to keep the assets verified at their own costs.

A withdrawal of market funding coupled with a buyers’ strike, where customers boycott sites with the aim of securing lower prices in the longer term, would leave a platform struggling to survive. Indeed, the only way for a platform to withstand the run risk is to promise to throw their own capital at supporting the blockchain and the assets if all else fails.

Yet that begs another question. Why would investors in an NFT platform on a dying blockchain be any more inclined to burn capital supporting underperforming non-cash generating assets than they would a distressed bank?

Cash flows matter

So where does this leave us in terms of understanding the longer term potential and value of NFTs?

We think it fits our wider thesis that NFTs are better thought of as a type of advertising market, wherein valuations reflect a sunk cost rather than any sustainable long-term value.

So, while a traditional advertising market turns creative content into a cash flow-positive asset, NFTs use outrageous upfront cash flows to direct eyeballs to images or messages spenders want to promote. The art is the advertising. And over time, as with art philanthropy more generally, only those images or assets that satisfy the cultural agendas of the hyper-moneyed classes are likely to continue to do well.

But that’s far from a cultural revolution in the making. If anything it gears artists towards making content that panders to the existing tastes and agendas of multi-billionaires like Elon Musk or Jeff Bezos.

At times like this, what a truly distributed and diverse creator market needs — and what platforms like YouTube have and NFT platforms don’t — are cash flows. With cash flows, properly investable assets and associated markets for such assets can be created and a much broader pool of innovative art can come to the table.

Which begs the question, given both systems are likely to end up just as centralised as each other, why wouldn’t YouTube seize on the NFT craze to create a secondary marketplace for the cash-flow generating content that already resides on its system? It’s probably something to do with scaling and liquidity.

Nonetheless, platforms whose reputations are already aligned with not just hosting content, but monetising it by verifying its authenticity and copyright conditionality, are far more likely to succeed at turning the non-fungible tokens they issue into assets than ones that are not.

Unless the true point of NFTs, of course, was never really to create a market for legitimate artistic content, but rather to help propagate or push images and messages that would never stand out (or even be accepted as advertising) on more conventional content platforms.