Why utility is the hottest trend in NFTs
Endstate’s physically-redeemable sneaker NFTs (Drop 2: Statecraft)
You get a push notification. Your favorite designer is releasing a new limited-edition pair of sneakers. No need to worry about waiting in line, clicking furiously to catch the drop on a buggy website, or dealing with scalpers. You cryptographically, provably own two items from this designer already, so your wallet is whitelisted. On release day, you send some ETH to the address on your own time. You get an NFT featuring a rendering of the sneaker that is wearable in all top metaverse venues. Before even collecting the shoes IRL, you are rocking them in your favorite online gathering place. You also try them on with the AR lens on your phone.
The redemption window opens, and you redeem the NFT for the physical item. No burning required: you get to keep the NFT as well as the physical version. The NFT itself, built on a mutable standard, simply toggles its ‘redeemed’ trait to YES. The sneakers arrive in the mail. The logo is impregnated with a polymer containing thousands of minuscule diamond particulates, creating a unique, scarcely visible, and unforgeable signature. You scan it with your smartphone camera and it takes you to the shoe’s corresponding NFT. For good measure, the tongue of the shoe also contains an NFC chip.
Wearing the shoes around, locational triggers grant you further experiences. Your wallet fills with goodies — a POAP here, a rebate there. You discover that the NFT comes with access to events thrown by the designer. Your ticket to their next art show consists of the chip embedded in the shoe. You earn a skin from attending the event and promptly use it to customize the digital version of your shoe. Basic biometric monitoring tracks your time spent wearing the shoe and builds a usage profile together with the locational data. Some users prefer stealth mode, but you don’t mind sharing the data — you permission its release to the manufacturer in exchange for a direct USDC payment to your NFT-associated wallet.
Later, you decide to sell the shoes. You strike a deal with a buyer, putting the NFT and the funds in escrow, while you mail the shoes. When they get the package, they scan the tag, safe in the knowledge that they are receiving the genuine item. They verify the shoes are in good condition and the escrow releases the NFT to the buyer and the funds to the seller.
This consumer lifecycle may seem far-fetched, but all the tools required to make it a reality exist today. As I’ll explain here, consumer products, especially high-end or luxury ones, significantly benefit from being paired with accompanying NFTs. The realization of these experiences is underway, and the more complete version is just a matter of time. The ‘digital twin’ or ‘phygital’ model will significantly outmatch standard luxury consumer experiences and I expect it to accelerate the mainstreaming of NFTs.
An NFT is a discrete digital payload. Sometimes the actual content of the NFT is present on the blockchain itself, as is the case with Artblocks or other on-chain art NFTs which are generated from code present on chain. No external reference required. More commonly, an NFT is just a pointer connecting the onchain object to an offchain data blob stored on IPFS or Arweave. (For a detailed guide to competing taxonomies of NFT on-chain-ness, see this piece from Takens Theorem.) Most NFTs exist “as is” — that is, they don’t offer a claim to anything other than a tradable receipt.
Increasingly, some NFTs come bundled with ancillary claims. They don’t just track the ownership of some scarce digital content but also give you access to services rendered by the issuer. Some examples include entry to events, membership in certain clubs, participation rights in future sales or drops, or admittance to shows and gigs.
Another dimension that can divide NFTs is their relationship to the real world. The vast majority are purely interested in the digital world. Arguably, the value of these digital-only NFTs is pure speculative premium. It scarcely needs mentioning that there is serious backlash emerging against NFTs, especially in the art community.
NFTs that entitle you to a real-world product aren’t as exposed to this accusation, because they possess an ultimate and easily assessed floor value. This is safer for brands and creators who might fear recriminations from their association with the NFT space. Countless brands are dealing with the fallout of poorly considered NFT drops which have soured their relationships with their fans.
The NFTs we discuss here fall into this latter category. They give you a claim on actual physical merchandise. The default model here is the burn, in which you destroy the NFT in exchange for the product, whether it’s a tungsten cube or a pair of socks. You can have either the NFT or the product; you can’t have both.
A new, better model is emerging, though. In practice, holders want to keep the digital product alongside the analog one. They have distinct, complimentary uses. The digital one can be used to provably flex in the digital world, where flexing mainly occurs these days; it can optionally serve as a persistent digital ticket, granting you access to subsequent experiences; it is a proof of purchase and can be used to institute strong anti-counterfeiting mechanics.
Consider Damien Hirst’s NFT art project, The Currency. As a holder, you can either keep the NFT, or burn it and receive the corresponding unique physical print.
“1. Totally gonna sell you,” the first piece in Damian Hirst’s The Currency
But that’s an inferior model overall, because collectors would prefer to get the physical and keep the NFT. You don’t just hang the print on your wall. You put in on your IG, your Gallery and your Twitter. The NFT lets you prove that you actually own it.
Weirdly, Damien made all of the art up front. Perhaps he assumed that most fans would redeem the NFTs for the physical? In practice, it was about a 50/50 split. So now he has to physically burn 4,851 unique pieces of art.
[Note: in my first draft, I listed the example of Unisocks as an either/or case of physically-redeemable NFTs, because holders had to burn their tokens to redeem for the sock, but it turns out that post-burn Unisocks holders actually get another NFT back proving that they had redeemed, so it does function in practice like an ersatz redeem-and-retain token. Thanks to Will Price for pointing this out.]
These Unisocks retail for a cool $29k
In a sense, these NFTs are like tradeable receipts, which also carry the ghost of the product. The term ‘digital twin’ is getting traction as the default name for this idea. Other terms that have been floated include physi-digital and phygital. Bennett at Endstate says he prefers ‘entangled, borrowed from particle physics — which I like, because it suggests a unity despite the separation of the objects. To be pedantic, ‘digital twin’ implies a distinction and a mirroring, whereas the ultimate objective should be to get collectors to think of the NFT and the physical good as inherently the same thing, just existing in different metaphysical realms.
Personally, I have taken to calling these ‘full stack’ consumer products, because you get the entire item, from the physical instantiation to its platonic form in the digital rendering. (Cameron from Kong points out that you can take this even further, creating NFTs that consist of coordinates to render 3D printed objects [which you then anchor to the NFT with a chip], effectively uniting code and physical in a wholly unique data blob.)
The RTFKT x Nike Cryptokicks NFT — not physically redeemable
This digital twin idea has been embraced by a number of brands, although the model itself has yet to stabilize. Burberry was an early mover in taking their brand to the metaverse, launching in 2021 a custom character in Mythical Games’ NFT-focused Blankos metaverse RPG, although the vinyl characters remained digital-only.
Last December, Adidas partnered with BAYC, selling 30k NFTs for 0.2 ETH apiece ($22m at the time), each redeemable for physical merch — hoodies, tracksuits, and beanies. Dolce & Gabbana released a set of mysterious glass boxes redeemable for a variety of merchandise options alongside digital access and benefits. Nike acquired RTFKT and issued the popular Cryptokicks collection, although that batch of sneakers were confined to the virtual world. Subsequent drops have extended to physical redemption for merchandise, which RTFKT calls ‘forging’. Nike’s patent hints at plans to unite the physical and the digital representation of the merchandise as well as track authenticity and provenance. From my survey of the current players in this space undertaken for this article, Nike/RTFKT in my opinion is the most advanced in their thinking and execution on the digital twin front.
Reverse Land’s custom Nikes made from a Coke sweater sold on Zora
Just a few days after I first published this article, Tiffany jumped into the fray with one of the most impressive offerings to date in the luxury/NFT space: called NFTiff, it is a 250 NFT issue of physical gem-encrusted pendants crafted to resemble existing Cryptopunks. Only existing Punks holders are eligible to mint an NFTiff; and they retail at a cool 30 ETH, the equivalent of 50,000 inflationary US dollars. In addition to the physical pendant, which will contain 30 gemstones and diamonds, holders get an accompanying digital twin NFT (independent of the Punk they already own).
This is interesting in a number of ways: instead of launching digital twin NFTs to accompany their own first party products, they chose to build on top of an established NFT franchise with a community of wealthy diehards. Punks owners like to flex (see their abundant PFPs on Twitter and LinkedIn) and they are, by definition, rich. Hardly a better audience for a luxury jewel-encrusted pendant retailing for 30 ETH. From an IP perspective this also demonstrates the strength of emerging NFT models. Cryptopunks owners Yuga Labs weren’t involved in the partnership; Yuga notes that their forthcoming Punks IP agreement allows owners to take advantage of their Punks’ likeness for derivative projects such as the NFTiff.
I think Tiffany’s offering is one of the most creative we have seen from a luxury brand to date. It wasn’t tone deaf — Tiffany’s EVP Product and Comms Alex Arnault is a proud Punks holder. They appealed to an existing hugely popular NFT franchise. The product will undeniably be popular. They avoid the accusations of ‘selling out’ by creating an actual product with a twinned NFT.
The reception was almost universally positive, which must have set off alarm bells among other luxury retailers hanging around the hoop. I imagine that there’s more than a few executives crafting presentations with titles like “NFTs are no longer toxic” and “we figured out how to issue NFTs without enraging Leftist Art Twitter.”
New web3 native brands have sprung up in this category. One pursuing the redeem and retain model is the footwear brand Endstate (disclosure: CIV portfolio company). They issue their own brand of sneaker-redeemable NFTs entitling buyers to both the rendered metaverse and the physical version. Rags uses Arx chips to create “soulbound NFT streetwear,” “[blending] the street futurism of the early 2000s with premium NFC enabled fashion.” Back in 2020, Zora facilitated the drop of 30 Nike sneakers customized by Reverse Land via the sale of the $REVERSE token. In March 2021, FEWOCiOUS teamed up with RTFKT and sold 600 NFTs for $3.1m, redeemable for physical sneakers. LNQ creates “blockchain enabled hardwear” including clogs and hoodies which come embedded with NFC chips, although the precise use cases are still vague.
The Endstate Drop 0: Predawn
A number of high-profile luxury brands are sniffing around the space, although they haven’t made their intentions clear just yet. Breitling and Vacheron Constantin invested in Arianee, a ‘digital passport for luxury goods’. PwC and others launched Virgo, a platform for luxury brand retail certification. Most notably, LVMH, Mercedes Benz, Prada and others launched the Aura blockchain consortium aiming to unite luxury brands under a single standard of traceability. Hublot for instance creates unique fingerprints based on visual cues from the watches which are embedded on the Aura blockchain and can be verified with a smartphone. Prada appears to be putting some of these tags into action too. Many of these initiatives tend to involve bespoke blockchain creation, which seems unnecessary. The digital twin model works fine with chip-embedded merchandise and an accompanying NFT.
‘Supply chain blockchain’ quackery has existed since at least 2016, but this new wave is different, and more promising. Merely entering data into a blockchain doesn’t make it special. What’s different here is that, like proof of work connecting computation to the physical world, the embedded chips or signatures link the physical goods to the NFT. And both collectors and issuers have an incentive to maintain the NFT record and to circulate the NFTs when the collectibles trade in the secondary market.
A number of startups are working to facilitate this transition. On the enabling side, Arx creates NFT/NFC chips designed to link merchandise with digital counterparts. IYK also produces NFC chips designed to be inserted into clothing that users can scan to unlock the linked NFT. Digital Twin (founded aptly by the Soto-Wright twins) works with jewelers and artists to create NFTs which are the counterparts to physical retail goods. Castle Island portfolio company TYB helps brands locate and reward their most loyal users and fans with NFTs and digital collectibles — many of which are now redeemable for physical products, alongside other perks. Appreciate uses NFTs to create proofs of purchase for buyers of luxury goods in order to drive post-purchase engagement between brands and buyers. Interestingly, Appreciate doesn’t mention “crypto” or “blockchain” anywhere on the website. In my view, crypto jargon is likely to be phased out and we will see a rebrand of “NFTs” in the consumer sector the same way “crypto” was rebranded to “web3” recently.
The Index Coop x BanklessDAO ‘GMI Hoodie’, featuring an embedded IYK* NFC chip
Most tech-savvy luxury brands probably thought about ‘doing an NFT’ last year. Hopefully, they thought better. Now that the hype has cooled, these brands will start to realize that the real innovation is not exploiting fans by selling them overpriced JPEGs with dubious utility, but by twinning merchandise with a persistent digital property. This elevates a hoodie from just a piece of cloth with a logo on it, to a verifiable representation of the brand in emerging digital spaces, a long-term ironclad communications channel between consumer and issuer, a counterfeit-resisting device, and a means of fair secondary exchange.
I believe that a large fraction of luxury consumer goods will eventually be issued this way. I cover a few more benefits of the model below.
Flexing is increasingly digital
Ultimately, this is the main reason I expect digital twins to catch on. Quite simply, the main place young people go to show off is online, not in the analog world. If you are super excited about a new luxury purchase, you rush to show it off on IG. You don’t even have to wear it much (or at all) IRL. More people that you care about will see it if you post it online.
Hexagon avis on Twitter are a good first demonstration of cryptographically-verifiable flexing. The problem is most people don’t care about images of Apes or Punks. You are flexing for a very narrow audience. A lot more people know about Gucci or Richard Mille. Digital twins are a perfect match for this model of online-first flexing. They let you show off luxury physical goods you own, while also adding a new dimension of verifiability. You can prove that your sick ride you’re posing with isn’t a rental and that that AP or Grand Seiko is really yours. (Granted, you can rent NFTs. The meta at this point would then move to users putting identifying information in the NFT metadata to prove their ‘true’ ownership.)
What’s more, if metaverses actually take off (I can’t say I’m particularly impressed by any of the ones that exist today, but I am sure one will eventually be popular), you can strut around kitted out top to bottom in your verified Louis Vuitton trackies à la Richard Heart. Brands will likely want to push the NFT-verified approach, because they will want to participate in the top metaverses, but they won’t want a ton of counterfeits and unauthorized derivatives running around.
So NFTs allow you to flex not just your digital collectibles online, but actual physical luxury goods in a provable way. The future might be all about digital-only goods, but for now, people still like actual watches, cars, hoodies, and shoes.
Digital twins offer strong anti-counterfeiting properties
This is one of the strongest value propositions for digital twins. If you embed a tag linking the physical good to the NFT (in the above example, I consider an example in which DUST is used, but there are numerous ways to do this, mainly with NFC chips so far), sellers can have strong assurances that they are purchasing the genuine item, with a digital chain of custody tracing its ownership back to origin. Note that simply putting a QR code linking to the NFT on the product isn’t sufficient, because any counterfeiter could do this. Ideally, you’d want the tag to be embedded or, better, incorporated into the merchandise. You’d want this to be done in a non-revocable way, because if the chips can be removed and inserted into a compelling fake, you can be fooled. (Note that this is still better than default luxury goods counterfeiting, because you are still limited by the number of NFTs and linked chips, so you still escape illicit inflation.)
In a sense, the anti-counterfeiting properties of an NFT-twinned physical item mirrors the transition from physical cash to cryptocurrency. Like cash, luxury merch first had to differentiate itself based on hard-to-replicate physical properties, making clones difficult. But now with embeddable tags linking to persistent digital objects, counterfeiting is very difficult.
NFTs solidify the brand-consumer relationship
One thing I’ve noticed with NFTs, whether they’re music NFTs or artwork, is that creators feel a sense of ongoing obligation to their collectors, whether or not this is explicitly codified. It’s very common for creators to give priority access to future mints to buyers of past mints. This is trivial, as buyers often operate from persistent on-chain addresses, so these serve as a proxy for their identity. Imagine the logistical challenge of trying to do this with physical merchandise and paper receipts. How do you go about proving that you bought a specific product from a specific manufacturer years ago?
Digital twins simplify all of this, making it downright simple to identify fans and even determine their track record of allegiance to the brand. The NFT also opens up the prospect of a communications channel from the seller back to the buyer, to be used for promotions or payments (in either direction). And once these relationships are established, token-gated experiences, whether digital or analog, are trivial to implement. Lastly, it’s trivial to include provenance information so the collector (and anyone they might sell the item on to) can learn a bit more about the origin of the item itself.
NFTs offer better auction models
There’s nothing inherent about NFT auctions that makes them better than standard ‘drops’ done on ecommerce websites, but the fact is that the crypto industry has been innovating aggressively on the auction model for years and has dealt with the problems of congestion, botting, and spam under an extremely high stakes environment for a long time now. All things equal, I expect crypto to provide the best tools to foster fair auctions.
Zora calls the issue of botted sneaker launches the “Yeezy problem.” Imagine that Kanye wants to sell his sneakers at $220, but the market clearing price is $2000. This means he is installing a price ceiling, which naturally leads to shortages. So instead of queues, you get botted launches, where a few tech savvy folks instantly buy up the inventory and then scalp it on the secondary market. Kanye earns less (because he’s giving up 89% of his primary sneaker revenue) and his loyal but non HFT-savvy fans pay a huge markup. Zora suggests instead a dynamic pricing model, whereby you sell tokens equivalent to the amount of merch you want to produce, and let these float on the open market. They even suggest a model whereby creators would recognize revenue equal to the market value of the token or NFT at the time they are redeemed, rather than at the price of initial issuance. I am skeptical creators would want that, because you’d see strategic redemptions by holders at low prices.
That saddles creators with undesirable unpredictability around revenue and margins. Legacy luxury goods buying seems like a game of access, loyalty, and relationships (as with watches or limited-run sports cars), waiting in long lines (as with sneakers), or dealing with scalpers and sketchy secondary markets. With NFT auctions, prices can float in real time and rules can be formalized and rules around whitelists can be fair and transparent. There are also the standard additional benefits of using digital bearer assets for payments. Issuers don’t have to deal with chargebacks, and sales can be global (as long as issuers are willing to ship globally), unencumbered by payment system restrictions.
Merch-redeemable NFTs introduce new efficiencies for manufacturers
One interesting feature of full stack merchandise is the inventory management efficiencies that issuers can benefit from. Though there is scant precedent, most of these drops work as follows: there is an NFT sale, followed by periodic redemption windows in which holders can choose to redeem their NFT for the physical product. This is great for sellers because they get all the funds up front and only have to deliver the product later, with predictability around timelines. They don’t have to take as much inventory risk. In practice, not everyone will redeem their NFT too (although issuers will have to set expectations that the convertibility feature of the NFTs may eventually expire if they terminate their manufacturing run.)
As issuers gain more data about redemption profiles — trivially attributable to specific users, they will be able to better plan around product runs and redemption rates. Eventually manufacturers will be able to predict by product how many collectors are likely to redeem, and how many typically redeem per window. Undoubtedly they will be able to sell more NFTs than they have to make units of merchandise. Inventory management isn’t a sexy concept but it certainly is a plus for brands here.
Wearable NFTs open up a brand new design space
Other interesting applications become possible when you pair luxury consumer goods with the innate financialization of NFTs. You could lend your NFT to your buddy for a small fee so they can verified flex on IG for a week. You could borrow against your sneakers, with the repo agreement specifying that the lender gains custody of the NFT if you default — voiding your digital counterpart (significantly devaluing the physical product). As mentioned in the opening story, you could receive payments or other on-chain goodies from the manufacturer in exchange for visiting certain places, agreeing to share data, or triggering certain usage patterns. Secondary sales are safer and can involve escrow and existing p2p infrastructure. Because your watch, hoodie, or necklace now contains a chip that is linked to your on-chain wallet and identity, you could in theory transform the device into an (extremely insecure) tool for contactless payments. Perhaps more usefully, you can prove cryptographically that you (or your on-chain alias) were at a specific place at a certain time. With sufficient ancillary infrastructure built up (this would require biometrics on the physical device proving that it’s ‘really you’ wearing it, you are effectively leaving a cryptographically-attested-to trail throughout the real world which you can selectively reveal when convenient or necessary. Your sneakers might one day be your crypto alibi.
Postscript: Do you need a blockchain?
A lot of this seems doable without a blockchain. For instance, you could maintain a personalized receipt of purchase between the brand and the buyer, issued via email and accessed with normal credentials. You could in theory build a marketplace to trade these receipts, although you’d have to define a standard from scratch and persuade people to use it. You can certainly embed an NFC chip in a piece of merchandise and link it to an entry in a corporate database containing the relevant metadata, but again, you’d have to develop some scheme to transfer that entry upon sale. You would need to find somewhere to store the record. You would have to bootstrap liquidity for all these uses. And there’s the additional issue of bit rot and all of the entropy associated with regular corporate databases, especially as these companies churn, get acquired, and go out of business. Blockchains aren’t great at many things, but retaining immutable, highly available data for long periods of time is one of their undisputed strengths.
So arguably, yes, you probably do need NFTs and blockchains to accomplish the things I am talking about here. NFTs give you digital persistence, and they exist on an open infrastructure that anyone can build on, query, and refer to. And there’s a huge market for NFTs that already exists, with lots of crypto-nouveau-riche buyers ready to go, and tons of already built financial infrastructure, so it just makes sense to build this there.
Yes, there’s might be a way to do some of this without blockchains, but why would you want to? It’s a bit like rolling up outside of Burning Man and pointing out that you don’t need to use that patch of land to throw a music and art festival in the desert. You could do it anywhere! Of course you could, but why would you start from scratch? Why wouldn’t you just… attend the gigantic, popular one that already exists?
NFTs started as a purely speculative market for digital-only goods. Over time, some of these came to possess artistic merit. In my view, there is a sound basis for the valuation of some purely digital NFT projects, especially those with clever mechanics around actually embedding the data on the blockchain. Generative projects, whether art or music, are also particularly compelling — they represent a novel artistic approach which aims to produce beauty and order with as little human oversight as possible. But it’s undeniable that most NFT projects are derivative, unoriginal, and frankly lame, and the NFTlash is well underway. Merchandise-redeemable NFTs offer brands a way to make their entry into this space without risking ripping off their clients. Moreover they offer a compelling value proposition, even if all of the pieces are still being assembled.
‘Physical’ NFTs seem very early to me. I am seeing a lot of fumbling around, false starts, and trial and error. But the category is compelling and gaining steam, despite the broader cooling off in NFT markets. A few years from now, I expect that people will think of purely analog luxury goods as a kind of anachronism. They will feel naked without their digital counterpart. Physical NFTs confer to the owner genuine, provable ownership, a persistent linkage with the issuer, and a conduit for safe secondary sales — not to mention the version you can wear in the metaverse . Given how much of our lives we spend online, it’s only a matter of time until the digital versions are more real than the analog ones.
Thanks to Cameron Robertson for feedback and Catherine Touchton for research assistance. Last edited: 07/31/22