NFT Close Up With Sfermion and Trustology

Host
Paul Gordon
Editor, Coinscrum Markets

Paul Gordon talked to Andrew Steinwold, managing partner at Sfermion, and Alex Batlin, CEO of Trustology, to explore the potential of non-fungible tokens (NFTs).

Andrew got involved in bitcoin in 2013. He participated in a few startups in the mid-2010s before launching an NFT fund in 2019. NFTs are now his full time focus.

Alex focuses on the custodian space, but he wants to move away from the old school way of thinking of custodians as gatekeepers.

(4:12) “It’s really important that you still have the security and control the custodian brings, but you must make sure that the utility of those tokens is not hampered by the custodian,” said Alex.

Paul Gordon talked to Andrew Steinwold, managing partner at Sfermion, and Alex Batlin, CEO of Trustology, to explore the potential of non-fungible tokens (NFTs).

Andrew got involved in bitcoin in 2013. He participated in a few startups in the mid-2010s before launching an NFT fund in 2019. NFTs are now his full time focus.

Alex focuses on the custodian space, but he wants to move away from the old school way of thinking of custodians as gatekeepers.

(4:12) “It’s really important that you still have the security and control the custodian brings, but you must make sure that the utility of those tokens is not hampered by the custodian,” said Alex.

NFT Overview

(5:51) NFTs represent a unique digital asset, as opposed to a fungible asset, which would be, for example, USD or bitcoin, which are completely interchangeable.

There are five categories in the NFT  marketplace:

  1. Collectibles — e.g. baseball cards or CryptoKitties
  2. Game assets — assets with high levels of utility within their universe, e.g. a weapon with a particular attack damage within a specific game
  3. Virtual land — user-owned social, e-commerce, gaming and creative platforms all rolled into one in which you can do whatever you want
  4. Crypto art — art which has been tokenized and put on the blockchain
  5. Other — domain names, property titles, insurance. These categories are smaller today but have potential to grow.

Investment Criteria

(8:00) Sfermion’s approach is to invest in the tokens, not the equity of companies. NFTs are very diverse and have different value drivers within them, including:

  1. Collectibles — it’s all about the narrative. For example CryptoPunks were one of the first movers and had a fair launch, all of which added to their unique story and eventually their value.
  2. Game assets’ value represents utility, where in their universe a weapon with +100 damage is more valuable than a weapon with +10 damage.
  3. Virtual land’s value is driven by location, content and parameters. Are you in Illinois or Manhattan? Single family home or skyscraper? Parameters represent the zoning laws in which you’re allowed to build.
  4. Crypto art — the value is the artist’s reputation or brand. If a random person makes a Banksy-type artwork, it has no value, where if Banksy himself produces it, it’s worth millions.
  5. The ‘other’ category has variable value drivers as the sub-categories within it are variable.

(10:07) “The approach that we take is research driven, fundamentals based investing…where what truly matters is we look at the team, the product, the token economics, the community, the market, the data, the risks and assess every project on those fundamentals. If it passes muster, we say ok great, we want to make a play. And so you have to identify which assets in this universe are investable and why would you invest in them, ” said Andrew.

Regulation and Taxation

(12:15) Art has a long history of being used as a money laundering vehicle, so the focus for regulators will initially be on high-value transactions — who’s buying it, who’s selling it, is it above board, said Alex. Once money laundering has been addressed, the next issue is taxation and how you deal with that.

NFTs can be put in a pot and fractionalized, effectively taking units in a basket of non-fungible tokens so it starts to look a little bit like a fund. At that point, you’d need to be careful you’re not running an unregulated fund. You can wrap NFTs together and make it fungible within a matter of days where this kind of play would have taken years in a traditional market, said Alex.

Then once you’re in liquidity pools, i.e. fungible units of non-fungible baskets of goods, AML comes into play because you need to be aware of risky transactions. Wisconsin is the first US state considering taking smart contracts as legal entities, which essentially recognizes that you can treat a smart contract address as an AML entity and assess risk against that, said Alex.

(14:58) In Switzerland, they recently clarified the law that essentially states the ownership of a private key effectively equals ownership of an asset. That’s an important step forward as to prove an asset is yours. This links to provenance are another important part of the picture, where custodians can provide evidence of who owned a private key beyond simple mathematical proof, said Alex.

(17:47) There is a trend of more informal notarization, such as artists publishing tweets referring to their work, so there’s potential for a formal notary system to be put in place, Andrew said. From a personal perspective, more regulation and more rules lead to stifled innovation. The freedom of optionality to use a notary or not would be important.

Potential Standardization

It’s essential to nurture innovation in this space.

(20:08) “I’m all for experimentation, so I don’t necessarily think there should be one standard today. I think that we should throw everything at the wall for the next couple of years and see what works the best. We want to strike the best balance of security, centralization [and] authenticity,” said Andrew.

The most popular NFT platform we’re seeing right now is OpenSea, specifically for art. But long term we’ll likely see the marketplaces bifurcate into their specific niches, where for all those categories previously mentioned such as collectibles, gaming assets and artwork we’ll see two or three marketplaces specialized in those kinds of trades, with one aggregator type platform such as OpenSea, said Andrew.

Ownership and Liability

(22:58) Trustology has access to every single marketplace and asset class, which means they don’t have to support any particular marketplace — they simply assign by each transaction. In the dApp world, you’re unbundling identity credentials, user interface and user experience, and business logic data, said Alex. All of the marketplaces and minting platforms all talk to the same back end, which in most cases is Ethereum.

(24:03) The question which logically follows this is how do you go ahead and transfer ownership, which is done by signing transactions that the dApp generates. If you have an NFT in your wallet, that wallet works across the blockchain, creating a single unified identity.

Another issue is risk.

(26:21) “As soon as you start to have professional organizations looking after NFTs as part of their portfolio, typically most of the employees are not willing to take the personal liability risk of safeguarding those assets, and they need custodians. The need for a custodian massively increases as soon as it’s not your asset… When it’s not your asset because it’s your company’s asset, it makes sense to consider a custodian because of the liability,” said Alex.

(26:59) The blockchain allows you to place conditions around what two intermediaries who don’t trust each other need to do to trade. Marketplaces can now be removed through smart contracts. What Trustology does through the DeFi firewall is to allow organizations to specify rules that determine who can do what with which method on a particular asset class or within a particular protocol, because that business logic doesn’t need to reside on the blockchain, as it’s expensive to build into the chain and it’s an internal logic which is not relevant to two different counterparties, said Alex. The main motive is the reduction of cost to execute on the chain.

What’s Next?

Sfermion is looking for a longer term solution in the NFT space:

(30:40) “Right now I would like to see higher quality projects launch NFTs. [We’re seeing] a lot of low effort projects especially in the past two months…I want to see something with more depth and staying power. The market is excited and if they see higher quality products, maybe they’ll be thinking hey, I want to own this for a couple of years, more like a piece of art or a collectible than a get rich quick kind of thing,” said Andrew.

(31:33) It’s really early within the fractionalization phase of NFTs, but it’s going to be an incredibly large market going forward. What we’re seeing today is less than 1% of what it’s going to be, said Andrew. The prospect of IPOs within the virtual world is also exciting.

(34:20) Returning to a previous theme, it’s great that so much innovation is happening and that we’re in the place where so many ideas are being thrown against the wall to see what sticks.

NFTs are a potential game changer for the monopolization of certain digital spaces:

(35:15) “I love the fact we now have digital books and music. It makes it possible for anyone to access those things. But I still don’t like the fact…that effectively so much of the world’s knowledge is trapped and potentially in the future controlled by a company. I think the latest movements in NFT royalties allow us to create effectively the Babylon of libraries where we have knowledge accessible to anyone in the world but also allow the creatives to earn a living on the back of that without that being controlled by a massive single corporate,” said Alex.

(36:44) We’re also starting to get to transactions being cheaper, and once we do get to that position, that’s going to free up knowledge. It will be the next evolution of the internet which breaks the stranglehold some organizations have, said Alex.

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All of the content published on this site is strictly for informational and educational purposes and neither does it constitute investment advice nor solicitation to buy or sell blockchain-based tokens or securities. No investments whatsoever should, therefore, be made based upon information provided or discussed by any guests or hosts appearing within this video or audio content.

Any appearance by any company or individual does not infer any kind of endorsement by Scrumline Ltd (trading as Coinscrum) of either their products and/or services or in any related investment opportunity that they may be pursuing from time to time.

Crypto-tokens and equity investments are high risk in nature and you should always take the advice of a professional financial advisor from within the jurisdiction in which you reside before making any investment decisions.

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