I think 2018 will be the year of non-fungible tokens. In the same way that ICOs were Ethereum’s ‘killer app’ in 2017, digital collectibles could be the killer app of ‘18.

And for savvy speculators, flipping “non-fungies” could be a fruitful pastime...

But first, what does it even mean for something to be fungible or non-fungible?

Something is fungible if it can be exchanged for anything else of its kind. A one dollar bill is fungible because my one dollar bill has the exact same value as your one dollar bill. Same goes for ether since all ethers are interchangeable (though arguably how or where they are stored can create an access, liquidity, or security premium).

A CryptoKitty, on the other hand, is non-fungible. One cryptokitty might sell for 10 bucks and another one for 114 k — depending on its unique digital traits like age and breed. Likewise, diamond is not very fungible since it’s unlikely to find two cuts that are identical in shape, color and other traits. This is one reason why gold became a more popular store of value.

Fungibility is a useful trait for currency. But for collectibles, non-fungibility means uniqueness and value. The Mona Lisa would not be very valuable if it were interchangeable with any other painting.

One of the key innovations of the blockchain was the invention of digital scarcity. Most cryptos are scarce at the currency level e.g., there will only ever be ~21 million bitcoins and fungibile at the unit level e.g., all bitcoins have equal value. Non-fungible tokens, however, represent one-of-a-kind assets.

I think non-fungies are well-poised to explode because . . .

Non-fungible protocols are maturing right now. In the same way that ERC20 paved the way for the ICO craze, ERC721 (or ERC821) could propel the rise of digital collectibles As Ryan Seleskis pointed out, along with gambling and porn, nerd games tend to be one of the first use cases of new digital technology. CryptoKitties and Ethermon (Ethereum-based Pokemon) are likely just the start. A lot of folks have made a lot of cryptocurrency lately. And what’s the easiest thing to buy with all this cryptocurrency? Probably more cryptocurrency AND digital collectibles. Non-fungible token markets may be even more FOMO-prone than normal token markets. You may fear that if you don’t buy OMG in the next hour it will shoot up 15%. But with a digital collectible that is being auctioned off within the hour, you may never get another chance to buy. At the same time, digital collectibles may be less prone to panic selling. Human greed, after all, did not evolve in a time when we had digital currencies. Non-fungies probably more closely approximate the types of items we evolved to be greedy over and may tap into something deeper and benefit from the endowment effect (see below). For short-term speculators the attractiveness of ICOs is dimming. It’s hard to find quality ICOs now that don’t have crazy valuations or exclusive pre-sales or lock-up periods. Flipping non-fungibles presents an intriguing alternative.

So how might one get an edge in flipping non-fungies i.e., buying and reselling digital collectibles? Here are a few traits you might look for in the next CryptoKitties…

Scarcity. Look for a digital collectible that has a low, finite, and ideally deflationary supply. This could also be a subclass of collectibles. Example: generation 0 cryptokitties are the most valuable, largely because they are ‘minted’ at a slow rate. My guess is we’ll see an exaggerated 80/20 i.e., over 80 percent of the profit will be captured in less than 20% of any given collectible. An additional source of scarcity would be a time constraint on purchase e.g., you have a couple hours to buy a collectible before it gets temporarily locked up or burned. Network Effects and Virality. Look for a collectible that accrues in value or utility as more people join the network. For example, as more folks buy and breed CryptoKitties there are more links back to generation 0 kitties i.e., the gen 0 kitties become the grandparents, great grandparents, great uncles etc of more and more kitties. (never in my life did I think I would be typing a sentence about the lineage of digital cats…but such is the world today). Value. Until non-fungies blossom into a full-blown tulip mania, I expect the first ones that succeed will actually have some utility. This means that they will satisfy some need or deliver some value aside from speculation e.g., fun, social status/interaction, a sense of ownership and control. Basically, the reasons why people collect things in the first place. Look for something fun and even addicting. Status may seem like an odd mention here, but I actually think it’s key. It’s one of the prime reasons we buy things like jewelry that have no physical utility. I think anonymous online networks have proven that we humans are flexible in creating a sense of self and identity in the digital realm. So the representation of the collectible is not all that matters, but also the representation of the owner i.e., you. If you feel completely anonymous, then you won’t care about your status within the network. So successful collectible networks will likely broadcast who owns what. Not real-world identities of course, as that would be a major security risk (we don’t want folks getting blackmailed for CryptoKitties), but rather digital identities. Access and UI. If you’re getting in early, look for something that is easy to buy. Now, if something is creating high demand despite the fact that it is hard to access, this is a good sign. Especially if it has the prospect of soon becoming more accessible. This is similar to looking for coins that are only on Etherdelta (not very accessible) but have the potential to get added to larger exchanges. Endowment Effect. In psychology, the endowment effect means people more strongly value things that they own. Look for collectibles where this effect is amplified. For example, a temporary lock-up period e.g., you can’t sell until 48 hours after buying. Timing. I think successful non-fungies are likely to emerge in bull markets when crypto investors have a lot of cash to throw around. This is especially true of ether, as most non-fungies will be paid for in eth. Looks Silly or Stupid. CryptoKitties sounded ridiculous. Who would spend thousands of dollars to own virtual cats? Turns out, a lot of people. If something looks stupid, it’s more likely to fly under the radar…for a while. The key thing is that once people start buying (or obtaining it via other means like an airdrop) they enjoy owning it. The motivation to own i.e., not sell is probably more important than the motivation to buy. Folks often talk of finding ‘the next Bitcoin,’ but this is a non-starter. The only reason bitcoin was once so cheap is because it looked ridiculous and was unproven. Today, any new cryptocurrency is priced from the get go on the basis of bitcoin’s success and that cryptocurrency has already proven a serious technology. Digital collectibles, however, still look pretty silly, some more than others.

Someday we may use non-fungibles to tokenize and transact major, real-world assets like houses, cars, and companies. For the time being, let’s have some fun flipping virtual kittens...

As always, just some thoughts. Not investment advice.

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