El Salvador’s Bitcoin Law met with price crash, Sotheby’s NFT auction closes at $24.4 million
Fair NFT drops — is the future of nonfungibles centralized?
An in-depth look at NFT distribution models, their shortcomings and potential solutions
Bitcoin's bounce from $30,000 and Ethereum's London upgrade have both helped improve market sentiment, and while the wider cryptocurrency market remains roughly $900 billion below its recent market capitalization high, the hype surrounding nonfungible tokens has been returning much faster. Combined, the sector smashed its previous weekly trading volume high of $200 million by posting $340 million in the last week of July. Meanwhile, the price floors of Larva Labs' groundbreaking CryptoPunks and Ponderware's once-forgotten Mooncats collectibles have also been rising.
However, with NFT projects back in the limelight, so are gas wars. The way Ethereum fees work allows those willing to pay more to front-run others in order to acquire valuable collectibles. Scalpers — i.e., entities only interested in flipping NFTs on the secondary market — often end up paying exorbitant fees, making the experience painfully frustrating for community members interested in the project.
For instance, in one of the more recent NFT drops, The Vogu Collective, some of the top minting transactions paid fees of over 4 ETH, or roughly $10,000 at the time — not uncommon for popular projects. Naturally, such a mechanism prices out a lot of genuine community members, and we've seen projects attempt various distribution models to make drops fairer.
As a result, projects invariably find themselves needing to implement some level of centralization to avoid free-for-all minting frenzies and to ensure a wider distribution of assets. In this OKEx Insights article, we discuss the reasons for centralized solutions, as well as pros and cons of such an approach. We then look at the example of Parallel, a science fiction-inspired digital trading card game that recently had a successful drop using such a hybrid model.
Crypto's decentralized distribution problem
Although fully decentralized systems often demonstrate robust security — in that they lack a central point of failure — the absence of a central authority can result in other, less desirable properties. Take, for example, a crypto asset's initial distribution. With subsequent digital currencies often borrowing Bitcoin's completely fixed total supply, the question arises time and time again: Who decides who receives assets when there aren't enough to go around?
Satoshi Nakamoto's solution was to design a competition that anyone could enter by deploying computing resources to support the network. To use human discretion when distributing BTC would have unfairly advantaged the selected recipients.
Many of the crypto assets created since — particularly those not native to a network or integral to its consensus mechanism — have not followed such an altruistic distribution schedule. Initial coin offerings, for example, typically involve the sale of a fixed supply of premined assets. When an ICO opens, investors rush in to buy tokens, with those organizing the sale selecting how much of the supply to award to themselves, to other parts of their planned ecosystem and to the sale itself.
With ICOs and similar methods, fundraising is often more important than ensuring wider asset distribution. As long as the organizers raise enough to fund their vision, it doesn't necessarily matter to them if 1,000 well-capitalized investors contributed the entire total raised or if there were 100,000 smaller backers.
More recently, following regulatory clampdowns on ICOs, initial distribution models have gone in two directions. Those requiring funding have typically held private sales to preapproved investors who later have the opportunity to sell their holdings at much higher prices.
Meanwhile, projects like Uniswap have taken an arguably fairer approach and airdropped tokens to their product's users. While this creates a wider distribution and sees tokens end up in the hands of users that have supported a particular platform, it doesn't always guarantee development funding.
These same issues surface when we look at nonfungible tokens and pose even more serious problems — given the limited number of collectibles on offer and often very high demand.
NFTs — different assets, same issues
The emergence of new blockchain use cases reinforces the shortcomings of many of the existing token-distribution models. Around 2017, tokens representing ownership of digital items started to appear, and NFT projects like CryptoPunks operated a first-come, first-served model similar to most ICOs. Taking part in the distribution was entirely free, with users only needing to pay Ethereum transaction fees to claim the nonfungible tokens. This model inevitably resulted in a highly skewed ownership distribution. Indeed, many of the top Punk owners still hold hundreds of the pixel-art portraits — despite the massive price increases that now see the so-called "floor Punks" trading for almost $85,000.
Dapper Labs' launch of the early GameFi title CryptoKitties in the same year highlighted a different problem, which would increasingly plague subsequent NFT projects as the sector's popularity rose. With estimates claiming around 800 ICOs took place in 2017 and the ETH price having risen from around $8 in January 2017 to its then all-time high of nearly $1,500 at the beginning of 2018, congestion on the blockchain was already at an unprecedented level. The overnight-hit digital cat-breeding game further increased demand for finite Ethereum block space in December 2017, leading to major transaction delays and a spike in the overall cost to use the network.
Minting an NFT with a transaction that commits a record of ownership to the blockchain is more computationally intensive than a standard ETH transfer. Meanwhile, the amount of computation the network can process is limited by the block gas limit. When this limit is reached, the network prioritizes those users who are willing to pay more. This incentivizes those requiring the fastest transaction processing to include a higher gas price. When competing for a finite number of potentially valuable NFTs, gas prices can suddenly spike, pricing out many would-be buyers.
As the niche's popularity grew, particularly during 2021, the success of those NFT projects mentioned above inspired many others. With more NFT launches competing for block space against not only an expanding decentralized finance sub-industry but also those speculating on rising ETH prices, the cost to transact on Ethereum quickly grew. As a result, all but the wealthiest were excluded from buying NFTs during the most-hyped launches.
Unfortunately, those including smaller gas payments would still have to pay the network for their failed transactions but would not receive the digital artwork, collectible or in-game item they wanted to claim. Perfectly illustrating this was the sale of actor Mila Kunis's Stoner Cats animated NFT series on July 27 of this year. The collection sold out within just 35 minutes but also saw failed transactions rack up $790,000 in gas fees. Such a system that favors those with the most capital and that effectively creates an advantaged elite is hardly consistent with crypto's overall democratizing vision. Potential solutions, however, are not without irony either.
A centralized approach for fairness
For the creator of an NFT series, such a rush leading to gas price spikes is quite the affirmation of their project's success. The fact that people are willing to pay sometimes astronomical prices, not only for the asset itself but to the network to ensure that they receive said asset, clearly demonstrates a project's popularity — or at least the speculator's belief that they can later sell their NFT for a profit. Indeed, with artwork or simple collectibles, the value itself comes from the fact that not many people can own a piece that is finite in supply.
However, for other projects, wider distribution is favorable. Take, for example, the sci-fi-based trading card game Parallel. For a trading card game to be a true success, it needs a substantial player base. As per Metcalfe's Law, such games benefit from userbase growth, just like any other network. Consider the enjoyment you would personally get out of a game that you could play against all of your friends, instead of always against the same single opponent or even just a handful of them.
Thanks in large measure to its marketing efforts and the investment from YouTube cofounder Chad Hurley, Parallel captured significant interest between its March collectible NFT presale and its first official drop at the end of July. With well-followed Twitter accounts promoting the upcoming sale, the game was already trending on NFT marketplace OpenSea before any playable cards went up for sale. Evidently, there were going to be many hopeful buyers on July 31.
If the team behind Parallel opted to either auction packs or sell them on a first-come, first-served basis, the result would have been similar to other NFT launches. Those with access to the most capital could bid up the gas prices or the items themselves to ensure they received the number of packs they wanted.
To help promote the wider distribution required to encourage the network effects needed for a truly popular game, Parallel introduced various centralized features to its presale. Firstly, it operated a registration system. As an OKEx Insights team member (who took part in the sale but had no role in the writing or editing of this article) recalls, users wanting to participate signed up for an account using their email address before the sale. At the time of the sale, buyers logged in via a link posted to the official Twitter account and requested the packs they wanted to buy.
The packs themselves come in three tiers: Premium, Enhanced and Core. To create the scarcity that NFT collectors and traders find attractive in a project, Parallel limited the quantity of each tier and included rarer cards in the upper tiers. However, to help promote the wider distribution required for a successful game, users could only buy three packs from each tier at any one time. Every five minutes, the limitations on each account were lifted, allowing buyers to pick up three additional packs from each tier again. This dynamic continued until no packs remained.
Moreover, this process reserved packs off-chain for users who were later sent a link to complete payments. Cards reserved but not paid for were returned to the pool and became available to other buyers. Parallel itself minted the NFTs behind the scenes and distributed them to their new owners.
The effect of this was twofold. Firstly, it mitigated the influence of market whales and bots programmed to buy up packs during the sale. Regardless of how much a well-capitalized market player wanted to buy a dominant share of the Parallel drop, they simply couldn't. This enabled more players to participate, encouraging a wider distribution of the assets.
OpenSea shows there to be more than 5,000 holders of the available assets. Given that there were a total of 13,813 packs dropped — each priced between 0.01 and 0.2 ETH — under the traditional, decentralized distribution model, any one of the top 10,000 accounts holding the largest ETH balances could afford to spend the almost 550 ETH required to buy the entire drop with change to spare. There being a single owner of the entire collection, however, would have immediately killed any of the Parallel team's future gameplay aspirations.
The second impact of this more centralized distribution model was that it enabled Parallel to charge a fixed gas rate for minting. Rather than having all prospective buyers attempt to mint their NFTs simultaneously, Parallel instead staggered the process. As a result, no user overpaid for gas, and, unlike the Stoner Cats drop, buyers did not waste hundreds of thousands of dollars trying to participate in the sale.
Will the NFT revolution be centralized?
Those participating in the Parallel drop have since commended the collective for organizing what one Twitter user described as the "best drop mechanic" they had witnessed. The lack of a gas price spike on July 31 meant that the sale did not greatly interfere with the transactions of non-participating Ethereum users on the network. Additionally, the generally positive sentiment of participants in the Parallel drop shows that the community found this model preferable to the free-for-all launches of other projects.
However, this hybrid model does require all participants to trust the team behind it. A typical NFT release sees users, themselves, interact with a transparent smart contract. In Parallel's case, the team took care of minting the assets on behalf of buyers. Therefore, the team had a clear opportunity to simply take payment for packs but never mint or issue them.
Similar issues arise when it comes to assigning assets to an individual account. For example, it is unclear whether the team used a proven, audited random number generator or if they assigned assets to specific wallet addresses using some other method. Again, buyers had to trust that assets were assigned fairly.
While the level of the project's transparency and the ease of its accessibility may not compare to a completely decentralized, on-chain distribution model, to the best of our knowledge, there have been no complaints about Parallel abusing this trust by selecting wallets to receive rarer NFTs. Similarly, the immediate secondary market activity proves that the collective did indeed issue the assets as promised.
Yet, given the warm reception of the distribution model, it seems likely that other projects will also adopt similar methods for their own launches. In an industry that is no stranger to overt scams, it is entirely possible that any of those choosing to copy the launch could eventually defraud their users in the same way that scams became a fixture of the ICO boom in late 2017 or, more recently, of the decentralized finance industry.
However, it is worth pointing out that these kinds of NFT projects are somewhat centralized by their very definition. There is a central team entrusted to honor the scarcities that they created. For example, Dapper Labs, the company behind both CryptoKitties and NBA Top Shot, could suddenly decide to issue 10x the supply of the rarest NBA moments, crashing the price of those already in existence. Similarly, those buying plots of land in the presales of virtual worlds like Decentraland, or Axies in the GameFi title Axie Infinity, relied on developers' efforts to build the world required to give said land any future utility. While it is in the companies' interests to honor their commitments to buyers, the fact remains that the future value of many NFTs depends on a central authority's later actions.
Given that many of the current issues with digital asset distribution exist irrespective of whether a buyer interacts with a smart contract themselves or a company does so on their behalf, Parallel's launch is commendable. Thousands participated in the sale on July 31 with essentially zero impact on network fees. Those ready to buy on the day could do so without risking paying extortionate gas fees and receiving nothing in return. Therefore, it seems likely that other projects will adopt a similarly central role in future releases — particularly when a wide distribution is integral to the idea's future success.
OKEx Insights presents market analyses, in-depth features, original research & curated news from crypto professionals.