Path to Market Efficiency: How Non-Fungible Tokens Become More Fungible
For almost any non-fungible asset class, sellers are the price setters.
Take housing for example: a home buyer usually only gets to decide whether to turn down an offer or not. A home seller decides what’s for sale (provides liquidity), how much to sell it for (pricing), and what discount they can give.
A seller-dominated market is typical of non-fungible assets, and at an initial glance, NFTs seem to be no different. In an NFT market, sellers provide liquidity to marketplaces via listings and determine market prices by setting the floor.
However, despite the similarities, NFT sellers are on a different path to liquidity. They increasingly rely on buyer interest for instant liquidity, and their asks (floor prices) are no longer the sole indicator of collection value. Even though NFTs themselves are non-fungible assets, NFT trading is becoming more fungible than ever.
An Already Liquid Market (Around Floor)
The most straightforward evidence of NFT trading’s fungibility is the ever-growing demand for floor NFTs. Some have even gone so far as to argue that NFTs are just “altcoins with pictures.” Indeed, when we compare settlement prices against floor prices on OpenSea, we see that a pretty substantial chunk of the trades was done around floor prices.
This means that there is a pretty liquid market where floor NFTs are traded as if they are fungible. Popular collections including BAYC, Moonbirds, and Doodles also see more trades settled around floor prices as the collection matures. In some cases such as BAYC, daily floor and below-floor sales could account for over 50% of the collection’s transactions.
Granted, not every collection sees the same trend. Some collections like Azuki have relatively flat historical floor sales, as shown below. However, even though there are not many trades around the floor, the number of trades settled below the floor price is still growing.
This is an interesting phenomenon worth attention in itself. Floor price, by definition, is the best ask on the market. It is an indicator of what sellers think the lowest market equilibrium should be. Because the floor price changes whenever there is a new listing with a lower price, the only way for trades to settle below floor is for sellers to accept an existing bid that’s lower than floor.
For example, 10% of trades settled below floor prices means that 10% of all transactions are done where the seller proactively takes a discount to the market’s best ask. This usually happens when sellers want to liquidate their positions fast and thus pay a premium for the time they save by accepting an offer lower than floor prices.
From April 30, 2022 to Jan 15, 2023, around 30% to 45% of OpenSea sales across seven collections we track were settled below floor. In other words, at least 30% to 45% of trades are done where buyers made markets for sellers, instead of the other way around. This is not including sales for non-floor NFTs, where sellers can accept offers that are higher than floor prices.
The trend of trading below floor is also rising. For example, while 21.1% of all BAYC transactions settled below floor since the collection launched on April 30, 2021, the number jumped to 30.3% for all transactions since April 30, 2022. The same pattern is observed for other collections such as MAYC, Doodles, and Moonbirds, as shown in the charts above.
Why do more sellers become market takers over time? This could be partially due to the deteriorating market condition since the beginning of 2022. When the market turns south, NFT holders tend to liquidate their positions fast and thus accept higher discounts to floor.
It could also imply that the pricing dynamics between buyers and sellers shift during a collection’s life cycle. As mentioned before, nonfungible asset sellers are usually price setters because they have more insights into the market. This is especially true in markets such as housing or art, where the universe of assets is large and structural opacity creates huge information disparity between buyers and sellers, thus allowing sellers to continuously dictate pricing.
In NFT trading, however, such an information gap practically does not exist. All transaction and order book data is either on-chain or accessible via open marketplaces. Even though NFT holders, as initial liquidity providers, do have more say in pricing at collection launch, the liquidity advantage quickly disappears as the rest of the market catches up. The existence of open marketplaces also ensures that new buyers can enter the market with no barriers and provides the market with a sustainable stream of buyer interest. As such, NFT collections, especially blue chip ones, can have a pretty balanced two-sided market where liquidity flows from both ends. This differentiates NFTs from other non-fungible assets — it is a non-fungible asset with fungible trading features.
Long Way To Efficiency
Although the NFT market is getting more balanced, there are still many challenges before it can be truly efficient.
As the market equilibrium becomes less skewed toward sellers, floor prices also contain less signal and are no longer a good indicator of market sentiment. However, up until very recently, floor prices had been the only price-related metric that marketplaces displayed, making it difficult for traders to understand the market correctly.
Comparing settlement prices with floor prices, we see that there is a persisting spread between the two. Here, the “average sale price” is defined as the average settlement price of the bottom 5% of all trades. The “listing price” refers to the floor price. In the chart, Azuki’s Realized Floor consistently underperforms Listing Floor by a considerable margin. It is clear that floor prices alone do not reflect collections’ true market value.
However, the problem doesn’t end here. The spread between bids and asks can be further widened by the various fees that sellers have to pay. The NFT fee war is a much-discussed topic over the past few months, and it seems like a convergence will not happen very soon. On the one hand, you have collections and marketplaces blacklist those who do not honor royalties. On the other, marketplaces such as Sudoswap and Blur are racing to the zero-fee bottom.
This situation makes trading especially confusing for sellers. When setting the floor price, sellers usually have to take fees into consideration in order to make their trades worthwhile. For example, marketplaces like OpenSea charge sellers a 2.5% platform fee on all transactions, and on top of that, collections usually take additional royalty fees that can range anywhere between 2.5% and 10%. This creates huge market friction for market participants, especially for frequent traders who are more sensitive to fees. For less sophisticated sellers, high fees can sometimes completely turn them away from providing liquidity to the market.
The impact of fees is also reflected in the disparate floor prices that marketplaces show for the same collections. Fungible token exchanges usually give very tight quotes that only differ by a few cents. This is true for both centralized and decentralized exchanges. In NFTs, however, this spread is much wider. Because marketplaces all have different fee rules, their floor prices also differ and make price discovery challenging. The hefty fees also deter maker makers from arbitraging out the differences, thus leaving the price gap open.
Aggregators partially solve the problem by giving users a panoramic view of the market, but even this solution faces headwinds. Some new collections such as Sewer Pass banned marketplaces that do not honor royal fees, and OpenSea runs a blacklist that helps creators prevent certain marketplaces from trading their collections.
At its core, the fee war is a struggle between a nascent market wanting to become more efficient, and a new type of business (collections) seeking viable paths for monetization. Zero fees encourage market participation, which then results in competitive pricing and better price discovery. Meanwhile, charging royalties incentivizes creators to continuously contribute to the NFT market and ensure its long-term prosperity.
It is difficult to predict what the outcome of this struggle will be. However, one thing is for sure — NFTs are on an irreversible path to trading more like fungible tokens. Although the way forward is rocky, the market will eventually trend toward efficiency.
Acknowledgments: @karimhelmy, @hildobby_, @tomschmidt, @0xkofi. @0xDiplomat, @kadin256.
Special s/o to SPICYEST for their help and insights on understanding the NFT markets and data.
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Footnotes:
- Floor price data does not include Blur, but transaction data does.
- The comparison between Floor and Settlement prices is for OpenSea only. Meaning that both floor price and transaction data are from OpenSea. The results can differ when comparing floor to settlement prices globally
- Reservoir does not have complete historical floor price data, so part of the data is from SPICYEST API.
