For digital goods, focus less on supply and more on demand

Digital goods are still in their infancy. As people spend more of our time in virtual spaces, we can expect digital assets to play a greater role in our lives. Most discourse around the future of digital goods has focused on scarcity. Issue the good on a blockchain and you can verify its supply. But I think focusing on scarcity is a red herring.

The allure of scarce digital goods is rooted in observations that rare physical goods tend to be valuable.

Take the Birkin bag, which I wrote a thread about. Retail prices for the bag go up ~10% each year. But even at the high $10K+ price tag, the bags sell for a significant marketup in the secondaries market right after. Short supply plays a big role–there’s a whole dance potential buyers have to do in order to obtain a bag which sometimes requires long wait times–but is only one albeit important piece of an entire narrative that fuels the high demand.

The reason these bags are worth such a premium to the cost of production is because of a shared belief that ownership of said bag signals membership into a class of elites. Because of this shared belief, the owner of the bag benefits from a feeling of both belonging and superiority as they interact in society. And these feelings persist in the privacy of their home, where a glance at their bag reminds them of their high place in society.

For a different group of people, the same is true of rare sneakers and limited designer apparel. And for yet another group, rare vintage cars.

We have seen some early examples of these behaviors in the virtual world. Rare cosmetics in video games are attention grabbing. I own a few rare Dota items that have appreciated considerably since I bought them. Here’s a hook and a staff that are up ~3x.

These items are worth something because they were hard to obtain (you had to buy them during the international tournament), will never be reissued, and are recognizable by all players in the game as something special.

They have value because there’s a shared belief that they’re valuable. In this way, digital goods are like bitcoins. They don’t have an intrinsic value, they’re priced by a market. And a high price is a result of a compelling story that enough buyers and holders believe in.

Scarcity matters, but not in and of itself. Part of why the golden hook is desireable is because there are no other golden hooks available. If another more plentiful skin looked identical, it would diminish the value of the original.

But scarcity comes after the establishment of an aspirational narrative around that asset. The item is issued and the community reacts to it. If the reaction is favorable, there will be demand. And if the supply cannot satisfy the demand, then it can become a collectible.

That same asset with the same art and same supply but unusable in the game would be worth ~$0. Without the conspicuous consumption of the item, the aspirational narrative fails to form, and any scarcity doesn’t matter.

It may be easier to grok the point I’m making by returning to physical goods. Birkins are the runaway winner of the luxury handbags market. Gucci, Chanel, Dior, etc. they all make good money selling their bags, but those bags do not retain their value (and even appreciate) the same way that Birkins do. That isn’t to say there isn’t a great business to build around selling luxury bags (there obviously is), but the market is not infinitely sized.

In other words, there is a limited number of assets in any category that can be collectibles and thus stores of value. The rest of them are essentially commodity goods that sell their products to those unable to obtain the collectibles.

What this means for digital goods is that for every aspect of our life that becomes increasingly virtual, there will likely be the Birkin bag equivalent. Something that the elite want to own to signal their elite status. And behind that high-demand asset, a collection of other, less desireable but still saleable assets that those without access to the “Birkin” will buy.

But the market for the items that are unable to win the collectible narrative will trend towards essentially worthless, as the cost to create them is zero.

A drum I’ve been banging for over a year is that crypto people have been too focused on “digital scarcity” as the end all be all for making digital goods worth something. In fact, as the Dota 2 skins marketplace shows, users are satisfied with the current level of trust. What makes digital assets valuable is the narrative that they are valuable. Scarcity can play into it, but much more important is the aspirational narrative and the conspicuous consumption.