Intrinsic Value for Digital Content & the Perpetual Price Floor Liquidity Mechanism
Intrinsic Value for Digital Content & the Perpetual Price Floor Liquidity Mechanism By Carlo Acutis
NFTs are a new form of digital network, where valuation is directly tied to network security, decentralization, and scalability. Let us consider the unique value proposition of an NFT marketplace where intrinsic value & earnings become a fundamental aspect of the platform, which is transparent to all users, and the unique economic properties of NFTs.
Sudoswap introduced the idea of liquidity pools for its NFTs so that there is always a liquid price floor. Elixir and others innovated on this idea so that the liquidity pools were not fragmented amongst different individual NFTs. NFTX allowed the launch of NFT-backed ERC20 tokens. Other protocols like Caviar experimented with NFT lending features. These are all important experimentations in the NFTfi sector that have impacted the evolution of NFTs. The perpetual price floor liquidity model utilizes a unique reserve backing mechanism that allows it to provide a combination of collection LP pooling, lending, and tokenization through one smart contract system.
Contrary to the idea that royalties are unimportant, royalties are actually the driving force of the NFT ecosystem, because they constitute earnings for the network. Earnings are a traditional valuation metric which allows us to assess the productivity and sustainability of a business. Royalties allow for a sustainable stream of income for creators, and serve to increase intrinsic value for buyers, sellers, & holders of an NFT collection. We will show how the latter is possible:
The Problem: The central problem in the digital asset economy is threefold:
1) Liquidity
2) Intrinsic Value
3) Foundations of Digital Economics & Culture
While the first is the most immediate problem, it is derived from the latter two, which are more of the intermediate and long-term problem.
We address these issues through two fundamental innovations in NFT market function:
Price floor liquidity mechanism
Content reserve model
The price floor liquidity mechanism is a smart contract functionality, which guarantees intrinsic value backing the floor price of each NFT. It takes a certain percentage of the mint price and locks it into a reserve. An NFT that is bought at a certain mint price can be redeemed by the holder of that NFT. This allows for there to be perpetual liquidity at the price floor.
And then the list price or the sale price can be understood as a certain multiple of the reserve backing. And this allows for a metric that is akin to a price to earnings valuation that is common in legacy finance. It is an imperfect but useful analogy, that gives a level of security to investors & allows them to calculate their risk more easily.
The content reserve model is a broader conceptual digital economics framework that allows us to think of content as a savings account.
Liquidity:
A central problem in web3 is the lack of capital liquidity. By this we mean the availability of capital in protocols, and the opportunity costs of allocating capital between different networks. Liquidity provides functions of market making and lowers bid-offer spreads. This is a problem for both DeFi and NFT marketplaces.
The Price Floor Liquidity (PFL) model addresses this by providing a reserve-backed treasury for digital assets.
When a digital object is purchased at the floor price, the money from that purchase goes directly into a reserve-backed treasury, which maintains backing for the NFT at the floor price. The buyer can redeem his NFT for the floor price amount, at any time, through an auto-redeem smart contract.
For example, if I am a collector, I can mint 10 NFTs at 1 $ETH each, from a collection. The 10 $ETH is deposited into the treasury wallet for that collection. The NFTs that I purchased are redeemable for that exact amount, 1 $ETH each. There is a kind of guarantee on the purchase.
This prevents the price of the NFTs from ever falling below the floor price on the free market. Rather than list the NFT, the buyer could just choose to auto-redeem his NFTs from the reserve-backed treasury.
This mechanism ensures against rugs, deception, or scams, building trust for collections. It keeps all parties in an NFT community aligned in their incentives and goals. It gives investors a guarantee that helps ensure the long-term health of each NFT community.
Intrinsic Value & Earnings:
The reserve-backed treasury feature allows for NFTs with *intrinsic value,* familiar to traditional investors and asset markets. Intrinsic value is a concept coined by the finance professor Benjamin Graham, and made famous by his student, the investor Warren Buffet.
It refers to the discrepancy between the actual value of the asset and the market price of that asset. Conventionally this has been calculated using the price to earnings ratio, price to book, or similar metrics.
However, the concept of intrinsic value as imagined by Graham and Buffet was never really reducible to a simple one-shot calculation or metric, but relied on a holistic understanding of the business / investment / asset. In digital assets, particularly layer 1’s, the concept of earnings is usually taken to refer to the transaction fees, which accrue to miners or validators. There is a direct analogy from layer 1 earnings to NFT projects:
In the world of NFTs, the analog of transaction fees is royalties. If we strip away all other utility & technological aspects, the way that NFT collections earn money is through royalties. An ideal NFT collection creates its own market that matches buyers & sellers. This capacity to match buyers & sellers is what grows the network and makes the community more valuable for everyone who participates. Popular NFT collections can collect large amounts in royalties. The NFT collection earns an amount of royalties corresponding to its capacity to form a sustainable community, and healthy, growing digital network of participants in its ecosystem. With the Price Floor Liquidity model, there is no reason that the NFT’s price would be listed below the reserve backing, but it could very well be that an NFT is listed above the reserve backing. The standard practice in NFTs now is that almost no collections have any reserve backing. And so any NFTs that do trade in the current market, almost all trade on secondary markets far above their reserve backing of 0.
The reserve-backed treasury allows for the NFTs to accrue an intrinsic value above their initial purchase price, through royalties.
Here is an example of how royalties can function as earnings, or intrinsic value:
An NFT is purchased for 1 $ETH,
That 1 $ETH goes into the reserve-backed treasury,
The NFT is then listed for 2 $ETH on the secondary market & sold at that price,
The royalty earnings for that collection are set to 10%,
So 0.2 $ETH (10% x 2 $ETH) from that sale goes to the treasury,
Now the treasury has 1.2 $ETH.
And that NFT has a “backing / price ratio” of 1.2 / 2 (or 60% backed).
With the PFL, the creator of the collection can choose how to allocate those royalty earnings.
He may choose to take the full royalty earnings amount (0.2 in the prior example) as profit for himself,
Or he could choose to allocate the royalty earnings all into the reserve backing,
Or any ratio blending between the two.
In the case that he allocated all royalties into the reserve backing, the NFT that was purchased for 2 $ETH would now have a auto-redeemable reserve backing of 1.2 $ETH, after any lockup period expires.
This allows the purchaser of the NFT to measure his risk. If he buys at 2 $ETH, but he knows he can always redeem it at 1.2 $ETH, then he knows that he can at most lose 0.8 $ETH, or 40% of the investment. Compare this to someone today who buys an NFT for 2 $ETH from an unbacked collection. They know that at most they could lose 100% of their investment.
This then allows us to have a dashboard which shows the exact price to backing ratio for each asset, the exact risk / reward for that asset, and also shows the total royalty earnings for that collection.
Foundations of Creator Economy:
Why is the meme of *intrinsic value* important for digital assets? The opponents of digital assets have always argued that they have no intrinsic value. And the advocates of digital assets have never really contested this narrative. The argument that digital assets lack intrinsic value is considered valid by many conventional investors and even by many digital asset advocates themselves, who do not understand intrinsic value in digital networks.
The same narrative about the lack of intrinsic value was wielded against software companies in the early days of the internet. Often this narrative turned out to be true, especially in the dot com bubble of the early 00’s. The same can was said about the crypto bubble of ‘20-‘21. Many of the projects indeed had little intrinsic value.
However, nowadays we no longer hear any Wall St. investors complaining that large internet companies like Google or Facebook have no intrinsic value. Just as internet companies turned out to have significant economic value, despite their perceived lack of intrinsic value, so we believe digital assets will also turn out to have significant economic value despite their current perceived lack of intrinsic value.
The reason that the notion of intrinsic value never gained traction with internet companies or with digital assets is that intrinsic value operates in an entirely different manner in digital networks, than it does in a conventional corporate or industrial business. As we indicated before, intrinsic value in digital networks refers to transaction costs — the ability to match buyers & sellers, and to cultivate an ecosystem or community of participation.
To answer the question we posed initially, narratives & memes play an essential role in driving digital asset markets, because content is the product. But content & memes are not useful for anything outside of itself, whereas money is. So it is still unclear why anyone would pay money for something that has no use outside of itself.
In a corporate or industrial economy, the value comes from a physical good, or a tangible service. The good or service ostensibly is useful because it allows you do something else with it. Since it has some usefulness, there is a supply of goods or services that meets a demand for those goods or services.
But as we see in digital networks, the value does not come from a usefulness, it comes from being the foundational value layer. The usefulness or value comes from its ability to give value or usefulness to all other things. Our inability to see any intrinsic value in digital networks comes from our inability to see anything outside of supply & demand. However, content is outside of supply & demand.
The fact that the content is the product is not new – this is how web2 works as well. However, the situation has inverted. In the world of web2 – “the content is the product” means that advertising is the product – think of digital marketers paying for google, youtube, facebook ads, and all of the extremely annoying ads and copywriting that gets spammed to your e-mail. Google and Facebook make almost all of their revenue from an advertising revenue model.
Whereas in the world of web3 – “content is the product” means that open-source code & narrative is the product. There is a big difference:
In digital assets, what you pay for is the design & the architecture of the system. When you own a digital asset that is what you own. And you pay for the memetic narrative that explains the mechanisms & incentives of this open source code. In other words, when you pay for a digital asset, you pay to own a piece of the knowledge that coordinates & aligns the motivations of many persons. That is their intrinsic value — the knowledge itself, which gives value to other things.
Code reflects the truth about the system as a whole. In digital assets, the most revenue does not accrue to the projects with the best advertising & marketing – Rather it accrues to the projects whose code & narratives most accurately reflect reality, and provide the best incentives & coordination structures. The projects that reflect the most basic foundations.
In a market where content is the product itself, there are only two options, either:
Content is less valuable than the money used to pay for it,
Content is more valuable than the money used to pay for it,
Content is able to coordinate & incentivize human activity better than the price themselves do. But that is precisely what digital assets represent, and what they are — they are a form of knowledge that people value more than money.
The fact that digital asset markets exist, means that there is content that can coordinate, motivate, & inspire human activity better than the price mechanism does. It means that there is a form of content that is more valuable than price. The form of content that is able to inspire & motivate people to an activity that is greater than mere profit – is the activity of governance, or virtue.
And that is why governance is such a central, if deeply neglected, aspect of digital assets.
Remember, there are only two options: either:
Content is more valuable than its price,
Or content is less valuable than its price.
The relation between the price of the content and the value of content, Is analogous to the relation between the appearances and the reality of the content. Content that has a high price doesn’t tell us anything about the truthfulness of that content.
The way to understand the truthfulness of the content is by the value that backs the content, which shows how much people are actually invested in it, or how much they actually believe in it, how much conviction they actually have.
This is expressed in the relation between the risk-free value of the content (backing) and the market price of the content (price). Intrinsic value in digital assets is more than an investment concept, as it is in traditional finance. The notion of intrinsic value in digital assets refers to the truthfulness of the content, or its capacity to allow appearances to correspond with reality. That shows how truthful content can contain an inherently self-organizing element within itself, over and above market prices.
Thus, the backing / price ratio allows us to see exactly how much more *valuable* the content is than its price, or the inverse, to what degree appearances exceed the reality. This allows for a new concept of economics & finance, where the main focus is on the interconnected, harmonized truthfulness of content narratives, as the primary driver, indeed almost entirely independent of, prices or profit motives.
And this motivates a highly long-term investment and careful analysis of content rather than schitzoidal, mind-shattering nonsense of an advertising-driven economy. The reserve backing element can only get larger if people are willing to risk capital in order to express certainty & conviction in the underlying value of the content. But this is a quantifiable, calculated risk, where the investor knows his downside. The content is ultimately the foundational value – it is what backs the underlying value of the whole monetary system –
We well know the old maxim, becoming ever more relevant today, “appearances can be deceiving.” It would be good to have an economic system & a culture where appearances do reflect reality, where prices do reflect value.
The backing / price mechanism has very much the same incentive structure as quadratic voting, by having a decreasing incentive to monopolize the vote. Instead the harmonization of motives happens through the higher modes of conversation, rather than by mere price or quantities. And what is content? Content is a reflection of organic human actions, in the real world. In this way, the price floor liquidity mechanism is just a reflection of a deeper economic reality —
Price reflects value
In the same way that
appearances reflect reality
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