10 Basic NFT Math Points
I love reading, writing, and arithmetic. Here are a few math points that may help you think about NFTs (in order of sophistication). Math, whether you like it or not, is fundamental and unavoidable especially when it comes to buying (and selling/trading for those who focus on those, too). Some of this hopefully may also serve as an antidote to hype, Twitter, and the incredible noise in the space.
A 50% loss requires more than a 100% gain to break even (and more because of Opensea fees and royalties). If a project has a total of 10%+2.5% fees, then a 50% loss requires you to gain 125% + 2 gas transactions (buying and selling) to just break even. While projects can moon after crumbling and many have, this is just basic arithmetic
It’s commonly mentioned that 99.9% of NFT projects won’t hold value long term. This directly implies that you should be flipping MOST NFT projects if you plan to buy a large number of them as they simply cannot all hold value long term. There are many caveats to this, but it signals that the ones you hold long term or commit to should really be of such extraordinary conviction you won’t get scared off if there is price volatility
Active traders are trying to make 2 correct decisions — the entry and the exit — while hodlers have to be right just once, on entry (which could be spread out over time/dollar cost averaged):
Consequently, the more you trade the more times you will be wrong. If you trade 10 times and were unsuccessful twice, do not expect to be wrong twice if you trade 100 times or 1000 times (everything else being equal). No one should realistically expect a 100% or even a 75% success rate buying a large number of NFTs as they scale up from 10 to 100 to 1000 or more actions
1% improvement a day works:
Human minds aren’t good at multiplication, and multiplication is the basis of compounding. Some may know what the product 11 x 11 equals, or maybe 19 x 19, but few can tell you what 11 x 11 x 11 equals off the top of their head or even higher multiples.
It is hard because (a+b) x (a+b) has a simple formula we all learn from beginner algebra, but (a+b) x (a+b) x (a+b) is pretty much forgotten the nanosecond after the final exam.
Multiplication is nonintuitive and even less attention is given to it in the hyper-fast NFT environment, but it is the basis to being longer-term successful if you plan to be around long-term.
Your disposable income = income - personal expenses
As a result, the maximum amount of NFT spending you ought to have should not exceed your disposable income (and know what those numbers are). In fact, your NFT allowance should be significantly lower than disposable income because of taxes, unplanned expenses like a flat tire, healthcare, rainy day savings, 401(k), etc.
Bankroll management is an extremely important topic (which I won’t cover here) but to say the least, there are similarities to managing poker bankrolls - such as keeping personal and poker finance separate, playing with the bankroll only (sticking to pre-set budgets), etc. in order to not go broke.
Probabilities matter and it helps both quantify events like upside and downside AND weight appropriately them in terms of rough probabilities.
This leads to the basic math of why buying at a lower entry price is “safer”: If you purchase an NFT for 0.05 eth, not only do you have much less to lose, this allows you to have a margin of error and still do well even if it has a large probability of going to zero. For example, as long as the probability of loss is less than 80% and you think it could 4x, then the trade has a positive expectation value (“EV”):
a. Downside Total Loss x Prob. of Loss + Upside Gain 4X x (1-Prob. of Loss) > 0
b. -0.05 eth x Prob. of Loss + 0.2 eth x (1-Prob. of Loss) > 0
c. 80% > Prob. of Loss
If you think the NFT could go up 10x, then the probability of loss can be as high as 90% (ignoring royalties and gas) for you to still be a positive EV.
Obviously, you have to have some sense of what probabilities and expected payoffs are, but even having a rough sense of payoffs could help you think about the upside and downside in a more quantitative manner.
If you’re a long-term hodler, the punch-card approach to buying may help you frame projects diligence and simplify. Take a punch-card that has 10 slots in it, representing all the NFTs you will ever buy in your life and will hodl throughout your life. Each time you buy an NFT (or NFTs from a collection you love), you have to punch it and once you have gone through all the punches, you cannot buy anymore. As a result, you will be pretty careful about what you buy and think pretty hard.
While this is not completely realistic, the metaphor reflects that there are limits to most of our NFT budgets and what we truly plan to hodl LONG TERM. I don’t think many of us seek to create our own museums like some whales, but personal collections, whether it is 10 or 20 or 50, have bounds.
NFTs likely follow a power law where the returns from the best NFT or NFT collection tower over the rest of the portfolio, followed by quite a few strong ones and mediocre ones (and then a lot of 0s, the so-called “long tail”). From Wikipedia:
In part, many NFT projects have similar characteristics and risk profiles as early-stage start-ups and venture capital investments. Because of the nascent NFT scene with many projects and teams barely a year old or less, these teams are building and selling NFTs to attract present and future customers. And these teams are by and large, start-ups: founded by a group of people (not a large organization), bootstrapped funding, and composed of entrepreneurial daredevils. As a result, it is not any different than an early-stage consumer products company or tech company. And a few huge winners (like RTFKT, acquired by Nike, or BAYC and Pixel Vault) are to be expected.
If you care about volatility, then quantifying/estimating volatility matters more: as an advocate of early science learning/research, I have judged dozens of middle school and high school science fair projects. Every display board shows average results. But not everyone displays the variance (or standard deviation, spread, or “volatility”) around data points. By not displaying the variance, all the rich data/history gets blended into a single dot.
As the well-known story goes, many have drowned attempting to cross rivers that are on average 3 feet deep.
NFT buyers often act the same as middle school science students in ignoring variance in their portfolios. For example, everyone knows NFTs are volatile, but if an NFT you own can go up or down by +/- 10% and another goes up or down by +/- 50%, would you feel the same? What about if that was the stock market? How much volatility can you really stomach? If you are more into trading and your portfolio has a huge variance, how does that impact your liquidity situation (bankroll) on future projects?
Obviously, if you’re a hodler then volatility should matter considerably less. But it is still pretty gut-wrenching to see things fall by 50% or more which is very common in crypto. While volatility is to be expected and even adored (otherwise things won’t go up), huge volatility tells you more about your risk appetite and yourself whether you are a collector, investor, buyer, trader, etc.
The whipsaws matter.