Non-fungible tokens (NFTs) — which enable the creation of unique tokenized assets such as collectibles, art, and even real estate — have experienced remarkable growth in 2020.

This led to a short-lived phase of exuberance in NFT-related tokens in September. However, expectations have since cooled off for a sector with several roadblocks before achieving its potential. 

As decentralized finance (DeFi) tokens retraced in early September, crypto traders started to look for the next trend with high growth potential. As such, the NFT space saw an influx of capital and attention, while broader markets crashed. 

Particularly, protocols such as Rarible (RARI), Meme (MEME), and Shroom.Finance (SHROOM) all significantly outperformed the market with triple-digit returns. This trend likely saw reallocation of capital from DeFi tokens into NFTs following the end of the “Summer of DeFi.” 

MEME, which started with a satirical protocol called “The Degenerator,” increased by as much as 1,300% in September and subsequently lost 90% of its value. The MEME token allows holders to mint NFTs by staking tokens in its platform. Their community executed an alternative to yield farming where liquidity providers (LPs) are rewarded with NFTs instead of a protocol-native token. 

MEME farmers can then sell their NFTs on platforms such as OpenSea. 

NFTs minted with MEME tokens have sold for an average of 0.93 ETH, or roughly $430 at the time of writing. However, less than 10% of the NFTs available in OpenSea have been purchased, suggesting that most users cannot sell their farmed memes. This drops the effective average price of all MEME NFTs sold in OpenSea to only $43. 

This did not stop crypto traders from speculating on the MEME token and other NFT-related ERC20s in September. Daily active addresses (DAAs) for MEME spiked along with prices, suggesting that network activity was being driven by hype and price action. 

The high correlation coefficient of 0.91 between prices and DAAs in September supports the thesis that  MEME’s network activity was strongly related to the asset’s price.

This doubled from 0.45 in August when more traders were focused on DeFi, and there was less hype surrounding NFTs. On-chain volumes also show that whales took advantage of the inflated expectations to sell. 

Large transactions volume, a key metric that IntoTheBlock aggregates as the total volume sent in transactions of over $100k, is a helpful indicator of whales’ and institutional players’ activity. In this case, the spike on Sept. 22 as MEME’s price peaked suggests that large players opted to sell amidst the NFT hype. 

While MEME’s peak valuation of roughly $50 million may not seem high compared to the long-term potential of NFTs, on-chain metrics point to large holders realizing that the sub-niche has a long way to go before becoming a mainstream alternative to current media. Since the September hype, most NFT-related tokens have crashed while NFT marketplaces saw a decrease in volume and average price per item sold. 

The graph above monitors aggregate data for the top five NFT marketplaces in Ethereum. The divergence between volume and number of traders points to more retail users experimenting with NFTs and whales settling down. Despite hitting a new high in daily active users in November, at just over 2,000 traders, it is evident that NFT marketplaces are still in their infancy. To live up to the hype seen in September, the NFT space must overcome several hurdles. 

High gas fees were the norm for Ethereum during the summer. While these may not deter whales from making large transactions to earn high yields in DeFi, gas fees have certainly discouraged broader usage and smaller transactions, leading to some non-DeFi protocols shutting down. 

Gas costs for a simple ETH transaction reached a high of $5.20 on September 17.

The costs of deploying complex smart contracts like minting and purchasing NFTs can be as much as ten times more expensive, pricing out average retail users and disincentivizing small transactions. This is evident in the previously referenced chart aggregating data for NFT marketplaces, with both volume and traders crashing on the same day gas costs reached a new high. As gas prices have dropped, the number of NFT traders increased. 

The recent drop in gas prices, however, does not solve the sector’s problem. Given the scarce nature of blockspace in Ethereum and other blockchains, transactions are likely to trend towards financial use cases as these have a greater willingness to pay.

For example, a trader expecting a 100% return should, in theory, be willing to pay higher gas fees than someone looking to unlock an in-game NFT item. This trend favors transactions that are financial by definition but also incentivizes the financialization of other sectors.

While blockspace scarcity is expected to be alleviated when ETH 2.0 launches and L2 solutions become adopted, NFTs face another roadblock to adoption: the Ethereum ecosystem itself. At the moment, to interact with NFTs, users have to follow as many as five steps before being able to own one. This hampers the adoption of ordinary people who may be unwilling to learn how to go through all of these steps. 

For visionary NFT applications like a decentralized metaverse to gain traction outside of crypto, entry barriers must drop, and user education must improve. There are steps in progress to reduce friction in using Ethereum-based dApps like USDC’s “gasless” transactions, but for the foreseeable future, users still need to rely on MetaMask and go through a steep learning curve. 

As the NFT ecosystem matures, novel use cases are still expected to drive demand, pushing new users to learn how to use Ethereum. At the same time, mass adoption is generally preceded by lower costs and barriers to entry. Ultimately, NFTs, and crypto broadly, have to overcome these challenges before realizing the vision of a decentralized future. 

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