Why VCs Are Investing In NFT Marketplaces

Illustration of blockchain

NFTs, or non-fungible tokens, are becoming mainstream, and that means more people are looking for ways to build upon the interest in these digital assets.

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Increasingly, marketplaces to buy and sell NFTs and companies to mint the digital assets are popping up. That includes NFT marketplaces like New York-based OpenSea, which last month raised $23 million in a round led by  Andreessen Horowitz, NBA Top Shot, where users can buy NBA highlight collectibles, and Rarible, a seed-stage startup that allows users to sell or collect digital items and has raised $1.8 million in funding, per Crunchbase.

“It does feel a bit to me like the very early web, and I can say that because I was there, in the sense it takes an extra step of imagination to grasp how big the economics of it is,” said Anthony Citrano, CEO of NFT marketplace Acquicent, a pre-seed startup based in Los Angeles.

As a recap, an NFT is a non-fungible token, or a sort of digital collectible item. NFTs use blockchain technology as a ledger to record their sale and ownership. Some people have compared buying NFTs to owning original artwork: In both cases, the buyer owns the original item and the title for it, although there could be reprints. The original piece of artwork still holds more value than copies, and there’s something to be said about owning the original. (You can read more about what an NFT is and how it works here.)

Marketplaces to buy and sell NFTs might be the most common type of company the average person looking to get into the NFT business will come across. They’ve bubbled up because as great as it is to say you own a digital asset like the first tweet ever posted, many people want the flexibility to be able to cash out on it later.

“It’s nice to own an asset, but you want to be able to trade it,” said Louis Lehot, a partner at the law firm Foley & Lardner LLP. “You want to know that at any given time you can liquidate that asset.”

That’s why marketplaces like OpenSea, Rarible, and NBA Top Shot have cropped up. 

But, starting a marketplace comes with the caveat of making sure an NFT doesn’t become a security. Maintaining a securities marketplace involves registration with the Securities and Exchange Commission, compliance and being subject to ongoing audit, according to Lehot. NFTs are not securities and shouldn’t be treated as such. Once they are — meaning that they’re bought or sold with the expectation that they’ll increase in value because of the work of someone else — they’re subject to regulation.

“A digital asset would fail to be a non-fungible token if the proceeds from the sale of the digital asset would be used to build the product, build a market for the product, and thereby increase its value,” Lehot said. 

So if, for example, a person or company sold a digital asset and used the proceeds from the sale to make more digital assets, then it becomes a security. And if that marketplace isn’t registered with the SEC (these startups likely are not), then it would be in hot water.

NFT marketplaces have formed as a result of the interest in NFTs, which in turn has been fueled by the price of bitcoin reaching new heights in recent months. People want yield, according to Lehot. Bonds don’t have yield, and since there’s been such a large rise in the stock market over the past two years, some people feel priced out of equities. 

The rise of the value of cryptocurrency relative to fiat currencies like the U.S. dollar is the primary driver of the NFT obsession, but so is the fact that it’s a collectible, and people have long had a fascination with collectibles, according to Citrano. Anything that’s authentic and has a story attached to it can carry value, and the fact that everyone’s talking about NFTs is only fueling the conversation further.

NFTs came about in 2017 when bitcoin reached a then-historic high of about $20,000 and with the release of the blockchain game Cryptokitties, in which users could collect and breed digital cats. Then, the price of bitcoin crashed and it was a bear market for a while, with people losing interest in NFTs as well.

Now, the larger shift to the digital economy thanks to the COVID-19 pandemic has renewed interest in NFTs, with many major brands and celebrities seeing NFTs as a “new frontier” for brand expansion, according to Craig Russo, director of innovation for Polyient Labs, an early-stage incubator for companies focused on blockchain.

And people this hyped about something paves the way for a business ecosystem to be created around it. In the case of NFTs, that means marketplaces and ways to mint NFTs. Citrano also predicts that companies focused on authenticating and verifying NFTs will likely come along soon.

Russo of Polyient Labs is betting the next iteration of NFTs depends on what people do with the tokens once they own them. NFTs could be incorporated into more digital gaming (they already are) or could be used as collateral for decentralized finance. They could also be used to unlock additional experiences or content in experiences like games or virtual concerts. 

“As we move forward, people will begin to wonder, ‘Now that I have this NFT and I paid $10,000 for it, what can I do with it besides looking at it in my wallet?’ ” Russo said.

Illustration: Dom Guzman

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