On DeFi and NFTs in Wine

I truly believe that blockchain will eventually change the wine industry. Over the last 5 years, Bitcoin surged to new highs and more corporations are making the push into blockchain. There are more practical use cases for crypto today as evidenced by the growing institutional adoption and it has even made its way to center stage in the Ukraine – Russian citizens digital showdown: crypto donations to the Ukrainian army and Russian utilizing crypto to avoid the impact of sanctions. Most corporate blockchains have been a failure (with the exception of companies like IBM, AWS, MSFT) – there has been a lack of product-market fit for most use cases. For any new technology to succeed, product-market fit is a must. Users need to understand the real value of moving to a new model, especially one that is more technically sophisticated than the familiar solutions that exist today.

IMO, two areas within blockchain technology have emerged with true product-market fit: Decentralized Finance (DeFI) and Non-Fungible Tokens (NFTs). I am exploring a combo of these two areas because it’s where things get interesting and why I think there is a compelling use case for the wine industry.

• If you need a 101 on DeFi or NFTs, check out Investopedia here and here.

In Wine Investing 101, I outlined some of the challenges within the high-end collectible wine market. I’ll dig further into those and offer a solution built on a public blockchain, using concepts from DeFi and NFTs. The high-end collectible market is the niche market segment we’ll start off with, as with most disruptive technologies, it will eventually move to a more mainstream market.

If the names Screaming Eagle, Sine Qua Non and Harlan Estate sound familiar, great! If not, they are very popular and very exclusive California wineries that have waiting lists of 10+ years just to buy the wines at the winery released price (WRP – I’ll circle back to this). For the most part, buyers will never drink these wines, which is sad to me but so be it – they will be held for investment or collection purposes and later resold at auctions or online wine exchanges.

• Challenge 1: the transaction costs are high and there is little liquidity. Remember, wine auction houses charge around 15-30% of the sale price in fees to buyers and sellers. In addition, packaging and shipping these wines to auction houses is expensive and settlement is time-consuming. More time + more money = very inefficient. You all know my wine collecting story – I am sitting on some bottles that I’d love to sell one day but there are barriers to entry, and I am forced to HODL.

• Challenge 2: and we circle back to winery released price (WRP). Wineries set their prices according to demand but on the secondary market, things change – many of the wines command a huge premium. Wines are bought at WRP and immediately sold at a higher price. I’ve heard of some buyers even selling their spots on those wait lists. This excess premium and secondary market activity is lost value for the winery. I’d draw an analogy to when a company IPOs – company sets a price of $10/share, it opens up for trading on the exchange at $25/share – the true market value was $25 and the extra $15 went to the bankers and investors who were “on the list” for the IPO.

Enter DeFi. It’s a better solution to solve for market inefficiencies. Several of the core principles can address these problems:

• Decentralization: no middleman entity has the power to set prices or control supply and demand.

• Transparency: transactions are visible and stored on the public blockchain, so it enables efficient price discovery.

• Immutability: transactions are securely recorded and cannot be tampered with. Remember: provenance.

• Composability: highly programmable smart contracts that create new transaction mechanisms.

Let’s envision what the wine market would look like after applying these principles:

The winery issues tokens to members on its mailing list each time a new release of wines is ready – let’s call the token $WINE. The tokens are minted, and the mailing list members purchase them and will redeem it for wine later, replacing the antiquated mailing list concept. If the holder of the token decides to sell it, rather than redeem it for the wine, a more formal decentralized exchange with price discovery is where the transaction would happen. The winery may not see an obvious value (just yet). Bear with me…

Using smart contracts – what if every time these tokens traded on the open market, the winery received a percentage, like a royalty structure and how some NFT art is designed. Someone with a token to Harlan Estate Cab sells it on the exchange for 4 ETH (worth about $9600 today), the winery would receive a % of the 4 ETH. If the tokens have not been redeemed for the physical bottle (i.e burned), the winery will get a transaction fee every time the bottle trades hands – an incredible incremental revenue stream and more efficient secondary market for all parties. The sellers create liquidity without having to worry about shipping and storing wine and the buyers benefit from the provenance on the blockchain and flexibility of reselling or taking possession. But wait….

Enter NFTs: an NFT is a one of a kind asset in the digital world. We all know those serious collectors love to show off those dope bottles in the cellar. An NFT would give people the chance to show proof!

Let’s go back to the winery because we’re not done adding value for them. Since they control the product, we must start there. Once the $WINE token is redeemed (and done trading on the secondary market), the holder of the token takes possession of the wine and receives an NFT from the winery. The NFT contains an image of the bottle and a unique identifier guaranteeing provenance for the wine. Wine fraud is a $3.2B problem and growing (up from $3B in 2021). There isn’t a great solution introduced to date, there are expensive consultants but nothing really tech forward. I’d love to see a solution that makes it more interesting to the buyer of the wine via NFT. They’ll have some value as a collectible depending on the scarcity of the wine but it can go further. Using the concept of composability, an NFT could unlock special experiences – think exclusive tastings at the winery or other special offerings like a “meet the winemaker”. Wineries get a new channel for creative expression to develop experiences that are on brand, improving the customer experience, and a deeper connection to the holder of the wine. Tokens would be more valuable and tradeable and the experience would be gamified for the consumer.

Once the $WINE token is burned and the holder receives the wine and NFT, a healthy secondary market can still exist. If the holder of the wine wants to sell, the NFT provides proof of ownership and provenance. This could allow wine storage facilities to inventory wine and release bottles upon proof of the NFT, at which point its movement is recorded on the blockchain enabling full transparency for future buyers. There are so many other ways to create economic value for the winery (especially when you disrupt the 15-30% transaction costs imposed by the middlemen).

I’ve mentioned VinoVest a few times already (although I am bearish on the company generally). It allows investors to gain exposure to wine as an asset class, but they are not only based on traditional finance structures, the relationship-based allocation (a la Dustin Wilson from Somme and other advisors of a similar status), and their inability to deploy capital effectively does not bring any value to the wineries or do much to add value or enhance the experience for the consumers. They are a new middleman with a shinier jacket (VC funding and great marketing).

I don’t want to go through this idea without sharing some of the hurdles in the industry that can impact the full-scale adoption of blockchain.

• Globalization: the wine world has been operating at an international scale for hundreds of years. The ecosystem consists of large corporations to small farmers and is very fragmented. Trust and education will be important as well as respect of centuries old traditions.

• Long Term Viability and Sustainability: no one can be completely sure of cryptocurrencies’ long term viability. Crypto mining, or the process of keeping the blockchain ledger up to date and adding new currencies to circulation, might necessitate the employment of huge, advanced processors that consume a lot of energy. It seems there is a movement away from the proof-of-work model to a proof-of-stake concept where layer 1 blockchain protocols like Ethereum will offer a clean and energy-efficient verification process.

To me, this is a full-circle micro-economy that is created with blockchain technology. There are many different permutations of how something like this could work and I’ve only scratched the surface. I often think about ways this could be extended into the mainstream market. Execution is always hard and the biggest challenge for the wine industry is that most are not technically sophisticated. And, for it to work, the on/off-ramps of tokenization would need to be extremely simple, the UI would have to be super intuitive and the ecosystem well managed. Perhaps, most importantly, building the bridge between the physical good and the digital experience will be most important (and an industry itself). I’ll talk more about that next week.

P.S:

While many wineries haven’t taken blockchain to the next level, I wanted to highlight some wineries that have become interested in either NFTs or Crypto as they are likely doing so to attract a non-traditional market (genius!):

• Yao Family Wines: a winery owned by Yao Ming (former NBA player) who auctioned a bottle of “The Chop” Cabernet Sauvignon in April ’21 alongside an NFT.

• Chateau Darius, St. Emilion: they started to sell four NFTs per vintage for $150. For each NFT, the holder gets a piece of artwork, the opportunity to store wine, and two physical bottles.

• Andrews Family Vineyard: started producing Trothe (my personal favorite) accepts cryptocurrency as payment.

If I had to bet, with even the limited options out there, the crypto community is buying more wine than wine people now because they understand the usability of it.