In many ways, buying and selling NFTs is barely charted territory. Because they’ve only been around a few years, this revolutionary new form of digital ownership is still gaining its footing and presenting new opportunities to those who buy and sell them. In plenty of other ways, however, NFTs are still subject to the same supply and demand systems that have always governed the free market. Let’s examine the dynamics of NFT price determination and look at the ways it aligns with and differs from other commodities on the free market.

Value and the free market

Before we discuss value determination, let’s define what we mean by “free market”. A true free market describes an economic system in which the price of goods and services are determined exclusively by market forces. More specifically, prices are determined by the forces of supply and demand. “Supply” describes the amount of a specific good or service available for sale, while “demand” describes consumer desire for that good or service.

Price is determined when supply and demand reach a price equilibrium, a monetary amount for which both buyers and sellers are willing to perform a transaction. As supply and demand shifts, this equilibrium price shifts with it. If the free market becomes flooded with new dentists, for instance, the supply is increased, so the price for dental services drops. If everyone suddenly decides to start going to the dentist more often, demand increases, and the price of dental services increases.

Determining the value of NFTs

Most of the world’s economies are mixed, meaning that they blend free markets with government intervention in some sectors. Because blockchains are decentralized, however, they operate on free market economics more completely than many other industries. Prices are determined almost exclusively through supply and demand. Initial prices come from those who mint them, but creators must adhere to market rates if they want to make a sale. Often, these prices come from analyzing market research and the going rate of similar assets.

More specifically, there are a handful of determining factors unique to NFTs which shape their equilibrium price:

• Creator’s reputation – If the head of an NFT project has had successful projects in the past, buyers will have more faith in the new project’s future. If this is a first project, buyers will be more skeptical.
• Uniqueness of an asset – NFTs as a whole are a bit of a novelty, but buyers are especially intrigued by new or exclusive applications of the technology. A perfect example is the NFT of Jack Dorsey’s first tweet. Since there can truly be no other NFT like it, the price skyrocketed almost immediately.
• Market demand – Though NFT popularity has been high overall for the past several years, it’s always in flux. Minting NFTs during a lull means lower prices. Selling in the midst of a boom can command higher prices.
• Profit potential – Many NFT buyers make purchases with the intention of selling them for a profit later. If people are confident that value will increase, they’ll be more willing to spend money up front.

Ultimately, all of these factors are deeply interrelated, and for the most part, NFTs with more hype and notoriety fetch higher prices. But there’s more to it than that.

Fixed supplies for NFTs

Even during periods when the value of NFTs as an industry has deflated, many of the most popular NFT projects have still seen soaring prices. Let’s look at a few examples to understand why this can happen. The prices of CryptoPunks and EtherRocks have consistently increased through thick and thin, and those who have purchased these assets are almost certainly happy with their investments. There are a few good reasons for their success.

Both CryptoPunks and EtherRocks are relatively old projects. Both were minted in 2017, when most of the world still had never heard of NFTs. EtherRocks started at a modest price of about .1 Ether, and CryptoPunks were totally free for anyone with an Ethereum wallet who wanted one. As a result, they weren’t particularly risky investments even when nobody was sure NFTs would become anything noteworthy. Most importantly, both projects also have a fixed supply. Only 10,000 CryptoPunks and 100 EtherRocks were ever minted, and that number can’t increase. Supply was immediately fixed, meaning that only demand was left to affect prices. When NFT popularity began surging, there was nowhere to go but up. Since then, countless other NFT projects have used fixed supply to support their prices.

Non-fixed supply

Many NFT projects don’t use a fixed supply, and this has the potential to be detrimental for traders. NBA Top Shot, an NFT project that mints clips from basketball games, is a prime example. The project achieved massive success toward the start of 2021, but it took a nosedive that summer. A major reason why lies in its business model. Because the NBA continued to have more games, more clips continued to be printed. This led to a flood of new NFTs which overloaded supply. If the supply of an NFT project isn’t fixed, it needs to maintain its popularity or continue to grow in order to support its prices.

NFTs as historical artifacts

CryptoPunks and EtherRocks enjoy another key benefit to being early to the scene: their historical status. Because they were early successes, they represent an intersection of technological and artistic history. Many NFT proponents believe their demand will continue to grow as NFT technology improves and spreads. People will fondly look back on NFT pioneers and historical artifacts. It’s the same reason why a Picasso original will fetch a higher price than that of an artist working today. He’s a part of history, and there are a set amount of Picasso originals that can’t be increased because he’s deceased.

Flux in supply and demand

NFT trading has long been compared to traditional art collecting, but there are a few key differences. One is that supply has increased at a rate far beyond traditional art’s capabilities. Countless new NFT projects flood marketplaces each day, and many are randomly generated, allowing artists to crank out new content at unprecedented rates. This leaves us with a question: what if supply outweighs demand? 

Ideally, this would mean an increased demand for better quality NFTs—ones with new features, more attractive aesthetics, and greater accessibility. As more artists move to the crypto space, we’re likely to see new applications for NFTs that are far beyond the capabilities of those currently available. If demand decreases, some projects will sink and others will swim, and there will be more pressure on creators to mint better NFTs and investors to choose better projects.

For now, demand is still surging. Total sales in 2020 amounted to around $340 million, and that increased to a staggering $24.9 billion in 2021. Where these numbers go throughout 2022 remains to be seen, but early figures are promising. January alone saw $7 billion in sales.

NFTs and price floors

Though the term has popped up a lot in the context of NFT trading, the concept of a “price floor” isn’t new. It’s an idea that has existed as long as the free market itself. A price floor describes a group-enforced price limit on how low of a price is deemed acceptable for a certain commodity. As discussed earlier, prices are usually determined through equilibrium, a balance between supply and demand. However, an organized group can raise a price through the use of a pre-determined floor which nobody sells or buys under. A price floor can be set either legally—a government mandated minimum wage, for example—or through organized consensus. In the context of NFTs, a price floor describes the latter.

In an NFT marketplace, a floor price is the minimum price you can pay to own an NFT and become a part of a particular project. Price floors are initially set by those who mint and sell the NFTS for the first time. It’s one of the most common metrics used to help value a project. In theory, a floor price can be broken by someone who buys an NFT and sells it at a loss, but because most people aren’t keen on losing money, this isn’t typical. It’s often a sign that an NFT project is losing steam or has gone wrong somewhere. A rising floor price indicates success in a given project. Often, group consensus of a new floor price among the various holders of an NFT project can raise it. For instance, if there are ten NFTs in a project and all have owners, those ten owners can agree that nobody should sell for less than X price. If the demand is high enough, that price becomes the new floor, even if one person would have sold for a lower price otherwise.




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