Tokenizing Fine Art - or How to Survive the NFT Bubble

Check out our CEO Christoph Ebell’s article on value in tokenized art (NFTs).

Originally published on Crypto Valley 5 April 2021.

Tokenizing Fine Art or How to Survive the NFT Bubble

by Christoph Ebell

We are clearly in a bull market for crypto projects. The latest “craze” (to use some observers’ words) is about so-called non-fungible tokens, or NFTs* . What drives the NFT market right now is digital art. From the sensational sale of the now-famous Beeple work to thousands of digital artists' creations –some great, many of questionable quality – there seems to be only one direction for valuations and sale prices to go: up. Marketplaces for Art NFTs, such as Maker’s Place, Opensea, and many others offer selling, auctioning, and buying services to collectors and artists alike. But where is the market headed – is it all just hype, smoke and mirrors?

Yes and no. “Yes” in the sense of a classic bubble, which is perhaps comparable to a 1990s Japan-driven fine art buying bubble that was followed by a crash the market took a decade to recover from. Worries about inflation, a hunger for alternative investment and asset forms, the availability of capital for investment with stock indices at all-time highs, and riding on the back of the general, thunderous, crypto cycle are certainly current drivers. But instead of just crying “bubble!,” it may be more rewarding to look at where lasting value and true utility can be found – and with it genuine investment opportunities rather than gambles.

So what does the future of (art) collecting hold?  

When valuating art for trade, there are a number of criteria to consider. While digital art presents its own categories, it makes sense to apply some or all of the classic criteria to separate the wheat from the chaff. For example,

• Quality

• Rarity

• Condition

• Provenance

• Geographical context

• Cultural context

There are more of course. As an example how such criteria may transpose for digital or digitized art, consider that “condition:” it may be translated to “availability of high-quality files” - important for creating gallery or residential displays. Also, has long-term digital preservation been taken into account, both for on and off-chain storage, including forward compatibility of the token itself? This becomes particularly important when high or very high value is in play.

Therefore, a collecting and investment approach to digital art should be modeled on valuation techniques that are well-tested in the physical art world. The goal is to hold NFTs of art works that will, or at least are able to, stand the test of time and the bust of a bubble. In fact, such art may appreciate disproportionally as the market matures and the community flocks towards value.

Another more radical approach to collecting involves the tokenization of physical Fine Art. From a purely investment-centric angle, Fine Art as an asset class is generally rather illiquid, i.e., it is not straightforward or easy to convert a valuable painting into cash. Nor is it cheap to do so. One solution for making this process easier is the tokenization of Fine Art. There is the often-cited provenance tracking and authenticity certification of course, but there are more, and exciting, possibilities: for example, a valuable painting can now be offered on a marketplace with the option of fractional ownership, thus lowering the bar for individual investors to own a piece by a famous artist. This also opens up the possibilities of a secondary market for traditional Fine Art, depending on the jurisdiction even without the need for a legal entity “wrapper” for the work. In terms of valuation, the artwork carries its appraisal value into the digital world and the NFTs become “asset backed,” and as such, can lower the risk for buyers quite significantly. In terms of regulation, it is important to ensure that it is clear if the token will be seen as a security or not.

Another possibility is to create dynamic NFTs that can ingest data from sources like auctions or even sensors: the token can “know” where the physical work is located, how many “views” it generates in a gallery, or what similar works are sold for at auctions, and so on.

Obviously, there are a number of practical issues to be worked out. Who will have custody of the original? How can we ensure that the token(s) actually represents the physical work? How will these digital tokens be preserved and maintained for the long term? When do we need to consider anti-money-laundering (AML) regulations? Here it is crucial to work with an expert team with a holistic view. There are of course also risks. For example, even if the NFTs can support liquidity, there may not always be a counterparty in this still-not-mature market. However, it seems that on average, the opportunities far outweigh the risks and given the right technology and strategy, there is a lot of potential for exceptional returns and appreciation.

In terms of legislation and infrastructure, we are in a comparatively very good position in Switzerland, where there are consistent laws and regulations. The first part of the new DLT (Decentralized Ledger Technology) legislation came into effect at the beginning of this year and the second is to follow by the end of this summer. The technology infrastructure is excellent, and the Swiss CryptoValley is one of the world's premier hubs for blockchain technology projects. Coupled with the experience in banking, and a global reputation in art (think Art Basel), Switzerland is becoming a destination for Fine Art tokenization.

So you invested in a Fine Art NFT. Now what? Here lies a whole, often overlooked,  additional piece of the NFT market. How do you present your collection and how do you savor and convey the pride of ownership? Sure, a web gallery of your collection is not bad, but there are endless creative options that open up a whole new way of owning and interacting with Fine Art: both natively digital or based on a digital twin of a physical work.  A residence or a gallery can become an immersive art space, with changing displays, large projections, or small treasure chests of holographic objects. Art can become much more interactive, and ownership can be shown, for example by reacting to the biometrics of the owner with a face or voice print. For example, upon recognizing the voice of the collector, a desaturated display can light up in brilliant colors, or a performance art video can start playing.

High quality tokenized Fine Art is here to stay and will see healthy appreciation. As a community and an industry, we must put together the technological infrastructure and knowledge of how markets and culture tend to develop. Depending on the collector’s or investor’s tastes, a sine qua non is a genuine passion for digital creativity in the 21st century and a passion for Millennia of human expression in Art.