Having bought, sold, traded and otherwise experienced the NFT market for more than a year now, I wanted to lay down a framework for how collections move and trade, and my observations about it. I’m not going to tell you here which collection might pump, or not, or why. I think the jury is still out on that and we’re all doing our best to get a step ahead. I’m also not going to try to guess at what a sustainable model for NFTs looks like. We’re early, everyone is experimenting. Let’s figure it out together.
But, that said, there are things that happen in NFT collections (and now I’m talking about large, generative collections), that seem to be somewhat stable, recurring, and worth thinking about. I think you can basically break down any NFT’s price into three components – floor price, rarity premium and liquidity discount. If you are thinking constructively about these three things, I think you can be much more deliberate about what you buy and sell, and why. And while these factors may not tell you – buy collection X, they may help you improve the profit you make once you’ve found a collection that you think will do well.
Let’s start at the bottom – what I will call the liquid floor. The liquid floor of a collection is the price at which a floor piece will move effectively immediately. For collections with a standing WETH offer, it’s that WETH offer. For collections without a standing WETH offer, it’s a price that’s adequately discounted below the floor that someone will have an incentive to buy it immediately and relist at floor. The liquid floor can also be negative – any NFT trader that’s been around for more than a few weeks will have NFTs they can’t even give away for zero. No one is even willing to incur the gas cost. So that’s the bottom, the liquid floor.
What can we learn by thinking about it? Well, clearly the floor (here I mean the lowest available listing) is important, but it is not the whole story. Things put on the floor may sell quickly, but not immediately. A reasonable timeframe may be a few minutes for a pumping collection to a few weeks for a dead one. What about a floor NFT listed slightly above floor – it may also trade over time, but you would have to believe it would take longer that the actual floor. Someone needs to come around that will pay a premium over floor because they like that specific thing, and that will usually take time. What about a floor piece listed way over floor? That will (almost) never sell. People aren’t quite that naïve.
So, you can imagine a sort of liquidity curve, going from time to sell of zero at its lowest value, up to a time of infinity for something that is priced way more than it is worth. The curve starts negative has some ‘median sale time’ point where the discount is zero, and then continues on to positive values as it reaches long lengths of time to sell. The liquidity discount changes over time, being not very meaningful in a pump or a major collection, and much more punitive with a collection that is dead or declining.
But this isn’t the complete picture obviously. If you put a hoodie CryptoPunk at floor it would sell immediately, whereas a floor punk might take days to sell at the same price. Rarity matters too. Depending on the collection, a rare piece may only sell at floor, or it may sell at 30x floor or even more. And rarity value changes over time. Rarity also varies within a collection at a single time – you would pay above floor for a gold grill ape but would expect to pay much more for a gold fur. It’s one of the most interesting things about NFTs - that these values should persist, given that the benefits of NFT holder-ship seem to accrue token-by-token, independent of rarity. Yet people are consistently willing to pay up for that gold whatever, or that 1/1 piece in a collection.
So, with those three factors in place you should now have a rough model for pricing NFTs – take the floor price, apply what you think is a reasonable rarity premium to the NFT you are looking at, and then apply a liquidity discount based on how quickly you think it should sell, and that’s your value. Now that we have the framework in hand, can we take it a level deeper?
Let’s take three strategies – buying at floor, buying mid-rares, and buying top-tier rarity – and see what else we can learn by applying this model.
Buying at floor is the simplest strategy in NFTs for a variety of reasons. You don’t have to think about or understand rarity, and by and large even in very weak collections, the floor will be reasonably liquid. What are you doing when you buy the floor? Well, presumably after you’ve bought the floor piece the floor will have increased slightly (to the next cheapest piece) but will in most cases remain basically unchanged. You have incurred the gas costs and fees (royalty and exchange) paid at exit, in addition as we have just discussed the liquid floor is likely below the collection floor, and so you have bought into a loss. If you change your mind and want to trade out immediately it may be a substantial loss. So, you need two things to be successful – the collection needs to pump, and you need to be willing to wait for a time to get back to liquid tokens.
This is where I think a lot of traders fail with buying the floor – they buy, the floor moves against them, they get scared and hit the exit button, but now they are solidifying their built-in loss on top of a decline in the floor. Repeat a few times, and poverty awaits. Still, if you are good at picking collections and have at least a little patience, this can be a great strategy for a flipper, and requires the least nuance and collection specific knowledge and commitment.
Let’s talk mid-rares next. This is a much maligned strategy, and for good reason. Here you try to buy ‘cheap’ rarity by sniping pieces that are being given away relatively inexpensively compared to the existing floor and rarity premium. The advantage of this is that if you do it right you are buying a built-in profit, and not a built-in loss. In other words, you can be less right about the direction of the collection, and even a flat floor can be profitable. Sounds great. But what are the challenges?
There are many. First, the liquidity discount and rarity premium change over time. When a collection pumps, the liquidity discount becomes small, and people are there to buy a piece at its ‘true’ value in a short amount of time. Rarity premium in a pumping collection also tends to rise, and people are more willing to pay for that gold whatever. But the reverse is also true. When a collection stagnates, or even just doesn’t pump, the rarity premium declines and the liquidity discount becomes more expensive. Add a floor decline and this is a triple whammy – you have an asset where the floor has dropped, the rarity multiple has dropped, and on top of that you need to offer a big discount to get liquidity. This is why people hate mid-rares.
Let’s add to this the problem of identifying valued rarity, especially early in a collection’s life-cycle. When a new collection drops, all numerical rarity is priced somewhat flatly, but over time some of those traits turn out to have been meaningless, while others hold or even increase their premium. It’s very hard to know in advance whether it will be the hoodie, or the diamonds, or the gold, or some other trait that people will value long-term. And even in the long-term these things tend to shift and change with the tides (although not nearly as much as early on).
Despite all these flaws, buying at a discount is always a good policy, and really the mid-rare strategy is about picking your spots and being careful. Much of it is about digging more, and not accepting fool’s gold – especially during a pump and early in a collection’s lifecycle when it’s out there in spades.
Finally, let’s discuss top-tier rarity. The top-tier game comes with big stakes, big gains, big losses and lots of street cred. You may be buying a single NFT for 5-20x the collection floor, or even more. Probably the sale will be noticed and talked about on Twitter, and you will automatically become an ambassador for the collection, with people seeking your opinion and inviting you to talk about the collection on Spaces. All of this can be appealing. What makes it so great (and terrible)?
Both rarity premium and liquidity discount increase and decrease over time and as the collection evolves, as already noted. But nowhere is the effect as pronounced as in the top tier. If you buy a mid-rare at 2x floor, and the collection floor dumps 50% and the rarity premium disappears, you’ve lost 75% of your investment. The same math if you bought at 10x floor to buy a top shelf item leaves you with a loss of 95%. On the other hand, the gains can be huge too – if you bought mid-rare at 2x and the collection floor doubles, and the premium increases to 3x, you have tripled your money. If you bought at 5x, the floor doubles, and the rarity premium increases to 15x, you have a 6x return on your money. And what you made on that single trade is going to be a large amount of ETH.
The top-tier strategy is further confounded by all the things that are hard in buying mid-rares. Liquidity in the top-tier is weak in general. Even during a pump, top-tier traits can shift or become less valued, etcetera. And now you are playing all of this in large amounts relative to the collection’s floor price. So, you better be damn sure about what you’re buying and the success of the collection in general. A lot of people have made eye-popping gains buying top shelf, and a lot of other people have gotten rekt. It’s beautiful when it works out.
Hopefully now you are starting to see how to use this framework to think about strategies, and I hope you apply it. There are many more strategies out there, and nuances within the ones above, but if you start with this framework as a way to take things apart and ask yourself ‘what am I really doing here with this buy/sale’ I think you will be surprised how much light it starts to shed on what is going on and why, and where the opportunities really are at any given moment.
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