October 21, 2021

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As published on TABB Forum (https://tabbforum.com/opinions/how-to-set-up-a-marketplace-for-nfts/)

Full article published below:

The interest in non-fungible tokens, otherwise known as NFTs, shows no sign of slowing down. Labelled by Christie’s auction house as “a unique work in the history of digital art”, an NFT of Beeple’s monumental digital collage ‘EVERYDAYS: THE FIRST 5000 DAYS’ sold for a record $69 million in October 2020. Six months later, an NBA Top Shot NFT featuring a LeBron James dunk sold for nearly $400,000 at auction. The month following, one of the earliest viral videos of the internet, ‘Charlie Bit My Finger’, sold as an NFT for $760,999.

 

To say there is keen interest in NFTs would obviously be an understatement, but what about the nuts and bolts of trading them? For those wanting to take advantage of the hype and set up a marketplace for NFTs, what aspects should be considered, including potential risks and pitfalls?

Not all digital assets are alike

NFTs are non-interchangeable digital files that live on a blockchain and, as such, are able to verify ownership of a specific work of digital art or other unique valuable asset, such as an investment-grade diamond. NFTs fall under the broader category of digital assets, yet there is a difference between NFTs and other alternative digital assets. If, for example, you were to buy a share of Bordeaux wine as a regular alternative digital asset, you would buy one case out of a hundred similar and interchangeable cases of wine. NFTs on the other hand are each guaranteed to be completely unique; or put in another way, you would be buying an exclusive, one-off, non-interchangeable bottle of wine, rather than a case that would be similar to many others.

 

What this means in terms of trading, however, is that NFTs are nowhere near as liquid as other alternative digital assets. It is therefore important that an NFT marketplace needs to be set up with that consideration in mind.

 

There are two different stages in the life cycle of creating and trading NFTs, consisting of a primary market and a secondary market. The primary market deals with the initial first offering and can take the form of either a list price marketplace, or an auction marketplace (please see here for more information on four different auction types). The existence of strong secondary markets, on the other hand, are important in providing reassurance to owners of an NFT that they could in future sell it onwards. Secondary markets can take place either as continuous price time priority markets or auction marketplace (as above). 

 

Because each NFT item is unique, it is essential to concentrate liquidity by attracting potential buyers when the owner of an NFT is considering a sale of the asset. When setting up a marketplace, consideration needs to be given regarding the price stability and frequency of market events or auctions. Creators of marketplaces need to ensure they design an auction that is unique beyond any doubt – similar to how famous auction houses, such as Christie’s, promote their forthcoming lots. Moreover, in order for people to enter your marketplace, they need to trust it. This trust is best built through transparency and historical prices, which are in turn achieved via secure delivery and custody. To help build trust in your prices, you need to clearly demonstrate that no market manipulation or market abuse is taking place on your exchange. 

Trusted marketplace infrastructure

For those thinking about building a marketplace for NFTs, an exchange infrastructure system needs to be put in place that is asset-class agnostic to ensure future flexibility as the space evolves, has visibility and transparency in terms of the order book history to determine price discovery and, most importantly, is scalable as your business grows, both in terms of number of users and number of NFTs available to trade. It is also imperative to keep abreast of relevant requirements by regulatory authorities around the world, which will only evolve and increase as trading volumes and public interest grows.

 

Ultimately, to attract customers, NFT marketplaces need to assure buyers that the platform is safe and that they can sell their NFT when they want to. This represents a crucial and down-to-earth component that will naturally follow-on from the initial very high levels of activity we are currently seeing on primary markets. A stable, trusted secondary market structure is crucial in the creation of sustainable, liquid and profitable markets, and in order to give buyers assurance they can get out of their investments in the future.

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