There’s an old saying, “Buy land, they’re not making any more of it.” When it comes to the metaverse, that isn’t true.
Artificial scarcity isn’t real. This may seem like a blindingly obvious and rather tedious observation, but it has important implications for how you think about the future of non-fungible tokens (NFTs), cryptocurrencies and other digital assets like virtual land.
Paul Brody is EY’s global blockchain leader and a CoinDesk columnist.
In the real world, scarce assets like real estate have increasing values driven by opportunities and constraints. Real estate becomes more valuable when it has proximity to infrastructure, services and other people. Cities and industrial centers “create” expensive real estate because of the efficiency and power of proximity, and investors balance out the higher cost of land by increasing density and building tall buildings. There are limits, however, as tall buildings are costly and too many of them cause traffic and congestion causing cities to limit the number that are built.
In the world of blockchain and digital ecosystems, some of these systems have scarcity driven by genuine constraints. Gas prices in Ethereum, for example, have been driven upward by the network’s limited transaction processing capacity. As layer 2 networks and roll-ups come to dominate Ethereum, there’s a good chance that gas prices (and the price of ether) could decline significantly as those constraints diminish.
What problem, however, does artificial scarcity, such as limiting the supply of virtual land, solve? Are we limiting virtual congestion? Do imaginary schools have too many students? Nothing of the sort, and because the scarcity involved here is arbitrary and artificial, I would argue that the value created is not the same. Buyers and investors cannot assume that virtual land prices will behave in the same way as real land prices do.
I’m not suggesting that artificial scarcity has no value. Exclusivity often creates some sense of value. Sometimes it’s a genuinely useful kind of value that comes from having a community of like-minded individuals who can work well together. Barriers to entry exclude amateurs and those who aren’t willing to contribute.
Second Life is a case in point. This virtual ecosystem has been around for more than a decade, and though the press hype has long since passed, the company has a dedicated fan and user base that has been buying and selling land and managing virtual social and business experiences consistently for the last decade. Second Life is very small compared to the big gaming ecosystems, but it is a reminder of the enduring strength of online communities.
What implications do these examples have for the booming NFT and virtual land ecosystems? First, scarcity must solve an actual problem and not simply exist for its own sake. Second, when the item in question isn’t genuinely scarce, its value proposition is a proxy for solving another problem: one of creating a community of like-minded members and providing some barrier to entry that signals commitment.
There are big differences between these two types of scarcity. A world-renowned soccer player can only wear one jersey while scoring a match-winning goal in a World Cup game. Those match-worn jerseys have genuine scarcity. For purely virtual items, the team can create an unlimited number of “limited edition” NFTs to celebrate different aspects of the match and sell them to fans. While a truly disciplined club could limit output, the temptation to fully monetize the fan base will never go away.
This reasoning has consequences for the kinds of scarcity-driven ecosystems that are most likely to succeed: very large numbers of small communities with modest asset prices, not small numbers of big communities with high prices.
It also means that the prices of artificially scarce assets are likely to behave in a way that is different from genuinely scarce assets. For truly scarce assets, prices are likely to be set by a market mechanism driven by the value of access. For artificially scarce assets, however, prices may be limited because there is an infinite supply of “scarce” assets available.
Let’s take a simple case example: imagine a world with about one million passionate gardeners. A virtual land system or NFT membership tokens that only support 100,000 members is likely to leave a lot of people on the outside. There is easily enough demand to send membership token prices quite high, but there are also enough people who care about gardening to support many more such communities, and since there are no real constraints on setting these up, it’s likely that we will, sooner or later, end up with many different gardening communities.
Everyone who cares enough to make even a modest investment is likely to find a place in one of these communities. And while some communities might end up being more exclusive than others, the range of choices and the simplicity of creating new communities will also function as a limiter on the upward price of most membership tokens. In a truly free market, if supply is infinite, the market clearing price is always zero.
It’s not quite that simple, however, because there are no genuine constraints on supply in the virtual universe. There will always be a blend of downward pressure on prices due to unlimited supply with upward pressure on prices due to the Veblen-good nature of access-limited memberships. (Veblen goods are those for which demand increases as the price rises.)
This brings me to a final problem: the end state of many different online communities built around NFTs or virtual land systems doesn’t appear to be very different from the way the internet functions now. We have millions of websites and online communities. Many of them use membership fees or other tools like participation metrics to sort and filter genuine contributors from lurkers and freeloaders. Do NFTs solve this problem better than any of these other methods? I’m not convinced they do.
Blockchains solve some very specific problems very well, such as handling transactions without a centralized intermediary and allocating and tracking scarce resources in a very efficient and transparent manner. Community membership, however, is about so much more than a transaction, and it is not, in most cases, a genuinely finite resource. And while there’s no reason to believe blockchain-based systems won’t work, they do not appear to be the best way found so far. And so, at least for myself, when it comes to land, I’ll be taking mine in real life, thank you very much.
The views reflected in this article are my own and do not necessarily reflect the views of the global EY organization or its member firms.