We’re not cool. That’s why we’re in finance.
But people want to be cool. As highly social and intelligent animals, we want and need to belong, differentiate against each other and negotiate for status. We create signals and hierarchies to create pockets of relational capital, which we then cash in for real world benefits.
Such mammalian realities are contrary to the economic rendering of the homo economicus, the abstracted rational agent making choices in financial models. In 2021, our financial models are waking up and instantiating themselves, becoming decentralized autonomous organizations (DAOs), spun up by decentralized finance (DeFi) and non-fungible token (NFT) industry insiders, and implemented into commercial actions on-chain. Behavioral finance finds edge cases where reason ends and our hormones take over. Then we can add (1) the democratization and commoditization of everything, and (2) technologically accelerated fashion and luxury.
One intuition is to sell things to as many people as possible and to make those things as cheap as possible. This is the intuition of an "attention economy," created and warped by the last two decades of internet advertising and venture capital blitz-scaling logic.
This is also the complete opposite of what you want to do with a branded, luxury good.
Then, you want to sell as few things as possible, and for as much as possible. That means instead of having everyone running around with your product, making it commonplace, a select few will be the beneficiaries. When everyone else is excluded, the beneficiaries accrue cultural capital. They are admired for their “having,” and it is precisely the “lack of having” on the behalf of everyone else that makes the luxury thing valuable.
Taken together with a brand narrative – a qualitative and consistent messaging about personal values that the brand represents – this creates intangible but highly valuable brand equity. That brand equity is destroyed with actions like cutting price or making the luxury goods feel less exclusive to access. This negative is what is highly priced in the first place.
These days, it is no longer mere exclusivity and price that drive purchases. Instead, emerging luxury brands and goods have to connect to the “zeitgeist,” the cultural heart of the global conversation. That might mean being backed by the largest musician or sports influencers. See the neobank Step being backed by TikTok megastar Charli D’Amelio, or the green finance company Aspiration get funding from Drake, or the cryptocurrency exchange FTX working with Tom Brady.
Purchasing social clout from the right people, plugged into the right story, will turn whatever goods you make from commodities for consumption into emotional avatars for the owners. If your target audience is price-insensitive, then you should charge their maximum willingness to pay, as well as protect their purchase by pricing out people who are not like them. That is partly why some limited editions NFTs, CryptoPunks, have been accruing unbelievably value.
As practical finance people, some might be wagging their fingers right now at irresponsible investing practices. What kind of pixelated asset allocation is this, one might ask? But that is entirely the wrong question – one about money, financial planning and mathematical outcomes.
The right question is instead about the size of the luxury market. Knowing what we do about the preferences of the human animal, let’s measure how these preferences are commercialized today. Bain tells us that people are spending $1.2 trillion per year on luxury goods, of which $34 billion is fine art and $550 billion is cars.
Within that, the luxury goods market is around €300 billion ($355 billion) per year, growing at nearly 8% annually. It is no surprise that such trends would make their way into our digital world, as the digital world reformats physical reality into the metaverse. There is nothing especially rational about people that find themselves on the internet – they are just as impulsive, tribal and mercenary as those in the physical world.
The function of fashion
It’s a big opportunity, and there is one more attribute we want to highlight, which is the connection between luxury and fashion. Let’s review the microeconomics of exclusive goods:
- What do you do if the demand for a high-priced luxury good is not there? The right answer is not to discount and sell to the masses. Rather, it is to destroy the unsold inventory.
- What do you do if the demand for your high-priced luxury good is extremely high? Do you create more prints or permutations? Nope. You raise the price of access so that fewer people can afford the special status.
But it is hard to build a business with recurring revenue on such grounds. You do not know the state of demand, or how successful the brand's positioning is going to be. Mistakes are irreversible. And there is no reason for engagement from the millions of losers (in the sense that they are not winners of some auction) if the exclusive thing is permanently defined and permanently owned by the elite.
Fashion makes things popular and then unpopular. It catalyzes consumption. That means that if you did not hit the right notes this season, there is always another season. Turnover creates hope for the masses and a constant need to re-invest by those with high status to keep their status. Therefore, revenue becomes recurring. The artistic or cultural value of the object from the prior season is no longer guaranteed as being in style in the following season. Further, there is a motion around a creative process, and an engagement around the unveiling of new creative outcomes. You can have an entire industry of stories, brand narratives and collaboration with non-exclusive participants.
And that is now exactly what we are seeing with digital objects.
NBA TopShot was extremely popular early in the year, and is materially slowing down. Axie Infinity, a blockchain insider collectibles game, is gaining some real steam. CryptoPunks have cemented their position as the premier luxury asset for crypto avatars, and their price is rising and falling with the rest of the markets. Demand for some projects, like Art Blocks, is rising organically. Other things are almost poisonous in how uncool they are, like some common CryptoKittys we hold.
All these sentiments are likely to flip, twist and change as the social hive processes new thoughts and positions on its own evolution. They are not market bubbles selling vapor to unsuspecting investors. Rather, they are art fashions, some of which may be everlasting Mondrians, while others are meaningless decorations that will fade over time.
As Silicon Valley's ethos and technology permeated finance, one hypothesis was the fear of media companies becoming financial companies – see Google. But something else is happening, too. Financial products and financial distributors are taking on media DNA. They are natively social and sentiment-oriented. They are massively retail, transactional and FOMO driven.
All of this brings us back to DAOs (see this article by Linda Xie or our 2018 meditation on the topic). The early DAOs are almost entirely financial in nature, coordinating the running of DeFi protocols. New entrants resemble either investment syndicates, artistic communes or some beast in between. But they all have the glue of internet culture and memetic connection between them. Unlike regular organizations, they are born of technological utopia even if some day anchored in human law.
Because DAOs anchor to the blockchain world, which enforces digital scarcity, they must manage the concepts of luxury and scarcity that we’ve explored. Code and data have no cultural meaning, and thus that meaning must be manufactured by a social layer of people organized for the purpose.
Not everyone can afford to be a market maker. But lots of people can govern the protocol that allows market making, create stories around it and profit from keeping it fashionable. Not everyone can buy an NFT. But lots of people can pool together to do it, while also building a meta-influencer entity that signals the cultural relevance of the purchased object. With this alchemy, a DAO could turn seasonal financial fashion into timeless investment art.