Preparing for NFT Winter

A short guide for long-term jpeg investors

Coinbase entering the NFT space might just be the catalyst for an NFT winter.

Counterintuitive, but the logic is simple: Speculative manias end when the last incremental buyer enters the market. With a waiting list over 2 million — and over 70 million crypto accounts — interest in Coinbase’s NFT marketplace is easily bigger than the ~500,000 unique buyers on OpenSea life to date. Coinbase’s NFT marketplace could bring in the last incremental buyer to the NFT space, at least for the short term.

When that happens to markets that look like this, it doesn’t end well:

Vertical growth in and of itself isn’t an evil, it’s what sparks that kind of vertical growth that creates reason for concern. We see it often as new technologies emerge — Internet, crypto, now NFTs — because they provide a limitless unknown potential. Could this new thing keep gaining in value forever? Who knows? It’s totally novel.

Even though the technologies that give rise to speculative booms are novel, the pattern of boom to bust is similar. We saw it with Beanie Babies, the Internet, real estate, and Bitcoin all in the last few decades.

It’s human nature to speculate. Quick riches are a powerful intoxicant. Money equals freedom. Speculation is tacit acceptance that the only path to true financial freedom for many is to get lucky. In speculative booms, anyone can get lucky.

Most don’t get lucky. When speculative fervor dies, acute market booms tend to die alongside. In the dotcom era, the Nasdaq was down almost 80% peak to trough. Crypto the same in 2018. The underlying technologies and products were real, so both have recovered plus much more, but losing 80% on the way is hard to swallow.

What does an NFT believer do to prepare?

Two things:

  1. Understand what will happen to liquidity in an NFT winter.

  2. Position to benefit from depressed prices when the market comes back even stronger.

Liquidity

In any bust cycle, liquidity dries up. What was once desirable to a sea of speculators is now hated by naysayers and questioned by all but the strongest believers. This is true for both fungible and non-fungible boom-bust cycles.

Fungible booms are built via speculation on easy to trade assets with high natural liquidity because they are fungible. Stock market booms like the dotcom bubble in 2000 and crypto booms like the crypto peak in 2018 are fungible booms.

Fungible booms differ from non-fungible booms in that there’s usually a price at which the asset holder can get out at some depressed price, even in the middle of the bubble burst. That’s because the asset is inherently liquid given its uniformity. A share of AAPL is a share of AAPL. One BTC is one BTC. There are millions of each, and none are different than any other. As long as there’s one buyer, there’s a market to be made.

In contrast, non-fungible booms get very illiquid very quickly when speculative activity dries up. Every asset in a non-fungible boom is unique, so every individual asset needs a buyer specifically interested in it to provide liquidity to the seller.

Within the non-fungible boom-bust cycle, there are two further distinctions of utility and non-utility to consider. We can distinguish the two using the examples of real estate and Beanie Babies.

Real estate has definite utility. A home provides shelter at a bare minimum. For the investor, real estate can also provide tangible yield by renting to someone that needs shelter. Beanie Babies have no utility. They sit on a shelf and do nothing. They don’t even reproduce like NFTs do.

Non-fungible assets with utility, like real estate, have some natural floor. Non-fungible assets with no utility, like Beanie Babies, have no floor. The floor is zero. In a bust, the latter category can easily become unsalable, and something that can’t be sold isn’t valuable in any way other than emotionally to the owner.

ENS names may be the NFT equivalent to real estate. They provide tangible utility. Beyond ENS names, NFT investors should prepare to be locked into their holdings in winter.

Any NFT that relies on supposed utility like exclusive drops, communities, game function, etc. should be viewed cautiously. In NFT winter, exclusive drops won’t be worth anything monetarily, communities will go silent, and many games won’t be worth playing, either because the play-to-earn mechanics no longer support meaningful earnings or because there’s no one else to play with.

The Patterns of a Crypto Crash

Looking back at the 2018 crypto crash is the best guide to what we might expect if NFT winter comes.

Both BTC and ETH followed a similar pattern:

  1. Prices peaked almost simultaneously with dollar trading volume.

  2. Volume bottomed.

  3. Price bottomed.

  4. Volume picked up.

  5. Price picked up.

This makes logical sense for an emerging asset class boom to bust. Local peaks are reached at the height of market mania. When new peaks aren’t reached, apathy sets in, and volumes decline. Ultimately prices bottom as the weakest hands leave the market. Then volume picks up as stronger buyers enter, and prices follow.

It doesn’t always work this way. NASDAQ prices and dollar trading volume also peaked almost simultaneously in the dotcom boom, but then prices and volume also troughed almost simultaneously in the crash. In more efficient markets, it’s reasonable to expect prices and volume to track closely together, but the NFT market will be far from efficient in its first winter.

Preparing for Winter

If the introduction of the Coinbase NFT platform plays out given our contrarian expectation, we should reach new highs — euphoric peaks on new record volumes — then see a quick depression. In 2018, it was a matter of weeks once new peaks stopped for BTC and ETH that volumes started to drastically decline, and prices with it.

This creates two phases of preparation for the NFT investor ahead of a winter.

The first is to liquidate any and all assets you’ve acquired that you no longer love or believe in. You should get the opportunity in peak euphoria. Only keep the things that you own for emotional reasons or those that you have high conviction in as long-term winners (e.g. Cryptopunks, ArtBlocks, etc.). If you want to get “cute” as we say in the equity trading game, you could even sell those assets hoping to buy them back 80% cheaper. My guess is the bluest chip assets won’t decline that much, but you never know.

Then you wait.

Wait until you see NFT sales volumes more than cut in half. BTC and ETH dollar trading volumes were down over 70% at their 2018 trough. NASDAQ dollar trading volumes were down 85% at their dotcom trough. NFTs will probably see something similar in winter. That may still not be the bottom of prices, but when we start to see volumes stabilize and return to some upward trajectory, that’s the time to start buying. Buy the assets you think have the brightest future. Buy the assets where communities stayed alive through winter. Buy the assets that just aesthetically resonate with you.

Then you wait some more.

It took BTC and ETH more than two years from the volume bottoms of 2018 to recover peak prices from that hype cycle. NFTs will probably take about as long to come out of winter. Two to three years seems to be about the trailing memory of markets in our information saturated age. This strategy isn’t get rich quick, it’s get rich thoughtfully.

Maybe winter never comes. Maybe conventional wisdom plays out, and Coinbase’s NFT marketplace is the catalyst for a sustained bull run on the long path to NFT’s becoming mainstream. Maybe NFTs are the one technology that bucks the speculative hype cycle that came with the PC, the Internet, crypto…

Maybe.

In either case, it’s better to be prepared for winter and enjoy an unexpected summer than get caught in the cold.