NFTs are emerging as a new asset class and why financial institutions should embrace it
Alternative assets continue to gain traction and the global alternative assets under management are expected to increase by 60 percent until 2025. One type of alternative asset has been at the forefront in recent months: the non-fungible token (NFT). NFTs have seen a continued surge in popularity since September 2020 and monthly trading volumes reached $10 billion in Q3 2021 with notable brands such as NBA and Formula 1 selling their own NFT’s.
NFTs are tokenized versions of assets that aim to manage ownership of digital collectible items by storing the ownership in the form of a digital certificate on a blockchain. That makes the NFT token unique, ensures digital scarcity and thus results in its value.
Digital collectibles are more than a temporary hype and could potentially behave in the mid-to-long term similar to traditional art. Art is seen by many in the financial community and beyond as an attractive alternative asset as it shows a positive correlation with inflation and resistance to market downturns. With the current economic outlook, we could see in the future increased demand from investors looking to invest in NFT’s to hedge against market risks.
For financial services, the emergence of NFTs could also be an opportunity to create entirely new business lines or products and offer them at a large scale to the market. One noteworthy example is NFTX, a company that created an ETF that depicts the NFT market as a whole and provides investors simple access to a seemingly illiquid asset. Financial services can potentially explore lending activities with NFT’s as collateral once the space matures and becomes more predictable. Companies like DeBank and NFTfi have started to offer their lending services on decentralized exchanges and allow users to monetize on their digital collectibles.
Another avenue for financial services is digital asset management and related services. Banks already manage the traditional assets of their clients and many would opt in to also have their digital assets and collectibles managed.
NFTs as a potential asset do not come without risk. The NFT space has a limited track record of 2 years on which their performance needs to be assessed. In the current market, most blockchain-related digital collectibles are strongly tied to Bitcoin and it is still a long way to go until digital collectibles and their respective value completely detaches from the price action of Bitcoin.
As much as digital asset management services are an opportunity for financial services, it also comes with their own challenges. For banks, it boils down to being able to access and manage private keys of digital assets securely and at the same time be responsive to rapidly changing market opportunities.
Current research suggests that multi-party-computation (MPC) is a viable solution for private key management but its effectiveness has still to be proven.
Due to the permanence of the blockchain and the traceability of ownership, NFTs are set to become an integral part of the alternative asset landscape. The question is not if financial services will be impacted but to what extent. Financial institutions can prepare and take advantage of this opportunity by already starting to explore different business models and product offerings internally and materializing on NFTs once regulations around digital collectibles become clearer.