„Wasting Money“ Is An NFT Use Case And Creates Great Communities

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The past few months have been brutal. Crypto prices plummeted, NFT trading volume collapsed and many speculators fled the market.

This spawned the „Use Case Debate“: Tech and media establishment folks yell that crypto is worth-, use- and pointless. Web3 folks respond by outlining use cases and a potential future.

These debates often focus on the financial infrastructure, but overlook the cultural aspects of crypto and NFTs.

Because if you’re in web3, you know many NFT communities are incredibly supportive and helpful—distinct from any non-crypto community. That’s not an accident. And a theory rooted in economics, game theory and evolutionary biology might explain why.

In this essay, we’ll explore why NFTs create such great communities. It all starts with a simple, but ridiculous insight.

“Wasting“ money is an NFT use case.

That sounds crazy coming from a guy who works full-time in NFTs. So let me clarify.

The collapse in NFT activity and prices seems like it vindicated the right-click-save regiment: Most now-worthless NFTs turned out to be just JPEGs. But that doesn’t mean the whole technology is useless. If you've ever been in a great Discord, you know NFTs are great at creating awesome communities.

If you've ever been in one, you know NFTs often generate better collaboration and culture than other online communities. Community might seem like a gimmick, but membership communities can be big:

  • Chief is an 8-figure business, likely bringing in more than $10 million in revenue yearly.
  • Depending on your source, Tiger 21 makes revenues between $16 million and almost $50 million.

Those are just two companies among many. So if NFTs are better at orchestrating useful communities, it could spawn big, decentralized businesses.

But while we’ve got tons of „bullish on community“ tweets, „Here’s how to build a 10x community🧵“ threads and community manager job listings, nobody seems to ask a simple question:

Why are NFTs so good at creating community?

Because nobody seems to be asking this question, I did.

In this essay, we’ll explore why I think NFTs build great communities because they let us waste money in the most effective way—and the biology/economy/game theory underpinning it.

We'll start with a primer on community, continue with the basics of signaling theory and finish with how it helps you build a great community.

(Note: This is not a definitive theory or the only reason why NFTs create great communities. It’s a lens that augments your toolkit of looking at NFTs. And the obvious disclaimer: Because NFTs can be anything and everything, this doesn’t apply to all NFTs, just ones with holders/builders actively creating communities.)

What is community? A primer

In true high school valedictorian fashion, let’s start with a dictionary definition.

"A group of people living in the same place or having a particular characteristic in common."

That's community according to wherever Google gets its definitions. This might seem vague, but is useful when you compare it to the definition of organizations:

"An organized group of people with a particular purpose, such as a business or government department."
(Bolding mine)

A community doesn't have a built-in purpose. An organization does.

You've seen this with mature NFT projects. They often have a DAO and a community. The DAO (where the O stands for organization) has a purpose: Make decisions about the project's future. The community doesn't: It just vibes.

Now, we said in the beginning that NFTs create great communities. But if a community is just a bunch of people with things in common, what makes one good?

Specifics depend, but let’s agree on these principles for this essay:

  • Members want to be part of this community and identify with it.
  • Members interact with the community regularly.
  • Members feel others in the community wants the best for them and they want the best for the community (and other members).

With that in mind, let's dive into how to create an NFT community which fulfills those ideals—by wasting money. And by „wasting money“ in all the right ways. The backbone to this is called signaling theory.

Why Signaling Makes NFT Communities successful

Why do people spend $250k on Lamborghinis? $5k on Gucci handbags? Millions on rockets that get them to space for a few minutes?

Signaling. We all have a fuzzy sense of signaling: Somebody buys/believes/says something not because they want/believe it, but because of how others will see them.

But signaling is more than flexing your belongings or spewing political beliefs onto Twitter/Instagram/otherwise peaceful Christmas dinner conversations.

Signaling is at the core of how humans interact. And because NFT communities are a function of human interaction, signaling drives those too—and NFTs make signaling way more efficient.

But let’s first clean up signaling’s image.

The Truth about Signaling (it's actually great)

When you first read „signaling“ you might’ve thought it's about buying useless things to impress others.

Yes, that's signaling. But while flexing is signaling, signaling doesn’t equal flexing. It originates in game theory (no strategy matrixes or math ahead, promise!).

In game theory, signaling solves a simple, but ubiquitous problem: Information asymmetries.

Here's an example: Let's say you're rich and you want to get a loan. The bank doesn't know you. In a post-Neural ink world where the banker knows everything you know via Bank-to-Brain API, they’d throw the money at you—the more they loan you, the more interest! But we don’t have Neuralink. In fact, when you walk into the bank, they know nothing about you. And if they gave out loans to anyone, they’d go bankrupt from the defaults.

The information asymmetry (the bank doesn’t know what you know) keeps you from making a mutually beneficial transaction.

Once you know the pattern, information asymmetries exist everywhere:

  • Good applicants know they're hard workers, but employers don't. If employers knew what the applicants know, they'd both be better off.
  • Brands know their products are superior, but their target market doesn't. If the target market knew what the brand knew, they'd both be better off.
  • Many people feel attracted to each other, but never make a move. If they both knew what the other knew, they'd both be better off.

You could come up with hundreds more. Information asymmetries are everywhere. And signals are a way to overcome them.

Signals bridge information gaps and enable cooperation.

„Why should we give you a loan?“, the bank teller mutters, clearly assuming you’re yet another huckster trying to build one of them newfangled NTF things.

„I’m actually pretty damn rich bro, made a lot of money couple years ago“, you respond. Adjusting your Ed Hardy tanktop to emphasize the point, you expect the money in your account tomorrow.

You know it’s true. And yet, the bank teller rolls his eyes, sighs, hands you a stack of loan application papers and hopes he’s exorcised you from his premises.

This hopefully somewhat entertaining story illustrates that merely telling people something is a weird signal. As they say, talk is cheap. That’s why we need more expensive signals:

To finish your loan odyssey, you have to make a down payment and/or provide collateral for the loan. This proves that you have money. In game theory lingo, this is called a costly signal. Costly signals have a cost (who woulda thought?), which makes them harder to fake.

Costly signals are more trustworthy and reliable than cost-free signals.

The more costs you're willing to incur to send this signal, the more likely your signal is to be reliable, i.e. accurately conveying the information that bridges the gap in the information asymmetry.

Let’s see how costly signals bridge the information asymmetries from the examples above:

  • The applicant gets into debt to attend a famous university which requires hard work to graduate from. The employer presumes the applicant is a hard worker.
  • Brands spend millions on primetime TV campaigns with celebrities and Hollywood-level filmmakers. Consumers presume the brand must have something to say if they’re willing to spend that much.
  • The single man brings the single woman flowers. Because that’s something he’d never buy just for himself, she believes he did that just for her. (Hat tip to Rory Sutherland for this example)

On the surface, these things all „waste“ money or energy. Universities teach next to nothing in terms of practical job skills. TV campaigns create no direct product sales. Flowers have no practical use to the man.

„Uselessness“ makes things work as signals. The receiver knows the sender expended resources only to convey information that enables cooperation.

Now, before I release you from the purgatory of terminology, we need to answer one more question:

What happens when an insincere person emits a costly signal?

Costly signals aren’t perfect. Some primetime commercials advertise questionable products and services. But on average, what’s advertised on primetime TV is more likely to be legitimate than what’s advertised on handwritten paper taped to street lights.

That is why these signals are also called honest signals. They’re not perfectly true all the time, but they’re true often enough to be useful.

So while down payments and collateral don’t eliminate credit defaults, they allow banks to offer loans at a profit.

Alright, grab a towel, wipe the sweat off of your forehead—we’re done with definitions. What does that mean in practice?

Luxury Products (and NFTs) Are “Just” Signaling

As we explored, the uselessness of costly items makes them better signals because they lower the share of resources spent on utility and raise that spent on signal transmission.

That’s why Gucci handbags are smaller than Eastpak backpacks, why the flashiest Lambos only have two seats and why mediocre cartoon JPEGs sell for big bucks.

Tk pie chart signaling vw vs. lambo

This is why this take is naive:

"That's a waste of money because it does the same thing my much cheaper/free alternative!“

(This is a generalization of the „right-click save“ NFT criticism)

But a Lamborghini doesn't exist to get you places. Gucci handbags aren't for storage and NFTs aren’t for anything tangible. They’re mostly signals—which is precisely the point.

In biology, this is called the handicap principle.

A flower is just a weed with an advertising budget.
-Rory Sutherland

A male peacock's beautiful feathers serve no purpose besides attracting females. The bigger, more colorful the useless feathers a male peacock drags around, the more females he attracts. This transmits a signal of extreme evolutionary fitness: “Look how many useless feathers I can drag around and still be fine!“

The same is true in humans. A Lamborghini communicates: "I'm willing to overspend on a sports car with almost no utility over a VW… and still survive.“

If you’re mostly paying for signal transmission, then you’re not buying the product, you’re buying away an information asymmetry.

If the utility of removing an information asymmetry is higher than the utility of the money it costs you, „wasting“ money on useless things is quite useful.

If you want to convince a community it’s worth having you as a member, could there be a better signal than buying a silly cartoon animal JPEG for thousands of dollars, just so you can join their Discord server?

Now, this „buy less to signal more“ doesn’t work ad infinitum. At some point, the cost either exceeds the utility of bridging the information asymmetry or the utility becomes too low—if you buy a Lamborghini to signal your wealth to women, you can’t drive them home with you in a single seater.

So costly signals have some boundaries. More specifically, there are 3 of them:

How many resources should the signaler spend on a signal?

Buying away the information asymmetry is a rational cost. Anything beyond that is truly wasted. That’s the theory.

But in practice, we don’t know what the right price for a signal is. Will a BMW be enough to signal you’re the richest person around—making a Lamborghini purchase wasted money? Not knowing the right price makes it hard for signalers to send the information they

How does the receiver know the signal is real?

A costly signal is only effective when the receiver recognizes it as such. If I spend millions on a Cy Twombly painting to signal my taste and sophistication, but you think it’s my toddler’s scribbles, the signal doesn’t work.

When does the signal stop being useful?

No signal is useful forever. If you want to signal something by always having the newest iPhone, then your current signal wears off whenever a new iPhone is released.

Similarly, a bank might reevaluate your loan if you lose your job—even if you made a down payment.

Wrapping up Part I: Signaling 101

People and/or organizations often fail to cooperate because of information asymmetries: One party knows something the other doesn’t. If both parties had the same information, they could collaborate and both would win.

You can bridge information asymmetries with signals which deliver that information to the other party. Because signals are so useful, people will fake them.

To deter lying, people are more likely to believe in a costly signal. Anyone willing to incur a cost to send a signal is more likely to be sending a true signal.

But even costly signals have 3 constraints:

  1. What’s the right cost? Signals need to expend resources to buy away the information asymmetry, but not too many.
  2. How do receivers know the signal is authentic? Receivers need to verify the signal conveys accurate information.
  3. When does the signal stop being useful? Signals cease to be effective when circumstances change.

The Handicap Principle explains why costlier signals often have less inherent utility: By incurring a high cost for less utility than cheaper alternatives, you send an even stronger signal: You can „waste“ your money on something which only exists to signal and still be okay.

That’s a short introduction to signaling theory. Now, our examples so far examined 1:1 interactions. But we’re here to explore why NFTs are great signals for cooperation in groups of people—communities.

So let’s turn on multiplayer mode and dive into Part II.

Signals & NFT Communities = Match Made in Heaven?

Now that you know signaling theory, it’s easy to jump to conclusions about why NFTs make great signals and call it a day. But we need to start from first principles—why do communities require signals? What’s the information asymmetry?

Communities are flows of resource contribution, resource extraction and resource creation.

At its simplest: If you’re answering questions in an NFT Discord, you’re contributing resources. If you’re asking questions, you’re extracting resources.

And community resources are always constrained. A simple example for the Discord above is that of community member time. There’s a total amount of hours spent by community members in the Discord. Let’s call that x. When the time required to answer each question exceeds x, you need to either lower extraction or increase contribution.

This applies to every resource a community may have, from talent to capital to emotional support.

In that sense, there’s an intangible, immeasurable balance sheet to every community. If it’s in the red, the community is on a runway before it breaks down. If it’s in the black, it’s growing and creating benefits for its members. This is a concept called social capital.

(Sidenote: Social Capital is a fascinating topic itself—and central to community building. If you’re curious how it applies to web3 communities, please harass me on Twitter to coerce me into writing an essay on it.)

So when someone wants to join a community, existing members need to discover whether that person will increase or decrease the bottom line of the sheet.

They can’t know that. And ét voila, we have an information asymmetry shining a bat signal for our superhero, the costly signal. So while it’s donning a cape and putting on a mask, let’s look at a successful example. Here’s how costly signals enriched the (non-crypto) punk community. These guys:

How Costly Signals Made The Punk Community Powerful

Since the mid-70s, the Punk movement has been a safe haven for weirdos, radicals and other outcasts. The movement has had its peak, but you can still see them asking for change in many major cities.

Punks have strong community. While they judge, insult and trample anything remotely resembling an establishment, they accept other punks with all their quirks.

This unwavering support is social capital that would be wasted on non-punks. That’s why, like many subcultures, punks sniff out posers like well-trained Rottweilers.

Posers would never invite the societal judgment that come with a rainbow Mohawk, spiky leather jacket and denim vests adorned with anarchy buttons. With „punk signals“, you’ll never get a normal job.

That’s what makes the punk community work:

The cost is high, so anyone willing to pay this cost to emit the Punk signal is authentic and will see the community welcome them with open arms.

The mechanics are almost identical in NFTs.

A weird phenomenon swept Twitter in 2021, causing confusion and outrage in its wake: From household name celebrities and tech CEOs all the way down to anonymous accounts, people changed their profile pictures to CryptoPunks.

Like the colorful bunch blasting hard rock music, NFT degens visionaries traded in their normal appearance to signal where they belong—even if their appearances had made them rich.

The same is true for Bored Ape Yacht Club, Gutter Cat Gang or whichever combination of adjective, animal and association you choose.

This is the social cost that adds to the financial cost of NFT PFPs. In other words: NFTs are good costly signals.

That’s because they solve the 3 constraints of costly signals uniquely well:

How NFTs simplify creating great communities

Let’s recall the 3 constraints that can inhibit effective costly signaling to break down:

  • How does the signaler know how much to pay?
  • How does the receiver know the signal is real?
  • When does the signal stop being valid?

Let’s talk about how NFTs solve these:

1. The market dictates the price.

NFTs have a transparent market price. That way, anyone knows the minimum price of emitting the signal without overspending (or spending without getting the result).

2. Blockchains serve as a base layer of truth.

The core function of blockchains is to authenticate which signals are authentic. A confirmed blockchain transaction never leaves the signal receiver guessing.

3. Token-gates kick you out.

Token-gating solutions kick out users who don’t hold the NFT (anymore). This clarifies when community membership is over and somebody has no more rights to the community’s resources.

Strong communities emerge thanks to these 3 points. Because they’re built into an NFT community’s social fabric, members trust each other enough to build together, meet up and create treasuries.

“But you don’t need a blockchain to do that!“

At this point, crypto skeptics, right-click savers and other heathens would shriek at you:

  1. “Communities can do these things without NFTs. Off-chain communities create useful signals and build things, too!“
  2. _"People in NFT communities mistrust, cheat and steal from each other too!“ 
    Both true. The signaling properties of NFTs don’t _eliminate _mistrust. Floor price obsessed, speculating gremlins haunt many communities. And NFTs don’t enable building together—modding and fan fiction communities have shipped impressive projects before blockchains ever existed.

But NFTs lower the bar to trust and cooperation. Information asymmetries require off-chain communities expend lots of resources increasing trust and decreasing mistrust, i.e. creating, exchanging and verifying signals before they collaborate.

As outlined above, NFTs automate most of this. Collaborating with strangers online (whether that’s a supportive community, launching fashion brands or building software) on the internet wasn’t impossible before. It just came at a high cost of bridging information asymmetries manually.

NFTs collapse these costs by providing signals that bridge those information asymmetries. People deterred by these high coordination costs now start to collaborate. NFTs don’t make new forms of community possible. They make them viable. So when people call NFTs a waste of money purely intended as signaling, they’re right. They’re just not the audience.

Community-driven NFTs signal to a community that someone is likely to be a net-positive member. The prospective member pays a cost for something „useless“, the community knows they truly want to join the community.

Because the signal is honest—true often enough to be useful—new forms of collaboration between strangers on the internet become viable.


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