Why is everyone buying NFTs?

Hannah Bateson • 6 min read

Introduction

What do the new Kings of Leon album, Nyan Cat and a 10 second video clip of people walking past a slumped-over Donald Trump figure have in common?

These digital pieces of art, freely accessible to anyone with the ability to conduct a simple web search, are all Non-Fungible Tokens (NFTs).

By providing an authenticating certificate to the original digital resource, an NFT marks it as the first of its kind. Because it is the first of its kind, it is the only of its kind and, with that, the digital resource becomes something that is irreproducible, existing only in the hands of its NFTs’ owner.

 

“By providing an authenticating certificate to the original digital resource, an NFT marks it as the first of its kind.”

 

Since February, the NFTs of the above three resources were each sold for over half a million dollars.

Coinciding with the emergence of the COVID-19 pandemic, these NFTs have seen a surge in creation, sales and overall publicity. In fact, the month of April 2021, alone, saw total sales values surpass $208 million dollars. That’s just short of the $250 million dollars NFTs generated in all of 2020.

However, the value of an NFT is becoming increasingly volatile. This means that NFT owners are given no guarantee of profit from their investment.

So, what’s convincing more and more people to take on the risk?

Insights from Behavioural Science tell us that it all boils down to the sense of financial uncertainty that has been brought about by the economic aftershocks of the COVID-19 pandemic.

Research has shown, time and time again, that we, as humans, tend to respond to this uncertainty with behaviours directed by cognitive biases and mental shortcuts, known as heuristics.

So how can these biases and heuristics help explain why people choose to invest in NFTs?

 

Scarcity: Sparking attraction towards a new investment.

Because understanding the system of blockchain technology can be quite cognitively overloading, the actual mechanism of an NFT is unlikely to be the new and exciting factor which sparks interest in its investors. Instead, what attracts investors to NFTs is their ability to mark an abundantly accessible digital resource as scarce by deeming only one version of it as the original.

As humans, we tend to value products that are scarce more than those which are abundantly available to us. Think back to when Wansink and colleagues (1998) investigated the effect of placing a limit to the number of soups each person could purchase from a supermarket. In doing this, they found that the majority of people bought more cans than they would have without the identification of its scarcity.

 

"What attracts investors to NFTs is their ability to mark an abundantly accessible digital resource as scarce by deeming only one version of it as the original."

 

We respond this way because scarcity serves as a marker of a product’s demand by others. In turn, our aversion to loss makes us more likely to want the product before it is taken from us by anyone else.

Therefore, when a beloved meme like Nyan Cat is tagged with an NFT, the perception of its scarcity is triggered – drawing art investors towards a virtual resource that, until now, had little unique value.

But the psychology doesn’t stop here.

 

Social proof: Buffering personal hesitation.

Because we, as humans, like to stick to what we know rather than change our current course of conduct, we are less motivated to buy into a new market – particularly when our existing investments are doing perfectly fine. In behavioural science, this is known as a default bias.

Frankly, the nature of cryptocurrencies and NFTs remains unfamiliar and rather complicated to new investors. So, while the scarcity of an NFT sparks newfound interest in its investment, our default bias prompts personal hesitation towards actually going through with its purchase.

In these circumstances, however, we are inclined to look towards others and their investment decisions as a guide to inform our own. This is because we tend to believe that others hold a more reliable interpretation of concepts that we, ourselves, are uncertain about. In turn, the behaviour of others is seen as social proof reinforcing the decision that is conducive to the optimal outcome for the decision-maker.

 

"We tend to believe that others hold a more reliable interpretation of concepts that we, ourselves, are uncertain about."

 

That’s why, when an artist like Grimes sells 6.6 million dollars’ worth of NFTs in under 20 minutes, we see an exponential increase in the total number of NFTs sold for months after.

Evidently, people saw the profit and success of her investment in NFTs as social proof that their own decision to invest would follow that which would give them greater benefit.

Prestige and Authority: Closing the gap between attraction and investment.

In looking for social proof, prestige is one thing… but authority is another.

A prestige bias describes how, often, we look to copy the behaviours of those who lots of other people are already copying. Celebrities are good examples for this.

People like Grimes, Ellen DeGeneres, Kate Moss – these individuals have large followings. Because they sold their own NFTs, we feel as though we should invest in them knowing that their prestige will attract the investment of lots of others – ultimately benefitting the overall market we’d be buying into.

In high-stake situations of greater potential loss, however, an authority bias is likely to be more influential in guiding the ultimate decision to invest. This bias describes how we are more likely to follow the guidance of individuals who we perceive are experts with authority in their fields.

This means we place more importance on the opinions of high-status investors regarding NFTs, over and above the artists whose contributions to the market are limited to just selling them.

Besides, not all of us are celebrities – so why would a celebrity selling an NFT give us a guarantee that others will buy into ours?

So, we when we see public figures known for their previous cryptocurrency successes investing in NFTs, we become even more convinced that it is the right decision for us to do so as well. This social proof makes investors feel as though they ‘know’ that an NFT will gain in value and profit them in the future. With this, one’s initial attraction towards the risky asset turns into the ultimate decision of its purchase.

 

3 Lessons we Learned from NFTs

The decision to invest in something new is difficult. Our aversion to loss and our desire to stick to investing in existing assets makes us less motivated to take on new ones.

Behavioural science has taught us, however, that despite these hesitations, people are still attracted to new, volatile investments like NFTs. This is because they:

 

  1. Make an asset seem scarce so that people feel a sense of urgency to invest before everyone else does.
  2. Increase the publicity of investment successes so that social proof can buffer personal hesitation.
  3. Use examples of success from figures of high prestige and authority to reassure investors of its future gain.

 

Evidently, the power of an NFTs’ influence lies within our behavioural biases. The rise of investment opportunities like NFTs serve only to remind of just how powerful biases are in transforming our perceptions or risk and, ultimately, influencing our decision making.

 

References

Aronson, E., Wilson, T. D. & Akert, A. M. (2005). Social Psychology (5th Edition). Upper Saddle River, NJ: Prentice Hall.

Bell, A. V. (2013). Evolutionary Thinking in Microeconomic Models: Prestige Bias and Market Bubbles. PLoS ONE, 8(3), e59805.

 Benartzi, S., & Thaler, R. (2007). Heuristics and biases in retirement savings behavior. Journal of Economic perspectives, 21(3), 81-104.

 Chernichaw, A., Lizaso, S., & Vallabhaneni, P. (2021). The Rise of NFTs – Opportunities and Legal Issues. JD Supra.

 Kay, G. (2021). Grimes made $5.8 million in under 20 minutes selling crypto-based artwork. Insider.

 Wansink, B., Kent, R. J., & Hoch, S. J. (1998). An anchoring and adjustment model of purchase quantity decisions. Journal of Marketing Research, 35(1), 71-81.

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