Alternative Investments I: Fine Art and Its Digital Forms

“Art is anything you can get away with.” - Andy Warhol

From pixelated apes to clipart of pet rocks, the list of creations that NFT artists have been able to get away with is extensive. As if the question of the true artistry of these works weren’t enough, observers may also question the logic behind their absurd valuation, especially considering those works which have fetched millions of dollars. The shift of art creation and investment to the digital space has major implications for artists, collectors, and investors alike, and this change deserves a deeper dive.


Traditional Art Investments

For many years, fine art has been a part of the portfolio of assets of many investors, especially high net worth individuals. A subset of this, blue-chip art (produced by widely recognized artists like Picasso and Warhol), has experienced significant appreciation in value over time, giving a sizable return on investment for those who can afford to own them.

One measurement of the increase in the value of these types of art is the ArtPrice100 index, a portfolio of artworks from renowned artists representing the upper echelon of the art market which can be compared to the S&P 500 in the stock market. Data from the index from 2000 to 2017 shows an average annual growth rate of 8.9%, while the S&P 500’s average annual growth rate over the same period was 3.4%. As reflected in the data, holders of fine art could expect to realize significant gains if they sell their pieces after a holding period. Indeed, they can sell them for a fortune at large auction houses such as Christie’s and Sotheby’s. For example, in May of 2021, Picasso’s Femme assise près d’une fenêtre sold for $103.4 million dollars.

However, one issue with these metrics is that the gains reflect only the art that sells successfully in the auction houses. For every Picasso that sells for millions, there are many other paintings hanging idle on walls, accumulating dust but declining in value. The index does not capture the loss in value of the art that never gets sold, which may mislead investors about their prospects of realizing gains from art.

Further complicating the matter, tapping into this market has a high barrier to entry. Blue chip art is very expensive, and most people are not able to access it. Some services such as MasterWorks have tried to solve this problem by allowing for fractional ownership (via shares in a holding company which maintains the artwork), but investors also face fees used to keep the works in good physical condition.

Although art can make a sensible addition to an already-diversified portfolio of assets, investors should be wary that their art pieces might not appreciate in value. For those hoping that their investment will one day snag a fortune, another route is available through investments in non-fungible tokens (NFTs).

Enter NFTs

First, a bit of background: The technology underlying NFTs is blockchain, a public ledger recording an ongoing series of transactions between parties (think of Venmo’s feed showing payments among a user’s friends). This blockchain is not only public but also decentralized and digitally distributed, meaning the data can be stored by a host network of computers. Because the same transactions are tracked at multiple sources, it is easy to verify the authenticity of each one. In an attempted fraud, if one computer were to record/alter a transaction which could not be verified by the other nodes, the discrepancy would be apparent. NFTs are units of data (entries) stored on the blockchain ledger, and they can be used to assign ownership of a digital asset (e.g. picture, video, artwork). The verification of authenticity provided by the blockchain system can provide proof of the ownership.

Positive Potential

The biggest potential contribution of NFTs to the art/investing landscape is that they help solve the problem of unique ownership of a digital asset, such as a GIF or picture, which can be otherwise easily reproduced. The reproductions of content linked to an NFT, theoretically, do not have the same “value” as the original because they are not marked for unique ownership on the blockchain. Additionally, since the transactions can be traced to a source along the blockchain, it is easy to identify the original producer of a work and give artists their deserved recognition. Some NFTs may even have built in contracts that provide royalty payments to the artist each time they are bought and sold. This can fundamentally alter the way artists interact with their audiences by establishing a relationship of direct support, and it will be exciting to see how power dynamics change between artists and their licensors/publishers.

Overhyped?

Although NFTs purport to create value through their scarcity and recognition of ownership, skeptics remain critical about their inherent worth. Some outside observers characterize the NFT marketplace as a bubble. With some NFTs selling for $69 million, it is easy to understand their sentiment, especially since the rules defining NFTs intrinsic value are unclear, if not nonexistent. Much of the buying does seem to be fueled by emotional excitement of NFT believers, including those who think that owning a piece of the early transition to a world of digital collectibles is highly valuable. However, it is unclear if the scarcity of NFTs will continue to drive their value, especially considering that access to viewing the underlying works is unrestricted. That is, while an NFT proves the ownership of a digital image on the internet, nothing can stop another user from viewing the file from his/her own computer and downloading it as a duplicate. In fact, there are many Twitter trolls who download the images marked by NFTs and owned by buyers in order to mock them. By reposting the .jpeg images that the buyers claim to own, they effectively demonstrate that ownership of the file does not restrict its practical use-cases for other viewers. Still, some clearly see ownership as a valuable asset in itself and are willing to pay a hefty premium for it.

Conclusions

In summary, alternative investments in art as an asset class have undergone a significant shift in recent years. Art has become not only more accessible through fractional ownership but also more digitized through NFTs (which likewise allow it to reach a broader audience). The field is still so new that many investors and the public at large do not yet understand it completely, and much of NFT trading seems to be based around hype, at the moment. Dynamic perceptions of value and time will tell whether early adopters of and investors in this landscape are geniuses or fools, but one certainty is that this field will continue to produce major changes.

“The chief enemy of creativity is good sense” – Pablo Picasso.

Sources and Further Reading

Coming Soon

Alternative Investments II: Cryptocurrencies - Christian Siaton

Alternative Investments III: Pirates - Matthew Laborde

Erik Carstens