Would you pay Four Million Dollars for a Digital Picture of a Dog?

Art has always been a tricky thing to value.  In traditional finance, the value of something is derived from the present day value of its future cashflows.  So a company’s stock is worth the present value of all of it’s future cashflows that will be paid to the owner of the stock.  There are various ways you can calculate cashflows and lots of reasonable ways for people to disagree on what those cashflows will be. But pretty much everyone in finance agrees that the basic premise of buying a stock is that the future cashflows are what you are buying.

Valuing Real Estate

Art on the other hand has no cashflows, and therefore we can’t value it the same way.  There are other things that don’t produce cashflows that we can still find pretty reliable ways of valuing.  Real estate for example.  Some real estate is valued for it’s potential to earn cash flows, but when it comes to residential real estate there are often never going to be any cash flows. So instead realtors and buyers value the home based on it’s comparables, which are of course the prices that similar homes have sold for.  

Looking at comparables is useful at assessing what the market value is, but it does have limitations.  The comparable home that sold is never going to be exactly the same as the one you are trying to value, unless it is in fact the same home that sold previously.  But even then, the difference in time means that the situation is not exactly identical. When you have a particularly unique home, it can be tough to find good comparables.  This can make it tough to value, or it can make your valuation less useful, or both!

Valuing Art

And that brings us to valuing art.  Valuing art has all of the trickiness of valuing a home, but it is even harder to find accurate comparables.  Art has to be unique in order to have much value.  There are lots of pictures of dogs out there but only when you have those dogs playing cards is it unique enough to stand out and be valuable.  I’m going to avoid pontificating too much of where the value in art is derived because frankly that is well beyond my circle of competence.  I am aware that certain artists obviously command more for their work, though I did learn recently that not everything a famous artist does is valuable.  I believe that it’s possible to buy a ceramic tile piece made by Picasso for only $2000. This is because Picasso was a prolific producer of art and therefore not everything he produced is really high quality and valuable.

So getting a famous artist is important, but not necessarily conclusive on value.  It seems to me that the only thing that is a guarantee is that in order to be valuable, art must be unique, and as a consequence there is a limited supply available.  One of the interesting things about the art market is that it is an asset with a diminishing supply.  If you are in the market for Picasso paintings, you know that there are no new Picasso paintings being created. As a matter of fact, it is common for Picasso paintings to be donated to museums over time and that actually reduces the available supply for private buyers.  This is good for prices because a reduced supply leads to a higher price so long as demand stays constant.

What is a Non-Fungible Token?

All of this leads me to NFTs.  An NFT or “Non Fungible Token” is essentially a piece of art… in digital form. Anyone can view or copy a digital image, but the magic of an NFT is it is coded to be truly unique.  This does not mean the image is unique.  You could easily copy an NFT and you would essentially have the exact same thing.  But I suppose there is a cachet for owning the original NFT for some people.  It’s kind of like art.  I personally would not pay large amounts of money for a painting to hang on my wall.  It doesn’t have the utility for me to do that.  But other people do want to pay lots of money for paintings and there is nothing wrong with them doing so. Similarly, I would not pay a large sum of money to buy an NFT, but that doesn’t stop someone from paying $4 million for an NFT of the Dogecoin mascot Shiba Inu called “Doge”.

This seems insane.  There are no comparables that would explain why Doge should be worth $4 million.  In reality, it’s valuable because someone is willing to pay that much for it.  But what is really going on here?

Well, one interpretation is that NFTs are just a new art form and are actually a better way for artists to monetize their work. That is one possible explanation for why NFTs have become so popular in recent months.  And I can’t really argue with that.  I personally would pay approximately zero dollars for the NFT Doge. But I also wouldn’t pay very much for a famous Picasso painting either.  Is one piece of art objectively more valuable than the other?  Maybe but my guess is probably not.

Another interpretation of what is going on is that the NFT prices are an offshoot of the crypto mania that has been so prevalent this year.  I think this is at least partially true. The person who bought Doge paid for it with Ethereum and not with traditional dollars.  So I think it’s pretty clear they were pretty tied into cryptocurrency markets. If you made $4 million dollars trading Ethereum in the last year (Ethereum is up about 1000% in the last 12 months), then you’d probably be more willing to blow it all on a digital picture of a dog (The actual bid was 1,696.9 ether, which I’m pretty sure is not a coincidence).  But not only that, as a crypto enthusiast you probably are more likely to see value in owning an NFT, just like you see value in owning a cryptocurrency, which again provides no cashflows and whose value is only derived from others willingness to pay for it.  There’s also the fact that these NFTs are often facilitated by the blockchain of a cryptocurrency like Ethereum.

Stick to the Things You Understand

All of this I find to be interesting, but also completely useless to me when it comes to investing.  I have no way of valuing an NFT and would be no more skilled at it then valuing a rare Rembrandt.  Do I think this NFT craze is a bit speculative?  Yeah I do!  Do I know how long it will go on for?  Absolutely not!  Does it make sense to me? Nope, not even a little bit!  But that’s ok… we don’t need to understand everything that goes on in investing.  In fact the best thing you can do is stick to the things you do understand, and leave the other things to people who are more knowledgeable or more willing to speculate.  Frankly I can’t wait to see how these NFTs turn out.  But I won’t be putting a nickel of my own money into them.

- Craig White, BA, LL.B., CIM®

Craig White is an Investment Advisor at Endeavour Wealth Management with iA Private Wealth, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Craig White an Investment Advisor for iA Private Wealth and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.