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NFT Institutional investment OKEx Insights GameFi Metaverse

NFT avatars — the future of online interaction or a bubble ready to burst?

2021.08.24 Rick Delaney

An in-depth look at the rise of profile-picture NFTs, their value beyond speculation and the risks they pose to investors.

NFT profile avatars

Despite a brief period of waning interest as cryptocurrency prices pulled back from all-time highs set earlier this year, the nonfungible token market is red hot. Digital artists, musicians and game developers are rapidly reimagining the relationship between creators and consumers using NFTs. Although the sector is increasingly varied, one niche finds itself at the center of this renewed wave of interest: profile-picture NFTs. 

Inspired by the success of the historically significant CryptoPunks and the niche's second major mover, Bored Ape Yacht Club, hundreds of new NFT collections have launched over recent weeks. Although fans and speculators routinely rush to mint almost every new NFT project, few sets achieve the kind of success of those elite-tier collections. 

In this OKEx Insights in-depth look at profile-picture NFTs, we consider what makes those projects routinely topping the charts on popular marketplaces special among an ocean of others. We begin by looking at how the current mania has developed before we then expand into newer projects. 

On the surface, a profile picture — or PFP, for short — of a cartoon animal or pixelated character doesn't seem all that revolutionary. However, with strong communities forming around projects, NFTs increasingly finding functionality in shared online virtual worlds and efforts beyond those of the niche's original innovators quickly assuming elite-tier status, speculators looking for the next CryptoPunks have driven prices skyward. 

Although the rarest PFP NFTs continue to see huge secondary-market sales, the rapid ascent of some of the most recently launched projects brings the market's sustainability into question. The craze certainly has the hallmarks of a rapidly expanding bubble. Yet, with fresh ideas, growing utility and strengthening communities, we may be witnessing the emergence of an entirely new artistic and social medium. 

The rise and rise of NFTs

The origins of PFP NFTs can be traced back almost as far as NFTs themselves. Launched in 2017, Larva Labs' CryptoPunks was among the first projects to leverage blockchain technology to enable ownership of digital items — in this case, pixelated portraits of generative art characters. Yet, the 10,000 digital mugshots comprising the collection were never marketed as social media avatars. That occurred naturally, for reasons we discuss later in this article. 

For much of its existence, CryptoPunks was either dismissed as a novelty or simply flew under the radar of all but those closest to the cryptocurrency industry and its emerging digital art sector. Indeed, despite a few alien Punks fetching more than $1,000 shortly after launch, it was not even the first smash hit NFT project. 

That honor lies with the blockchain-based digital cat breeding and trading game CryptoKitties by Dapper Labs. Kicking off its own brief speculative mania were multiple six-figure cat sales at the height of the 2017 crypto price bubble. Indeed, the game proved so popular that it caused Ethereum usage to spike, leading to long transaction delays for network users. 

During the bear market years that followed, CryptoPunks continued to change hands and other NFT projects were launched. However, with only the most committed eyes on the cryptocurrency industry and even fewer looking at NFTs, the sector inspired little excitement.

That all changed toward the end of 2020. During the summer months — a period known within the industry as DeFi summer — many of those involved with cryptocurrency realized enormous profits from investing in and using cutting-edge decentralized financial applications like Compound, Yearn Finance and others. At around the same time, CryptoPunks started selling for increasingly higher prices. 

In correspondence for an earlier OKEx Insights piece, the cofounder of Nonfungible.com, Gauthier Zuppinger, explained DeFi summer's impact on the NFT market: 

"It somehow acted like a money printer on the Ethereum blockchain and a lot of people became millionaires within a few weeks. Most of this revenue was stored in not-so-famous cryptocurrencies or DeFi tokens, so the best way to reinvest this money and ensure it to be profitable long-term was to convert this money into other crypto assets. NFTs are definitely among the assets targeted by what the industry calls 'DeFi Degens.'" 

Figures from NFT data provider CryptoSlam.io support Zuppinger's view. September 2020 was the first time CryptoPunk's monthly trading volume exceeded $1 million and — other than in November of that year — the project has seen seven-figure volumes each month since. 

Rising CryptoPunk prices coincided with other NFT developments that brought greater mainstream attention to the sector. In October 2020, Dapper Labs, the company behind CryptoKitties, released NBA Top Shot to the public. The fully licensed product appealed to a wider user base than typical for blockchain applications and daily trading volume quickly rose above $1 million during February 2021.  

At around the same time, NFTs representing ownership of artwork in a more traditional sense started to attract attention. On Nov. 29, 2020, digital art collector and NFT enthusiast Kang paid about $45,000 in ETH for an NFT linked to a piece by crypto artist Pak, titled "Moebius Knot." An early ETH investor, Kang later paid more than $777,000 for a work by the now iconic digital artist Mike Winklemann, more commonly known as Beeple. 

Beeple went on to become the darling of the crypto art movement, selling his "Everydays: the First 5,000 Days" piece for almost $70 million at a Christie's auction in March — the first NFT sale held by a traditional auction house. Christie's would go on to auction nine CryptoPunks on May 11 for a combined total of almost $17 million, further strengthening the appeal of the pixel portraits. 

Fueling this first wave of speculation was a change made by the popular NFT marketplace OpenSea. In late December 2020, the platform introduced "lazy minting" — passing the cost of creating an NFT onto the buyer. Previously, the creator was responsible for paying the Ethereum network fees required to mint an NFT. With the cost of production now essentially zero, huge numbers of CryptoPunks-inspired collectibles began to appear, attracting speculators hoping to repeat the success of those early Punk buyers. 

OpenSea's "lazy minting" lowered the financial barrier to entry for creators, helping to fuel NFT speculation. Source: Nonfungible

As the wider digital currency market cooled in late May and prices of almost all cryptos plummeted, many declared the NFT bubble over. However, galvanized by celebrity interest, the sector recovered much faster than cryptocurrency prices, with sales rising into July. Catalyzing this renewed interest was multi-platinum rap star and entrepreneur JAY-Z changing his Twitter profile picture to an image of CryptoPunk #6095 in late June — weeks ahead of his own debut NFT sale hosted by Sotheby's auction house. 

Several notable CryptoPunk sales took place toward the end of July and into August. On July 30, entrepreneur and NFT enthusiast Gary Vaynerchuk spent $3.76 million on Punk #2140. That evening, a pseudonymous investor, known only as 0x650d on Twitter, bought 88 CryptoPunks for around $7 million. Some speculated that the mystery buyer was cryptocurrency hedge fund Three Arrows Capital. However, it was later revealed that the fund had, in fact, bought 10 Punks, including zombie #6649, for $2 million. 

Seven of the top 10 CryptoPunk sales occurred at the end of July and the beginning of August. Source: Larva Labs

Bored Apes validate second and third mover avatars

As mentioned, CryptoPunks were not intended for use as social media avatars. However, as early as late June 2017, some owners had switched their profile pictures to an image of their Punk. The cryptocurrency industry's roots in the cypherpunk movement and its penchant for anonymity made the portraits a fitting choice for those closest to an industry that was still a long way from mainstream acceptance. Later buyers also started to represent themselves using their CryptoPunks. Some even formed their online identity around their Punk, with notable examples including pseudonymous Twitter users @beaniemaxi and @punk4156.   

As the NFT market started to heat up in 2020 and 2021, using a Punk as an avatar had already become increasingly common among owners. With NFTs as profile pictures an established concept, many of the projects that emerged during the beginnings of the first major speculative period hoped to capture similar enthusiasm. Some collections launched straight to OpenSea, like CyberKongz and Bastard Gan Punks, and enjoyed relative success. 

Yet, most failed to take off. Meanwhile, projects with the Web 3.0 functionality required to mint directly from their websites had taken to pricing their NFTs using a bonding curve. When minting projects like Meebits or Pixls, earlier buyers got a better price than latecomers — the idea being that the market itself would determine the eventual supply cap of the collection. 

Taking an entirely different approach in terms of both art style and pricing was the Bored Ape Yacht Club. BAYC employed a fixed-price mint with no bonding curve. All members paid 0.08 ETH for their Ape on the primary market, regardless of their mint number within the 10,000.  

In a documentary about BAYC by The Defiant, its pseudonymous creators Gordon Goner and Gargamel describe their desire to create a members-only internet sketch pad. While discussing the idea of a fine art NFT granting access to an elite online drawing club, it dawned on them that the community would likely fill the canvas with the kind of graffiti found in dive-bar bathrooms. With fine art an ill fit, they decided that the perfect club members would be crypto degenerates. It being an Ethereum project and "to ape" being prominent in the space's vernacular, apes became their NFT's subject matter. 

BAYC launched quietly on April 23 with very little artwork and no images of the finished NFTs. During the first week, around 200 were minted. Then, the art dropped, and the remaining 9,800 sold out within around 12 hours. 

Bored Ape Yacht Club's art style broke from the PFP NFT pixelated trend established by CryptoPunks. Source: OpenSea

BAYC quickly found a strong following after influential NFT traders rushed to mint the collection — one such investor, known as Pranksy, claims to have personally minted 250 BAYC NFTs. 

Data from NFT-Stats.com show that by May 20, 2021, the average BAYC sale price was $1,555. By June 5, the project was already ranked number one in weekly NFT trading volume with an average price of $4,550 when NBA Rookie of the Year LaMelo Ball joined the club. 

The average price continued to rise through July. Before 3AC started buying PFP NFTs, it was around $18,320. By Aug. 11, it had passed $88,000 — coinciding with Christie's Hong Kong revealing plans to hold an online-only auction for PFP NFTs. Included at the September "With No Time Like Present" sale alongside CryptoPunks and Larva Labs's second project, Meebits, will be the Bored Ape Yacht Club. 

Laura Shao, an Associate Specialist in 20th and 21st Century Art for Christie's Asia Pacific told OKEx Insights about the decision to include BAYC in the upcoming sale: 

"One of the very special features about BAYC is its roadmap and strong sense of community — ape owners are eligible for a series of perks and exclusive benefits from time to time. Another reason why BAYC appeals to collectors is its distinct visual and aesthetics — instead of previous avatar projects that are often in low-res style, BAYC have a unique comic style and detailed traits. When you click into their website it almost feels like you are in a well-executed video game — you are in a club 'aping' with others from the community." 

With BAYC demonstrating the market's hunger for other high-value PFP NFTs, several avatar projects have seen similar, albeit less impressive, price rises. Those of note include Pudgy Penguins, Gutter Cat Gang, World of Women and CyberKongz.

The substance behind the PFP hype

Individuals paying $469,000 for a picture of a cartoon penguin on the same day the New York Times published a story on Pudgy Penguins certainly gives off bubble vibes. Yet, price bubbles often form around disruptive technology. Consider the internet and the boom-and-bust cycles of the cryptocurrency markets and the niches within them, for example. 

Evidently, there is a lot of pure speculation going on in the PFP NFT market at the moment. However, something more profound may be occurring alongside it. 

Digital status symbols

The first NFT project to be adopted as social media avatars was CryptoPunks. Even before the massive sales that the collection has become known for, displaying a Punk as a PFP carried with it a certain degree of status. It signified that the bearer was involved at the cutting-edge of Ethereum development at a time when the overall industry was much less closely followed. 

Stating that "a CryptoPunks profile pic screams crypto OG," Twitter user @CryptoPunkist highlighted this notion in January 2020, following NBA star Spencer Dinwiddie tokenizing his playing contract on the Ethereum blockchain. It is not clear whether Dinwiddie followed the advice, yet CryptoPunks' increasing prices since demonstrate the widening appeal of Punks as a form of digital status symbol. 

To own a Punk today, one has to be rich or a crypto OG — or, given price appreciation over the years since Larva Labs launched the collection, both. As BAYC and Pudgy Penguins NFT prices increase, these PFP projects also provide an opportunity to telegraph one's financial status. 

From a Rolex watch to a flashy car, humans use all manner of items to signify their status in the physical world. Indeed, while an obscure band t-shirt might not carry the same financial cost as a luxury yacht, the rationale behind wearing one stems from a similar desire to signal to one's social peers. Just as CryptoPunks PFPs enable their bearers to display deep knowledge of a subject or simply wealth, so too do these physical status symbols.

Commenting on people's need to project their status, in a 2019 essay, Eugene Wei — a former product advisor at Amazon and Oculus — went as far as to describe humans as "status-seeking monkeys." It is, therefore, unsurprising that those who spend increasing amounts of time interacting online would also want to signal their status to others.    

Digital artist and BAYC member Digitmental commented on the growing popularity of PFP NFTs as status symbols in comments to OKEx Insights: 

"People have been collecting things for ages which in real life were also granting them certain status. It’s very similar to NFT avatars. People want cool and shiny things, and they want new things all the time. They want to belong to certain groups, communities and identify with them. That's why there are so many successful projects around even with not a very average quality. Nowadays these avatars seem to be much more than just your new profile picture. They grant access to wider horizons which we are not even experiencing yet." 

Community tokens

Related to the idea of PFP NFTs as status symbols is the community that forms around such projects. One of the features common across PFP NFTs is their generative artwork. The model, employed in CryptoPunks and used by other projects, is to create around 10,000 characters based on a simple template. Each character has 10 traits — such as hairstyle and accessories — and each trait has 10 variables. Not only does this create scarcity within the set, making some pieces more sought after than others, but it gives a collection a unified feel. 

Communities have historically formed around cryptocurrencies, with members bonding over a shared desire to promote the project — take, for example, the so-called Link Marines of Chainlink. However, PFP NFTs give an even stronger sense of community. In much the same way that wearing your team's colors or dressing in a certain style signifies informal membership of a societal subgroup in the physical world, a BAYC or Guttercat Gang avatar immediately demonstrates affiliation with those communities. 

Although Larva Labs did not necessarily nurture a CryptoPunks community, many subsequent projects have embraced the idea of a PFP NFT serving as a sort of online club membership card. With BAYC, for example, members receive various exclusive perks, such as the ability to draw on the clubhouse bathroom sketchpad. Also, only proven BAYC holders can join the Discord server in which club members pass the time. 

Interestingly, the company behind BAYC, Yuga Labs, empowered the community to help with its own promotion by officially granting intellectual property rights to the owner of an Ape. As such, we see side projects emerging, such as the series of animated shorts "Yawn of the Apes." Such efforts serve to strengthen communities, as they not only increase the appeal of membership but also provide an opportunity for an imaginative owner to bring greater value to a project. 

The cost of membership to online communities like Pudgy Penguins or BAYC has quickly priced all but the wealthiest out of participation. As such, these elite PFP NFT projects resemble country clubs and other exclusive communities in the physical world. Yet, it is not just the rich who value interaction with a community bonded over a common interest. Inspired by the success of BAYC, many other projects offer similar membership perks at a much lower entry price. For example, at the time of writing, membership to the Bored Mummy Waking Up PFP club costs as little as 0.05 ETH — or around $150.    

Metaverse avatars

Many PFP NFT projects feature just the head and shoulders of a unique character within a collection. Consequently, they lend themselves well to the two-dimensional online social interactions we're familiar with today. A BAYC, CryptoPunk or Pudgy Penguin NFT can serve as your profile picture, a pseudonymous identifier across the multiple platforms we predominantly use to communicate on the internet.

However, many PFP avatar projects have a much grander vision. Meebits, for example, are three-dimensional characters with a complete body. With some animation magic, a Meebit can easily serve as an avatar with which its holder can explore virtual worlds like Decentraland or The Sandbox.

While few other projects are GameFi-ready like Meebits, efforts are well underway to bring the communities forming around PFP NFTs into shared online virtual spaces. Digimental is among those artists animating characters from popular collections. Their 3D rendered BAYC avatars provide an early glimpse of future virtual world communities. 

An example of Digimental's BAYC 3D renderings. Source: Twitter

Digimental told OKEx Insights about the natural appeal of representing oneself in the metaverse using an NFT avatar: 

"Decentraland, Somniumspace, or Cryptovoxels all host community members who I guarantee would like to look like their beloved characters. However my thoughts here go one step ahead. It’s not even about the use of your character in this world but the experiences you can shape around it."

Efforts like Digimental's are certainly promising. Given the sudden popularity of using one's NFT as a profile picture, it is not difficult to see the appeal of taking your Ape, Punk or Penguin into the metaverse. For now, Discord servers represent community clubhouses of sorts — online spots where members meet, socialize and discuss club matters. The natural progression is the creation of spaces within virtual worlds, and that's exactly what some of this new breed of online club are doing. 

Looking at The Sandbox's map, we see PFP NFT communities among those claiming metaverse turf. Most prominent is BAYC, which bought a collection of adjacent plots in May with a plan to gift land to members. Also represented are Wicked Craniums, CyberKongz and The Doge Pound.  

Images posted by BAYC members on Twitter hint at the beginnings of this intersection between PFP communities and GameFi in the metaverse: 

BAYC is one of the more prominent projects working toward metaverse club representation. Source: Twitter

Such expansions into virtual worlds like Decentraland create greater utility for a PFP NFT holder. This, in turn, strengthens not only the community itself but also the appeal of an avatar asset as a form of status symbol. Representing yourself in one of the many Decentraland casinos using an extremely rare Ape, for example, may become the digital equivalent of sporting a pair of one-of-a-kind Air Jordans to a real-world nightclub or opening a bottle of vintage wine at a dinner party.

NFTs as social capital

Related to the concept of digital status symbols is that of social capital. Online, many prefer to keep their real-world identity hidden. This affords some personal protection, in that a wealthy individual who obfuscates their identity is less likely to become a victim of criminal extortion. However, as economies increasingly digitize, pseudonymity also has its drawbacks. 

For example, if a pseudonymous individual online wants to broker a major deal for a tokenized digital asset, it may be difficult for the other party to trust that they are good for the money. A highly valuable NFT linked to an individual with ownership proved onchain could serve as a form of social capital. 

The owner of Punk #4156 explained the concept of NFTs as social capital to OKEx Insights for an earlier in-depth article: 

"With 4156 provably linked to my Twitter account, everything I do has the credibility and sincerity of my $1.2+ million bond (the value of the ape) behind it. For example, I can make large private art deals and people know I won’t bail on them because I have staked so much capital on my reputation. 

Owning a Punk and using it as an avatar is a life hack with an ROI much greater than the [then] $40K (entry-level) price tag. As more people realize this, the price of Punks will increase, and their utility as social proof-of-stake will increase too. This is a virtuous cycle that will cause Punks to become incredibly valuable and will open the door for other avatar projects to become very valuable as well."

Speculation begets risks

As discussed, NFT avatars have emerging utility as a means of representing oneself and status online, and through membership of exclusive clubs that are increasingly moving into 3D online spaces. However, with the recent meteoric rise of PFP NFT avatars and BAYC validating the value proposition of second and third movers in the niche, speculation on the next must-have PFP has, unsurprisingly, become a fixture of the market.

When speculation is the driving force behind asset prices, investment risk becomes more prevalent. Unfortunately, those poorly positioned to take on financial risk are the most likely to do so. For a reasonably wealthy investor, risking thousands on a Pudgy Penguin or BAYC PFP might not be such a big deal. However, those hungriest for the largest gains often take disproportionate risks. Many of those rushing to mint and buy avatar NFTs do so in the hope that they may later sell the asset to someone willing to pay a much higher price. Of course, there is no guarantee that the project will prove popular among those with the capital to pay the asking price of elite-tier PFPs. 

Combine this with the incredibly illiquid nature of NFTs and the risk only increases. With a highly liquid, fungible asset, like BTC, the market has many buyers and sellers, making it easy to exit a position as new information emerges. With NFTs, a buyer needs to want to own the specific image being sold. If no buyer is interested in the seller's asking price, the token simply will not sell. This illiquidity makes avatar NFT prices highly volatile and unpredictable, and it means many investors will likely end up holding worthless NFTs as projects fall out of favor with the wider market.

Similarly, the mania surrounding NFT avatar projects of late invites opportunists to prey on the most desperate investors. We saw the same with initial coin offerings and DeFi yield-farming opportunities. The speed with which developments occur in the cryptocurrency industry means that those first into a successful project are often handsomely rewarded. This incentivizes investors to rush into projects without necessarily doing proper research. The fear of missing out is a well-established concept in investing and causes individuals to make irrational decisions without considering their consequences fully.    

Just as malicious anonymous developers pose a risk to those rushing to participate in DeFi protocols, we are now seeing similar occurrences with NFTs. For example, the developer behind the NFT avatar project The Great Ape Society disappeared with 400 ETH from its community wallet shortly after its creation. 

A similar — although less nefarious — risk relates to the value of celebrity endorsements in the NFT sector. High-profile investments from the likes of Pranksy and LaMelo Ball helped catapult BAYC prices into the stratosphere. Aware of this, members of smaller communities started to drop their NFTs into known celebrity wallets and then promote it as if whichever influential individual was interested in the project. 

The wallet in which JAY-Z's avatar CryptoPunk is held contains many NFTs that were minted and then transferred there rather than purchased on the secondary market. In a market in which it often pays to be fastest, a screenshot of a wallet containing items from a collection alone can be enough to cause a naive investor to rush into a project without doing their due diligence. 

Finally, there is a longer-term risk with all NFTs. The blockchain networks on which NFTs are minted are still highly experimental. Earlier in August, for example, Ethereum, the dominant network for high-value NFTs, hard-forked its code to introduce a significant protocol change. Packaged with other improvement protocols, EIP-1559 significantly alters the distribution of new ETH and, as such, has an impossible-to-quantify impact on long-term network security and functionality. 

Additionally, Ethereum critics attack the network's ongoing transition to a proof-of-stake consensus mechanism because of its assumed tendency to centralize the transaction validation process among a wealthy elite. Regardless of whether these upgrades are long-term positive or negative for the overall network, the fact remains that changes to the underlying protocol could impact the future value of an NFT. These unknowns at the protocol level are rarely considered part of the NFT investment thesis but certainly represent a non-trivial risk to those hoping to hold an avatar NFT for a longer period. 

Related to protocol risk is the hosting of the NFT images themselves. Many projects store their NFT artwork on centralized servers, with the NFT simply pointing to the file's location. Should the centralized server disappear one day, so too will the supposedly immutable PFP avatar image. Similarly, crypto artist Neitherconfirm demonstrated how easy it is to change the image linked to an NFT when files are stored on centralized servers in March 2021 — when the original images were replaced with rugs. While solutions like saving files to IPFS somewhat mitigate this, they are by no means universally used across the sector, and naive market participants may not even be aware of such risks.          

Given the dangers inherent in the NFT sector, it seems it is only a matter of time before regulators move in to protect investors. How this will look and the efficacy of any forthcoming regulations remains to be seen. However, any future regulatory clampdown may also harm the long-term value of NFT PFPs and should also be considered when deciding whether to invest in a project or not.  

The future of NFT PFPs

Looking at the sheer level of speculation in the market today, it seems likely that many of today's hyped NFT avatar projects will drift into obscurity in much the same way that most of the ICOs of 2017 left investors holding bags of worthless tokens. Yet, like the ICO bubble, the utility of some of the more innovative projects will surely survive any major market downturn.

As virtual worlds like Decentraland and The Sandbox enable new forms of social and economic interaction online, the importance of digital identities and status symbols will surely grow. While those born before the proliferation of the internet may scoff at the notion of a high-value JPEG avatar, the appeal of digital ownership is much easier to grasp for younger generations that have been online their entire lives. The jewelry of the ancients dug up by archeologists the world over demonstrates that the concept of displaying one's wealth on your person is almost as old as humanity itself. 

As humanity increasingly moves into digital spaces, it would be naive to assume that this part of human nature will suddenly disappear. Just as the wealthy executives of yesterday enjoy the feel of a Rolex on their wrist when a much cheaper watch performs exactly the same function, so too will those in the future. However, given those developments discussed above, it seems likely that some will prefer their digital assets to be within the metaverse — whether that be a Bored Ape, Pudgy Penguin or a future NFT avatar character that is still to be launched. 


OKEx Insights presents market analyses, in-depth features and curated news from crypto professionals.

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Disclaimer: This material should not be taken as the basis for making investment decisions, nor be construed as a recommendation to engage in investment transactions. Trading digital assets involve significant risk and can result in the loss of your invested capital. You should ensure that you fully understand the risk involved and take into consideration your level of experience, investment objectives and seek independent financial advice if necessary.

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