Here are a couple of popular definitions and explanations to get the conversation started:
Investopedia: A hedge is an investment that is made with the intention of reducing the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting or opposite position in a related security.
Varsity: Hedging makes sense as it virtually insulates the position in the market and is therefore indifferent to what really happens in the market. It is like taking vaccine shot against a virus. Hence when the trader hedges he can be rest assured the adverse movement in the market will not affect his position.
The way it is commonly described, hedging is the act of taking offsetting positions against a portfolio to even out the bumps in the market.
The CAPM β
According to EMH, a portfolio’s return could be fully explained by the market (source):
r = rf+ ß(rm – rf) + α
Where:
r = Expected rate of return
rf = Risk-free rate
ß= Beta
(rm – rf)= Market risk premium
If you set the risk-free rate (rf) to zero, you get r = ß*rm + α
Now, subtract away the market from the asset returns and you’ll be left with α.
Basically, a perfectly hedged portfolio will be a completely market neutral portfolio who’s returns will be pure alpha.
The offsetting positions can be taken via futures or options. To keep it simple, we will use futures to illustrate an example.
An Example
It is 2005 and the master analyst that you are, you expect HDFCBANK and KOTAKBANK to be decades long compounders. So, you setup an equal weighted portfolio that has only those two stocks.
If you stayed with this portfolio, then you truly have ??
Even though the annualized returns during the ~15 year period is twice that of NIFTY 50’s, very few investors would have stuck through the 70% drawdown that the portfolio had in 2008 and the 40% drawdown it had in 2020. Not to mention the numerous 20% dips along the way.
The question that hedging tries to answer is as timeless as time itself: Can I have my cake and eat it too?Is there a way to get only the excess returns without the market’s ups and downs?
What is the “market?”
Given that your portfolio consists entirely of banks, what exactly is your “market?” The answer to this question is not trivial.
You could go with the NIFTY 50 index but it has companies from different sectors like oil, metals, IT, etc. How much of an offset do you expect it to provide?
Or, you could go with the NIFTY BANK index. Intuitively, you would expect it to be a better hedge because it is composed almost entirely of banks – just like your portfolio.
Rolling βs
Rolling βs of the portfolio to each index gives us an idea of the appropriate benchmark to use.
What this is telling us, with perfect hindsight, is that the NIFTY BANK index comes close.
Theoretically, Hedging works in Theory
The math checks out. Irrespective of whether you hedge against the NIFTY or the NIFTY BANK index, you end up with much lower drawdowns.
For example, if you hedge against the NIFTY BANK, assuming no frictions and slippage, drawdowns never exceeded 20% and returns came in at a respectable 12% annualized.
Reality Sucks
Hedged portfolios have high Sharpe ratios and look attractive in backtests. However, reality is quite different.
βs are not Stable
The chart of rolling betas of the portfolio over different indices highlight the biggest problem with hedging: the hedge ratio needs to be constantly adjusted because the relationships are unstable.
Adjust it too often, then you lose to transaction costs. Adjust it too slowly, then you are no longer perfectly hedged.
βs > 1
Sometimes, betas can exceed 1. This means that your portfolio is net short during those periods. If the original intent of setting up the portfolio + hedges was to just even out the market fluctuations in a long-only portfolio, then being net-short is something that you may not have bargained for.
Margin requirements Vary
The backtest presented above allocates 90% to the cash (long-only) part of the portfolio and 10% towards margin requirements. However, during periods of market stress, brokers are known to hike margins to protect themselves. This might end up putting you in a position where you will need to pare back some of your long-only exposure to raise funds to meet the increased margin requirements. Basically, selling the dip.
Markets have a Positive Drift
Over long time horizons, markets typically have a positive drift. With a hedged portfolio where you are short the market, you are betting that this drift is overshadowed by volatility and portfolio alpha. It may very well be true, but you are betting against the winds.
Who should Hedge?
Leveraged Investors
Hedging doesn’t make sense for long-only cash portfolios. If you are a CNC (Cash N’Carry) investor, then you are better off de-grossing (reducing overall exposure or positions) and focusing on diversification rather than trying to hedge your portfolio.
Investors who employ leverage, however, should hedge. For example, if you were to take levered positions in HDFCBANK and KOTAKBANK through futures, then it makes sense to try and hedge out the market risk. Futures have 5x leverage built in, so it has the potential to boost your CAGR, as long as you can meet the mark-to-market during the 20% drawdowns.
Tactical Positioning
Some investors may prefer to hedge only when they expect market volatility. In our introduction to Tactical Allocation, we touched upon how we can use moving averages to shift between stocks and bonds. Instead of trading in-and-out, investors might prefer to add a hedge instead.
Needless to say, we are not big fans of investors trying to time the market like this.
Conclusion
Hedging makes sense if you are a leveraged investor. Given the costs, complexity and performance drag involved, it doesn’t make much sense for cash investors to hedge.
Looking for a sensible way to invest? Here’s how to get started.
I will admit something first. Dogecoin is fun. Dogecoin makes you laugh out of sheer joy, despite yourself. Dogecoin sucks you down into a rabbit hole of memes, parodies, and all things not serious.
But is everything a joke? Obviously not. So, in that spirit – let’s get serious.
Bitcoin is an idea. A meme, if you will. Like how the original Doge meme is backed by a cute Shiba Inu dog, the Bitcoin meme is based on the idea of what money is. As we know, money is just a made up thing – a meme – which people ascribe value to. Money doesn’t have to be “backed by” anything. All you need is the collective belief of people in the meme of money. To take this comparison further, on the Doge side, the meme goes a bit deeper than just the dog. We have words like: “much”, “wow”, “so”, “amaze”, “many”, etc. that can enhance the context in which the Doge meme is being used. On the Bitcoin side, you have the mythical founder, dead simple cryptography, and a few other powerful ideas that go on to implement a glorified ledger of IOU’s. That ledger is considered legit because of the meme that Bitcoin is set in stone.
If Bitcoin itself is a meme, why not make a coin out of a literal meme? Enter Dogecoin.
Started off in 2013 as a joke, Dogecoin needed to work just like Bitcoin, but with a few tweaks. Why tweaks? Why not? It’s just a joke anyway. But sadly though, these weren’t “fun tweaks”. Like there is no Doge ASCII art in the transactions, or a “much wow” after every block of transactions. The tweaks were almost arbitrary technical departures from Bitcoin. Notably:
Proof of Work with the SCRYPT hashing algorithm in Dogecoin vs. SHA256 in Bitcoin.
Arbitrary rewards for block producers, but now changed to a fixed reward of 10000 Dogecoins per block (which are generated every minute).
Dogecoin works, in the sense that the jokes are funny, and if you choose to – you could use Dogecoin as money. If enough people choose to use it, it might very well thrive, not just survive. In 2021, enough people are buying it, holding it, talking about it, “meme-ing it”, and watching its value skyrocket in terms of USD. Because it’s funny, it’s an F.U to the traditional financial establishment, and perhaps even to the Bitcoin establishment (whatever that is).
But if everything about Dogecoin is warm and fuzzy, what gives?
Two things, specifically.
1. What makes a meme?
A meme implodes if what literally backs the meme fails to work. When I say “literal”, I mean the literal thing that backs the meme. Like in the case of Doge the meme, we want that Shiba Inu dog to have been real dog (and not secretly a stuffed toy), and the meanings of English words like “much” and “wow” to not change. In the case of Dogecoin, the literal technology that underpins the meme has to work. Let’s say Dogecoin can be double-spent because of the quirky way it is mined, or let’s say users cannot audit the global supply and the ownership of their Dogecoin because they cannot run a full node, or let’s say Dogecoin’s governing rules change tomorrow….for the lulz. In fact, those tweaks that Dogecoin did over Bitcoin can be argued to be quite unsound. These, and other technical artifacts can undermine the Dogecoin meme fundamentally.
Without being controversial, I can say that Dogecoin is orders of magnitude weaker than Bitcoin in these terms.
Why is that? That’s my second point
2. Stronger meme
Bitcoin’s meme is serious, to the point of almost being noble. This has inspired serious people. Some of these people have worked hard to make small technical improvements over the surprisingly good initial design, make the code robust against bugs, have a small footprint, and keep running forever. Some others have looked hard at the theoretical aspects of Bitcoin to see why it works, and have almost convinced themselves that it works because it has to work. Some others have meme-ed the idea that Bitcoin’s rules cannot change at all, and have fought long and hard wars of attrition to keep it as it is. There are entire industries built around Bitcoin’s mission, and words like “mission” get used quite often.
On the other side, we have Elon Musk and Joe Weisenthal of Bloomberg who have meme-ed about Dogecoin. And they have meme-ed well. Like Elon putting a Dogecoin on the literal moon (whatta great meme). Joe has even joked that Dogecoin is a purer incarnation of what a cryptocurrency should be, without all the added serious baggage of Bitcoin. I argue the opposite. The serious nature of the Bitcoin meme is what makes it work, by getting the virtuous cycle of seriousness begetting robustness begetting soundness.
To meme Dogecoin into a phenomenon stronger than Bitcoin, it has to come from many fronts. Textbooks have to written about it. Academic conferences dedicated to it should emerge. Universities should start teaching courses about it. CME has to create a futures market for it. Central Banks all over the world have to start aping it. Folks should be drilling holes into the Alps to create vaults that can store a piece of paper with a private key written on it. These and many more have to happen for a meme to emerge stronger. Also, critically, despite the memes, the thing has to not change, and keep its singular purpose.
Bitcoin, luckily, had many things go its way, which kick-started the virtuous cycle of meme-ing, and those memes attracting people who were good enough to improve the thing that underlies the memes. Dogecoin might get there as well, or might not.
Looking for a sensible way to invest? Here’s how to get started.
Volatility measures changes in price. Price is a measure of sentiment. Volatility measures changes in sentiment.
Most of the time, it is impossible to tell the difference between the two.
Exhibit A: AIG
American International Group, AIG, had enjoyed a AAA rating for 22 years and had been just one of eight US companies to hold the top rating from both S&P and Moody’s.
As mortgages started to go bad, AIG stock began its long journey to zero from July 2007. During that time, a majority of investors thought that every dip was a buying opportunity.
The problem with trying to be too smart about “volatility” vs. “risk” is how do you know what is priced-in vs. what is panic-selling?
If you are going to panic, panic early!
Panic is good only if you panic early, and as a trader the first thing you learn is to panic early. – Nassim Taleb
Discretionary investors wax eloquent about the strength of their conviction. Having done their homework, they claim, they have the “diamond hands” to hold onto their investments during bouts of volatility and to buy the dip.
However, these narratives are heavily driven by survivorship bias. You will never hear about conviction and diamond hands from investors who bought the dip in Bear Stearns, Suzlon or Kingfisher Airlines.
As an investor, you get no points for being a hero. If there is a whiff of something unpleasant, it is better to get out of an investment entirely, take a beat, re-evaluate, do a relative-value assessment to figure out how it compares to other opportunities and only then decide whether you want add it back to your portfolio.
Exit first. Ask questions later.
Compounding works both ways
Losers average losers – Paul Tudor Jones
We have all seen the Whatsapp forward about compounding: (1 + 0.1)^10 = 2.59 i.e., 10% compounded over 10 years will turn every rupee into 2.59 rupees. Rarely do you see the reverse: a 50% loss requires a 100% return to get back to even.
If you care about compounding your portfolio, stop compounding your losses!
Investing is risk management
… and risk management is not free.
Most investors focus on the glamor part of the process: scuttlebutt stock-picking to find the rare “hidden” gem that will 100x in 5 years. They would have better odds buying lottery tickets instead.
There are plenty of investors who became millionaires simply by grinding away at harvesting risk premia and managing risk.
Avoid blowing yourself up and allow statistics to do play out.
The only investors who shouldn’t diversify are those who are right 100% of the time. – Sir John Templeton
There is a big difference between the advice professional investors give to other professional investors (like the ones above) and the advice that savers need to follow. The media often focuses on the former because it is exciting and there’s always something new whereas the later is mostly timeless and boring.
The media’s sampling and survivorship bias ensures that only large, successful, telegenic professional investors get the spotlight. And media’s short attention span ensures that most of them are never held to account for their pontifications. As far as the media is concerned, the only crime is to be boring.
The tragedy is that there are only so many ways in which you reframe “save into a diversified portfolio by dollar cost averaging into a low-cost, broad-based equity fund and a short-term bond fund.” So it is guaranteed to never get the airtime in proportion to how important it is.
— Dividend Growth Investor (@DividendGrowth) April 22, 2021
Diversification means that your incremental dollar is buying the asset that has not appreciated as much as the other. For example, if you keep a static 50/50 equity/bond portfolio and equities are up 10% but bonds are up 2% then the next dollar you put into that portfolio is going to buy more of the bonds and less of equities. This is where the Risk Management is Not Free rule kicks in: diversification is anti-momentum, a premier market anomaly. By diversifying and rebalancing, you are not maximizing your portfolio returns but minimizing volatility in a cost-effective way.
Remember, that in the end, we are all short volatility.
In the short run, market is a voting machine; in the long run, it’s a weighing machine. – Benjamin Graham
Price is a measure of Sentiment
Early last year, when it became clear that the China Virus had spread all over the world and was getting millions sick, overwhelming healthcare systems everywhere, the markets tanked. In USD terms, Indian stocks were down more than 40% and the S&P was down more than 30%.
Then, a miracle cure was discovered and the markets quickly recovered.
Just kidding!
Governments and Central Banks everywhere did whatever they could to lift sentiment. And markets quickly followed.
Sentiment remains one of the least understood but the most important factor in investing. All prices are eventually tied to how optimistic or pessimistic investors are feeling about the future.
While Graham’s weighing machine might arrive in time for tenured investments, like bonds, that have a fixed maturity date, perpetual securities like stocks are always at the mercy of the voting machine, i.e., sentiment.
The Market sets the Price
For stocks, Price = multiple x earnings
For prices to go up, you don’t need earnings to go up. It is enough if multiples do.
There are two pieces that drive returns… multiple expansion / contraction and the earnings themselves. It’s hard to predict the former (they’ve gone opposite their expectation of normalization), but they completely whiffed on the fundamentals. US companies have crushed.
Russell 1000 Growth Price to Book Grew from 5.2 to 12.4 in 5 Years…Russell 1000 Value 1.5 to 1.6 in Same Time Frame … forward P/E has doubled for growth and flat for value over past 5 years. h/t TOPLEY'S TOP 10 via @MarketWatchpic.twitter.com/0zj1DlkIjz
The market doesn’t care why you are transacting. Only that you are. It doesn’t matter what your investment horizon is or the type of investor you are, all transactions take place in the market at a price set by it.
As an investor, you can be right about the company (direction of earnings) but wrong about the sentiment (direction of multiple) and can end up with a stock that goes nowhere in price for years and exit with no rewards for your effort.
No such thing as Buy-and-Hold Forever
It is the end of a “long-term” for a subset of investors everyday.
Investors usually save with a specific goal in mind. These goals tend to be time bound: retirement, kid’s education, etc. While their horizons can be “long” at the outset, it gradually shortens as the D-day arrives. Equities (and other high-risk securities) are constantly being sold and rotated into bonds (and other low-risk securities) set by a glide-path.
As much as professionals like to fantasize about long-term investing, the investors in their funds have bounded horizons. This is especially true for open-end funds.
Sentiment + Finite Holding Periods = Volatility
Finite holding periods create the need to transact. This makes it impossible to ignore sentiment. The two combine to create volatility.
It is easy to blame investor greed and fear for bad portfolio outcomes. We have all seen this sketch make the rounds:
However, even if an investor overcomes the call of greed and fear, it is impossible to ignore time. This makes sentiment the prime determinant of investment outcomes.
If you think investors having longer time-horizons can ignore volatility. Think again. As the chart above illustrates, volatility is an equal opportunity hater.
Embrace and Extinguish
Volatility clusters. You have reasonably long periods of calm, then suddenly a lot of things “go wrong.” Markets gyrate and you feel that all hell has broken lose.
This leads investors to assume that periods of calm are normal and volatility is abnormal. But in markets, the reverse is true. Sudden shocks, volatility and jolts to sentiment are the norm. Calm periods are the anomaly.
Sentiments wax-and-wane. Multiples expand and contract. Markets melt-up and melt-down for no good reason.
The only time-tested way of reducing volatility is asset allocation. Invest in a basket of different assets (make sure that at least a few of them a not financialized) and accept the market for what it is.
Embrace volatility and extinguish it.
Looking for a sensible way to invest? Here’s how to get started.
In 1996, a federal mint employee was eating bananas near where US dollar bills were being printed, and a Del Monte sticker on one of the bananas fell into the printing press and got under a transparent layer of a $20 bill. The Del Monte note was created. This particular $20 note is a collectible in some circles and has been auctioned many times before, and most recently for around $400,000. That the serial number of the note is printed over the Del Monte sticker makes this even cooler, and kind of unforgeable, and a fungible token became a non-fungible token.
What?
What does it mean for something to be “fungible” anyway? As an example, dollars (or any money for that matter) are fungible. That is, a dollar is a dollar is a dollar. It doesn’t matter if it’s a note with serial number XYZ or ABC or a ledger entry in some bank’s database. If I give you a $10 bill to transfer an equivalent value, the actual printed bill is irrelevant. This was made much easier when we went from cash (physical transfer of value) to digital transfer of value, and we now transfer an abstract notion of $10 without having to bother with a physical vehicle to carry that value. Now that we have digital money like your bank deposits or Bitcoin – what is the equivalent of the Del Monte note? We will get to that question in a bit.
In the physical world, there are two primary requirements for an object to become a collectible.
It should be one-off, or a limited edition.
It should have some intrinsic appeal because of aesthetic reasons (a Picasso, a Ferrari 250 GTO) or quirky reasons (the Del Monte note).
The appeal of a collectible is driven by popular culture. That’s beyond the scope of this article. The limited edition nature is what I am interested in.
Limited Editions and Artificial Supply Caps
Most paintings appreciate in value after the painter has died. This makes that artist’s work provably limited edition. In rarer cases, the technology used to create the collectible in question is provably obsolete, or some raw materials have become extinct. Many times, if the creator is still active, they could implicitly make a promise that the collectible is limited edition. For example, the car company McLaren has implicitly promised us that they won’t make more of their iconic F1 supercar from the 1990’s. Or Ferrari with their 250 GTO from the 1960’s. Note that there is no technical reason that prevents them from making more of these cars. It’s just that if they break their word, the collectible nature of these cars will vanish.
On the other hand, Seiko and Casio G-Shock, the Japanese watchmakers, make many limited edition collections of watches every year. In the watch collectors’ community, it’s almost a joke when a new “limited edition” Seiko comes out. Sure, there will only be 50 of these specific watches with some specific quirk, but tomorrow, there will be another limited edition collection with some other quirk. Eventually, even among watch collectors it’s hard to know which of these is a true collectible, and which is not. But they are all limited edition, according to Seiko.
What about collectibles in the digital world, where anything can be copy-pasted? Making a limited edition of anything is quite hard. For the most part, digital money is the only thing that cannot be copy-pasted. Government controlled digital money does this by having a centralized database with a trusted party (commercial or central banks) and this trusted party is – er – trusted to not copy-paste. Bitcoin and related cryptocurrencies prevent copy-paste using cryptography, distributed computing, and game theory.
If you can make a unit of a digital money unique, by affixing a banana sticker on a it digitally, you get yourself a digital collectible, or a Non Fungible Token (or NFT).
Can we “affix a banana sticker” on a unit of digital money in your savings bank account?1 Bank account balances are not represented as cash-like notes with serial numbers. Every account has just a numerical balance, and that makes it quite hard to take a part of that balance, and affix a banana sticker on it. So, that’s out. What about the other money that we know about: Bitcoin? Bitcoin is cash-like, in the sense that each digital unit of Bitcoin (technically called a UTXO, or Unspent Transaction Output) has a unique serial number associated with it. But how do we affix a banana sticker on it? For better or worse, Bitcoin is a bit too focused on being a secure implementation of money, and makes affixing this banana sticker much harder, like that Del Monte note was a one-off with the US dollar, but most US dollar bills are unmarked and fungible. Bitcoin is out.
What if we had Bitcoin-like platforms where affixing banana stickers on non-copy-paste-able digital tokens is easy. These are NFT platforms built on Ethereum.
A bit of history here: Ethereum, being a more ambitious platform than Bitcoin, wanted to allow general purpose computation on a decentralized system with no central operator (the opposite of say, Google Cloud or Amazon Web Services). General purpose computation is all fine and dandy, but most users wanted coins equivalent to Bitcoin, but with more fine-grained control on how the actual units were minted and transferred. Note that Bitcoin itself has these minting and transfer rules, but they are all set in stone. Ethereum’s underlying currency: Ether, also has such rules, and for the most part, they are also hard to change. But if a single user wanted to create their own such coin platform, with their own minting and transfer rules, they could create such a platform on Ethereum. This platform standard was called ERC-20, and all the ICO’s you heard about from 2017-2018 were ERC-20 coin platforms with specific mint and transfer rules created by specific teams. To give another analogy, every ERC-20 token-platform is like a bank. Users of a specific ERC-20 token-platform have their own account in this bank with fungible ERC-20 tokens in these accounts, and can transfer these tokens from their account to someone else’s account. This entire ERC-20 bank, along with other such banks, are all built on Ethereum. There are 1000’s of popular ERC-20 token-platforms on Ethereum, with each of them having many users.
One such platform is Cryptopunks, which is an ERC-20 token platform created by a company with 2 engineers. Cryptopunks added one new feature to each of its erstwhile fungible tokens. Each token is associated with a unique 24×24 pixel art image representing various human like faces, which added – er – personality, to each token. It turned out that these tokens were now not fungible at all – some of these tokens have cooler personalities and are valued higher. Thus was born the ERC-721 standard, which allowed token-platforms to add a unique personality to each token that the platform mints. The ERC-721 standard is also popularly known as the NFT standard. Any token-platform that conforms to this standard allows creation/transfer/showcase of tokens with personalities – and sometimes, the personality is as random as a random string of 32 characters. The digital fingerprint of an image file can be 32 characters, and if you add such a fingerprint to a token – this token now has art associated with it. You could add digital fingerprints of music files to a token. Cryptokitties is another famous NFT platform on Ethereum – where each token represents a kitten, with kitten like features – all digital, of course. Note here that the token is associated with the token platform, which is in turn associated with the meta-platform on which the token-platform is built. Could the same 32 character fingerprint of some art be associated with a token from another NFT-platform? Yes, it can be.
Point:
NFTs liberate art. Traditional art is confined to time and space. You have to be in the right city, go to a museum, be invited to someone's home, etc. Anyone, anywhere with an Internet connection can view NFTs and take them in. This is a huge breakthrough.
That doesn't answer my question. If I look at a NFT of a picture how is that a different experience than just looking at the picture online? If there is no difference then how is this revolutionary for viewing art?
After all that background, the main question is – are NFT’s valuable? From the earlier analogy, we could ask ourselves – are watches valuable? There are more watches coming out every year – and Seiko makes many limited edition collections every year – is a particular Seiko watch from a particular limited edition collection worth $69 million? You have surely heard of the Paul Newman Daytona Rolex. As we said earlier, it’s hard to understand the popular culture that makes something a collectible. But, what’s definitely understandable is – what makes a digital artifact a limited edition. The NFT standard says nothing about NFT’s being limited edition. It just says that there should be a way to create NFT’s, transfer ownership, and show their uniqueness. So, we have to trust the NFT platform that it will somehow enforce the limited edition nature of these tokens. In Ethereum, the computer code (also called a smart contract) that controls any deployed NFT-platform cannot be changed after it’s been deployed. This gives us some notion of trust: we can inspect the deployed code, and check for ourselves tokens minted by this smart contract are truly limited edition. Does that give us true limited edition now? Not quite – there are two major caveats.
Deployed smart contracts can be modified in the future, if there are backdoors or hooks, in the code. Proving their non-existence is quite hard. Foundation App, a popular NFT-platform, is just one public backdoor. The contract can be changed unilaterally by that organization in the future.
An organization which deploys the V1 version of the NFT-platform could deploy a V2 version tomorrow, and a V3 version next year. If the organization puts enough marketing around these new versions of the same platform, users move. Case in question – Uniswap, the popular DeFi exchange contract is now in its V3 version.
Short version:
The NFT token you bought either points to a URL on the internet, or an IPFS hash. In most circumstances it references an IPFS gateway on the internet run by the startup you bought the NFT from.
Oh, and that URL is not the media. That URL is a JSON metadata file
In contrast, Bitcoin was deployed just once, and cannot be changed. And the code is open and has been pored over by normal users, bounty hunters, cryptographers, butt-hurt software engineers, and other experts over the last 11 years and it’s almost certain that there is no backdoor. A backdoor could be built in the future, but it will be very hard, and very visible. An NFT, on the other hand is a single token created by one among many NFT-platforms, on top of one among many meta-platforms like Ethereum. To put that in context, there are around 10,000 NFT-platforms on just Ethereum right now. If we leave Ethereum, we get other blockchain platforms, which are ostensibly decentralized across the world – and NFT-platforms are being built on them. NBA TopShot NFT-platform is on the Flow blockchain meta-platform. I have no idea how Flow works.
To give a concrete example, let’s take the NFT that captured the popular media’s limited imagination. Beeple’s $69 million “EVERYDAYS: THE FIRST 5000 DAYS”. The painting itself is 300+ MB, and like most NFT’s is not actually stored on the blockchain, but somewhere else on the internet. It’s not that easy to find, but I will save you the trouble by pointing to a link the works (for now).
Here’s how it was done:
A SHA256 hash of the actual image file – its digital fingerprint – was computed.
The fingerprint was then affixed to a token minted by a smart contract that lives on the Ethereum blockchain. This smart contract is actually called “MakersTokenV2” (no, I am not making this up).
The token was then transferred to the buyer’s Ethereum wallet. The buyer apparently paid the equivalent money in Ether to Beeple through Christie’s, the auction house.
Ironically, this transaction itself cannot be traced on the Ethereum blockchain. We really don’t know for sure if the money was truly transferred or not. Assuming the transaction happened, the buyer now owns the right to transfer the token on the MakersTokenV2 smart contract on Ethereum to someone else.
A grand total of 10 people might have inspected the MakersTokenV2 code. We know not what we know not.
There is this other idea that poor artists, ripped-off musicians, multi-billion dollar sports-organizations like the NBA could associate their content with an NFT platform and get better remunerated for it. Each piece of content goes on a specific token from a specific NFT-platform, and committed fans will buy them. What I fail to see is how an NFT-platform is different than a private art-gallery or a record label, or a pay-per-view sports channel. They can all channel money to the artist, and they can enforce copy-paste protection through law. If a piece of art is fingerprinted and attached to another token on a competing NFT-platform, and this token is then sold – what happens? The artist or the NFT-platform representing the artist will sue the other platform or buyer. Or some such.
So, are NFT’s a fad? Yes.
Is every Bitcoin an NFT? Technically, yes. But every Bitcoin is worth the same value as every other Bitcoin.
Is every USD bill with a unique serial number an NFT? Technically, also yes. But every dollar bill is worth the same value as every other dollar bill. The Del Monte note though, is the kind of NFT that is in vogue now for being an NFT. That’s the fad part.
Looking for a sensible way to invest? Here’s how to get started.
