By releasing his third publication in 1776, Adam Smith concluded an immense project that he had mentioned for the first time 12 years earlier. He had spent over a decade building the theories that he meant to set out in a treatise of political economy. The result: the Wealth of Nations, the seminal book of the Classical school of Economics , which became an immediate best-seller. Even if you have not studied Economics, you have certainly heard about the title or the author.

Among those who have held a more-or-less condensed version of the 5-volume work, some may remember that the actual title is An Inquiry into the Nature and Causes of the Wealth of Nations. But few have actually read it. In fairness, the read can be daunting, in particular if you have chosen an original version in 18^th-century English. But once you overcome this hurdle, it is fascinating, irrespectively of whether you are an expert or a novice in Economics.

Assessing the validity of Smith’s arguments is difficult if you are not an Economist by trade or training. However anyone can follow the simple reasoning that lays the foundations of most economic concepts, and always supported by clear examples. Despite the two and a half centuries that have lapsed, many aspects seem to remain valid for the globalized societies we live in.

Adam Smith had an undeniable talent for teaching, which he could make use of as a Professor of Logic and Moral Philosophy at the Glasgow University. Yet, his ambitious project could not have materialized had he not left his prestigious Chair in Scotland. In the 18^th century, gathering the necessary documentation on topics as specific as the output of silk spinning mills of the suburbs of Lyon or Rouen, required to go on site. Or at the very least, to interview locals who could share insights. No Professor could have afforded a journey of several years through the nascent industrial Europe. For Adam Smith, the opportunity came from Charles Townshend, a powerful English aristocrat who hired him as Tutor to his son-in-law, the young Duke of Buccleuch. This did not only led him to accompany the young man on a two-year trip through France and Switzerland, but also guaranteed him the financial resources on his return to be able to focus on writing the Wealth of Nations.

Because of this landmark-book, Smith is often remembered as the father of liberalism and, in a somewhat reductive way, a “prophet of self-interest and free competition” ¹. His theories were taken up and developed by the Classical Economists over the hundred years following the publication, before being partially challenged by several movements, starting with the Neoclassicals in the second half of the 19^th century.

New products, new markets

250 years after Smith started to work on his treatise, the emergence of completely free markets of digital assets can shed a new light on his economic theories. In fact, we could approach it the other around: if the precepts set out by the various schools are applicable to digital assets, they could provide a useful framework to understand the evolutions of these embryonic markets.

PITTI have followed one of these projects, Sorare, since its beta launch in early 2019. Sorare produce NFTs, these digital assets underpinned by a blockchain that guarantees the ownership and scarcity of each token. Sorare's NFTs represent digital cards of professional football players and these cards are issued in a limited number each year. The owners can simply collect them - a digital version of Panini cards - but they can also build teams for fantasy football tournaments where scoring is based on the players’ real-life statistics during weekend games.

Kylian Mbappé Super Rare Source : sorare.com

What has driven men, for millennia, to spend their disposable income on games or collections of all sorts is a question that probably falls in the scope of Psychology rather than Economics. But Sorare’s products seem to meet these irrepressible needs so there was little doubt about the warm reception that their NFTs would get from users. And consequently, about the emergence of complex ecosystems with their own economies and markets.

Upon Sorare’s public launch, users appetite was undeniable and extended far beyond the circles of crypto-enthusiasts. Sorare auction sales amounted to about 3,000 ETH from March 2019 to June 2020, i.e. $610k converted at daily ETH/USD rate. And during the first 18 months of activity, an ecosystem quietly took shape. Update – November 2021: over the first 10 months of 2021, Sorare sold NFTs for a total of 36k ETH or 91.4m dollars, and closed 2 funding rounds, the last of which valued the company over $4bn. In less than 3 year, Sorare have established themselves as a global leader and are regarded as a major commercial and financial success.

At inception, everything almost started from a blank slate: there was nothing but NFTs "minted" over time and wallets where users could store their cryptocurrency (ETH) to acquire the NFTs in auctions. From an external perspective, very few aspects of the platform economy seemed to have been planned. This was probably the evidence of the founders’ confidence that key features of the blockchain technology, namely transparency and freedom, would naturally lead to a form of equilibrium. Yet, despite the great autonomy granted to the participants, the Sorare team retained control over few important functions, akin to the sovereign functions of a State in a real-world economy:

• User infrastructure: Sorare provide the main exchange platforms for primary auctions and secondary market, as well as a gaming platform. The way Sorare built the user infrastructure led to an anomaly since the existence of the currency predated the ability to barter cards. Before the barter functionality was developed, participants had to agree on an arbitrary price to sell and buy back each other’s cards, which led to biases in reported prices in the first months.
• Regulation: like a central bank, Sorare have official licences from clubs or leagues to issue tokens. Sorare set the volume to be issued on the primary market and can thus influence prices through supply. There are also a small number of restrictions or obstacles to transferability of their NFTs, which seem to primarily aim at protecting Sorare’s economic model. Finally, Sorare define the volume of rewards and the rules of the only game using their cards to date, with important implications in terms of utility of the NFTs beyond the mere collectible dimension.

The critical role of the blockchain technology is worth highlighting in many respects: it guarantees ownership on the one hand and, on the other hand, it removes counterparty risks during a transaction. These are two essential pillars to any efficient market. Incidentally, the blockchain technology allows to track all transactions from day one, which constitutes incredibly valuable information for anyone willing to study the economy of the platform.

Value & Prices: a paradox of the Classical School taken to extremes

To kickstart their project, Sorare brought together people from various backgrounds operating under pseudonyms - complete strangers to one-another – and therefore with limited sympathy towards each other. At best, they shared the feeling of being the same boat if it were to sink. Everyone had to rely on their own research to assess the “quality” of the NFTs and determine what a fair price could be. There was no secondary market place – transactions negotiated bilaterally were possible albeit cumbersome – and no certainty about the sustainability of the model… Everything fell into place naturally under the combined effects of the supply and demand, upgrades of the platform and developments in the broader ecosystem.

Price volatility was high during the first few months due to the concentrated user-base and the great disparity in profiles: a collector would approach value differently than a user who exclusively focuses on gaming utility, not only in terms of ability to participate in fantasy football tournaments but also in terms of maximising chances of winning.

Establishing the link between price and utility of NFTs is particularly significant in the context of economic theory. This link is indeed the cornerstone of the Neoclassical revolution that took place at the end of the 19^th century. To illustrate this, we must state the obvious :

• Sorare’s NFTs have a negligible input costs compared to their issue price (set in auction), even if you factor-in all the costs associated with IT infrastructure, intellectual property, labour costs , overheads, etc
• On the other hand, cards utility is multi-dimensional but not all dimensions are relevant to all user profiles. The collectible value is the perfect example of dimension that varies according to individual tastes. Then, provided you own a minimum of five cards to put together a fantasy line-up, each card has gaming utility. The gaming utility can vary massively from one user to another since, all else being equal; a new card would always have more utility for a user who only owns 4 cards than for a user who already owns 5…. or 500. For elite players, the cards’ gaming utility can extend to financial utility as in-game rewards can represent a substantial return on investment. Finally, users may try to take advantage of arbitrage opportunities on the short term or on the long term, which constitutes trading utility.

This setting offers an interesting perspective on one paradox that Adam Smith pointed out about his own theories: the paradox of diamonds and water. According to Classical Economics, the value of any good is determined by the input costs for the production process, in particular capital and labour. According to this theory of objective value, it is possible to determine an absolute exchange value for any good. Extracting and transforming a diamond requires significant resources, so the price of a diamond must be very high even if its practical utility is low. At the other end of the spectrum, water is essential to life but it is available in large quantities so very limited resources are necessary to collect it, and therefore its price is low. In the Classical theory, concrete utility does not come into consideration to establish the value of a good, only the factors of production matter. The diamond-water paradox lies in the fact that one could find by chance a perfectly clear diamond on a hike, but the low cost of sourcing this diamond would not materially affect the price for which it could be subsequently sold on a free market.

Several Economists proposed, independently but around the same time, a solution to the Diamond-Water paradox by dropping the theory of objective value and focusing instead on a subjective approach. According to this subjective theory of value, each individual determines the price of a product depending on the marginal utility, for themselves, of one additional unit of this product. Thus, price is directly related to utility but not to total utility of the product: it is instead linked to the marginal utility of one unit to a potential buyer. Water, for example, has very high total utility – in absolute terms, everyone needs water – however it’s marginal utility is generally low because, once you have drunk all the water you need, you can hardly take an extra unit. As long as it is available in abundance, its marginal utility decreases very quickly. Scarcity affects the rate at which marginal utility decreases because, even if an additional unit would have no concrete utility for its owner, this unit could be very valuable in an exchange with someone for whom concrete utility would be very high. This explains why rare goods are expensive: irrespectively of concrete utility, the imbalance between supply and demand on an open market drives prices. There is no concept of intrinsic value according to this approach - sometimes qualified as the marginalist revolution - which sets out the founding principles of the Neoclassical School. Whilst the Classical theory relied on value and articulated any economy around supply, Marginalists built their theory around price and considered demand first. For the former, cost drives price but for the latter, price drives cost.

Besides the fact that an approach based on factors of production would not really make sense for a digital asset, the subjective approach is perfectly illustrated by Sorare's NFTs.

Starting with collectible utility, it seems likely that marginal utility of a player's card drops significantly for an individual who already owns a card of that same player. Rapidly decreasing marginal utility can be partially mitigated by the limited resources required to store and maintain a “spare” digital asset, which means storage cost is virtually zero. Therefore, marginal utility probably decreases less quickly for a collection of NFTs than for a collection of physical assets, all else being equal.

In terms of gaming utility, marginal utility collapses beyond a certain number of cards owned by a user. This number ultimately depends on the number of simultaneous tournaments, which the cards can be used in: if users can only participate in 7 simultaneous tournaments and submit in each case a lineup with 5 different players, marginal utility necessarily decreases beyond 35 cards. At the time of writing, there were nearly 350 users with more than 50 cards. Update: As of November 1 ^, 2021, Sorare organised up to 32 simultaneous tournaments on a bi-weekly basis , and the number of users owning more than 200 cards was estimated to be between 500 and 1000.

It is worthwhile highlighting that, since the cards are issued in limited quantities varying from 1 to 100 copies per year depending on their categories, some cards could end up being very rare if Sorare attract hundreds of thousands of users. This speculation is sufficient to maintain a medium- to long-term trading utility for cards, and justifies that users hold on them even if they have no gaming utility. Speculation on trading utility can therefore support marginal utility of a card for its owner. In 2021, Sorare introduced a new category with 1000 copies per year.

As a final nail in the coffin of the theory of objective value : an irrational dimension to price can arise out of auctions, because adrenaline may affect decision making. But that again is more about Psychology than Economics.

The emergence of a market

Because of individual tastes and motivations, the "fair" market price of Sorare cards is and will always be subject to one’s judgment. In practice, no market price could emerge before a critical mass was reached in terms of users, cards in market and transactions. Normalisation of prices was also influenced by the emergence of third-party platforms leveraging Sorare’s API and blockchain to analyse and display transaction history, aggregate them to provide moving averages, and help putting prices into perspective with the cards in-game utility. And of course, market prices were strongly influenced by the increasing tension between supply and demand when the user base started booming.

Indexe prices (left) and number of paying users (right) through June 30, 2020.
source : soraredata.com

Daily transactions (left) and number of paying users (right) through June 30, 2020.
source : soraredata.com

The information edge was not limited to trading purposes: qualitative information about football players, their past performances and their statistics, allowed users to increase materially the yield on invested capital through in-game rewards. As information on players became more widely accessible, and as the number of licensed players and the number of tournaments continued to increase, many new users chose to allocate their capital to a limited number of segments in order to be more competitive. For example, by only buying players under the age of 23, or only players from Chinese, Japanese or Korean leagues, which can be played in dedicated tournaments.

On Sorare, specialization is difficult to assess a posteriori because the steep decrease in cards’ marginal utility drives users to diversify over time: maximizing yield on invested capital involves swapping rewards earned in one segment for cards that have gaming utility in another segment. Purely on the basis of gaming utility arbitrage, no user should refrain from recycling their earnings away from their initial focus, unless they doubt the sustainability of Sorare’s model or they lack time to properly follow other leagues. The expected development of new tools allowing users to minimize the time required to play in multiple tournaments, and therefore to maximize yield on invested capital, must contribute to a higher reinvestment rate.

The earning recycling strategy finds its limit when all spots are filled, including alternative options in case of injury, for all simultaneous tournaments. It is therefore surprising that no lending platforms has ever emerged to help maximizing the cards’ gaming utility. If counterparty risk seems extremely high in a market where most participants operate under pseudonyms, there are technical solutions on the Ethereum blockchain to prevent situations where the lent assets are not recovered. Such smart contracts would be a prerequisite to the setting of acceptable interest rates. To address the capacity constraints on Ethereum and associated spikes in costs, Sorare transitioned to a model involving an intermediary layer between their own platform and Ethereum. This solution presents many benefits for users and Sorare, but does not currently allow "smart contracts", which prevents the implementation of collateralized solutions, including loans or any "derivative" products supposedly backed by Sorare's NFTs.

Absent of a scalable solution enabling loans to any counterparty, maximizing marginal utility of the cards is likely to imply bilateral – or multi-lateral - arrangements between users. These groups would then have a chance to maximize the return on their pooled capital, albeit solely relying on trust. In that scenario, marginal utility ironically drives the constitution of a political economy motivated by individual interest, which is the starting point of Adam Smith's theory. This reasoning also constitutes an interesting bridge between the Game Theory and Economics, another reason to study Sorare’s peculiar model. Drawing the parallel with real-life economy, if such groups of users manage to secure a substantial share of in-game rewards, they should be in a position to influence prices. As an issuer, Sorare may find a benefit in artificial prices in the short term, but that is not necessarily true in the long term. If such scenario materializes, it will be interesting to see how Sorare approach the issue.

What to expect in the long term?

Given Sorare's incredible momentum and booming demand for their products which are scarce by nature, it is impossible to assert that maximizing gaming utility will be a better strategy in the long term than holding on all rewards to bank on trading utility down the line. The drawback of long-term strategies on Sorare is that a large number of factors can hardly be anticipated due to the low maturity of the platform, even in the most optimistic scenarios:

• On the demand-side, the pace of user acquisition, not merely growth in user-base, is bound to play a critical role since new-user demand carries the most gaming utility, and therefore supports the most the value of new cards, including in-game rewards. Since rewards constitute the financial utility of the cards, their value remains critical to Sorare’s economy.
• Considering the broader ecosystem, any arbitrary decision by Sorare could materially affect – positively or negatively – the gaming and/or financial utility of the cards. Decisions from regulators could also affect utility - most likely in a negative way, unless the clarification regarding their stance towards NFTs allows third-party platforms to emerge, thereby boosting utility of the cards for gaming purposes or otherwise. Focussing on gaming utility, if third-party platforms enable to use the same card in several tournaments simultaneously, which Sorare do not allow today, the impact on price could be significant (and would not necessarily affect all cards in the same way).

There is so much to speculate about the future of Sorare's economy. But for anything that's in the past, it's on the blockchain. Economists will certainly end up making it a subject of study.

When this happens, all holders of Sorare cards will hope that their conclusions will not confirm the theories of Alfred Marshall (1890). His work attempted to reconcile the Classical and Neoclassical schoolsby asserting that, although the subjective value prevails in the short term, in the long term, the objective value shall prevail. The diamond-water paradox would thus find a new example with these NFTs that have negligible objective value in the primary market, yet high objective value in the secondary market if sellers have either acquired them for a high price, or won them in tournaments using very expensive cards.

That said, there is a realistic scenario where the objective value of these NFTs increases significantly for Sorare themselves: given their auction revenues are available via the blockchain, clubs and federations could quickly raise the stakes for licenses. If so, the economic model of Sorare will play a crucial role: the price of licenses, the rewards payout, etc. No doubt that follow-on articles on the economy of Sorare will be necessary.