Collectors Seek Lottery-Like Returns in NFTs

The allure of non-fungible tokens (NFTs) for many is the hope of a profitable investment, but a study found signs of the lottery effect at play.

While investors purchase NFTs with the intent of selling them at a higher price in the future, a Federal Reserve study found evidence of behaviors indicative of seeking a big payoff for a small price with these investments.

Specifically, Fed researchers examined data pertaining to the NBA Top Shot market. Though there was evidence of participants making use of all available information, there is also evidence showing that participants overestimate future prices. This latter finding can be seen as irrational or risk-seeking behavior.

NBA Top Shot is a marketplace allowing participants to collect non-fungible tokenized NBA “moments” in digital card form. It also facilitates the trading of NBA digital collectibles. These collectibles, called moments, are officially licensed NBA video highlights.

There is also a lottery aspect to the platform. Participants can collect certain NFTs to use in “challenges.” During a challenge, a participant collects predetermined NFT moments and potentially collects a reward that is deemed valuable or unique. Challenge rewards are NFTs that have never been available before or are available in a limited quantity, providing potential allure.

The scarcity of the reward and its serial number (lower is better), which affects a moment’s value, is unknown in advance. Participants do have data on asking prices for existing moments. By looking at listed prices, collectors can freely purchase an NFT on Top Shot at any time and observe every listed price for each moment on the platform.

While participants benefit from pulling in a low se-rial number in cheap (lower-cost) challenges, the actual returns on such challenges are often negative. This suggests an overestimation of future value. The average return for challenges deemed cheap was –14.0%, giving evidence to the idea that collectors are displaying risk-seeking behavior. Cheap challenges are more accessible to investors yet yield negative returns.

The study likens this behavior to the lottery or meme stocks, all three being low-reward strategies. Another theory is that this is purely entertainment value, and the low-risk high-reward strategy of completing cheap challenges is sensation-seeking behavior.

Source: “Are Individual Investors Rational? Evidence from NBA Top Shot Challenges,” by Ignatios Draklellis and Yeonjoon Lee; SSRN, August 2022.