This article first appeared in The State of Fashion 2022, an in-depth report on the global fashion industry, co-published by BoF and McKinsey & Company. To learn more and download a copy of the report, click here.

As digital environments come of age, they are transforming from linear and transaction-focused spaces into multi-dimensional, experiential and collaborative virtual worlds. Tech-savvy and younger cohorts are spending increasing amounts of time in these spaces — from social media and gaming to virtual realities — and are adopting multiversal identities along the way. At the vanguard, digital assets in the form of virtual fashion and non-fungible tokens (NFTs) are offering new ways for consumers to shop, exchange goods and inhabit those identities.

Hyper-interactive and creative digital environments are a natural evolution of how people use technology and reflect the ever-growing amount of time consumers are online. Gen-Z spent an average of eight hours per day on screens in 2020. Part of the appeal of virtual worlds is the chance to engage with others and build communities — a need that was exacerbated when global Covid-19 lockdowns put an end to most in-person social contact. As digital spaces become more dynamic, some consumers are participating in “digital campfires,” around which they can connect with others who share their values, have conversations, tell stories and co-create.

These soaring levels of engagement have spawned a new generation of digital fashion creatives, who are pushing the limits of possibility online. Brands, meanwhile, see the emerging “metaverse,” in which people work, play, socialise and shop, as an opportunity to engage more deeply and creatively with their customers and unlock new value streams.

“There are more and more ‘second worlds’ where you can express yourself [but] there is probably an underestimation of the value being attached to individuals who want to express themselves in a virtual world with a virtual product, [through] a virtual persona,” said Gucci’s executive vice president of brand and customer engagement, Robert Triefus, citing the 19 million visitors who came to the Gucci Garden within the Roblox gaming metaverse.

The $176-billion gaming industry, which attracts more than three billion players globally, has a long history of community-building. Meanwhile, the metaverse is becoming a big business, with funding pouring in from investors. Epic Games raised $1 billion in April 2021 to accelerate its work in building connected social experiences across a metaverse of linked games and services.

As gaming increasingly becomes an extension of the real world, and with the pandemic supercharging participation, it has become a prime target for fashion brands.

As gaming increasingly becomes an extension of the real world, and with the pandemic supercharging participation, it has become a prime target for fashion brands. In many cases, engagement has taken the form of collaborations with gaming platforms to design virtual fashion assets. Ralph Lauren partnered with South Korean social network and avatar simulation app Zepeto to create a virtual fashion collection, giving users the opportunity to dress their avatars in exclusive products, or appearance-altering “skins.” Gucci has created digital assets for gaming platform Roblox, as well as for Pokémon Go and Animal Crossing. Some brands have set their sights even higher. After unveiling its Autumn/Winter 2021 collection in the form of a fully-fledged video game, Balenciaga teamed up with gaming giant Fortnite to unveil a collaboration including shoppable virtual clothing and physical products. It advertised the partnership across traditional and metaverse channels.

The opportunities in gaming are extensive and offer a platform to engage younger consumers, as well as create buzz with cohorts that would not usually interact with brands in physical formats. Tapping into in-game merchandise further allows brands to monetise digital assets where it is the norm to pay for elevated experiences.

Virtual clothing is picking up momentum across a range of digital environments. “Gamers are famous for buying skins in games [but] we have two sets of [broader] customers,” said Daria Shapovalova, co-founder of DressX, a platform that estimates the total addressable market for digital fashion at $31 billion and has more than 100 partner designers offering digital fashion items. “First, there are those Millennials who immediately understand the idea of digital fashion and are active shoppers of luxury goods; they want to try something new, so they use it to elevate their social media. Then there are Gen-Z customers who are on platforms like Snapchat or TikTok, where video is becoming the main communication tool rather than the still image.”

Indeed, for some consumers, digital fashion is the natural extension of applying social media filters on platforms like Instagram and Snapchat, says Simon Windsor, co-founder and joint managing director at Dimension Studio, an agency that worked with Balenciaga on its video game. “We’re just at the tipping point of this new era… It starts to change the meaning of fashion itself.”

Beyond social media and gaming, artificial intelligence (AI) and augmented reality (AR) technologies present additional opportunities for new business models leveraging virtual fashion. Online fashion wholesale platform Ordre uses 360-degree view technology to present seasonal collections through online showrooms, offering a complementary channel to facilitate management of luxury wholesale networks. Elite World Group and Tommy Hilfiger have recently partnered on various virtual ventures, including avatars of models walking 3D virtual runways.

Much of the excitement around virtual environments is directed towards NFTs, which have seen an explosion of interest over the past year. NFTs are unique crypto assets whose authenticity and ownership are verified on blockchains and are bought, sold and exchanged in the metaverse, often with cryptocurrency. Their uniqueness means that the value of some NFTs can skyrocket: one created by digital artist Mike Winkelmann — also known as Beeple — was sold at Christie’s auction house in 2021 for a record-breaking $69.3 million. NFT platform OpenSea exceeded $1 billion in sales in the first seven months of 2021.

Proponents of NFTs argue that the recent boom is no flash in the pan. “This is fundamentally going to change digital ownership, creative structures, the creative economy, how we view money even,” said Karinna Nobbs, co-chief executive and chief experience officer of NFT marketplace The Dematerialised. “This is bigger than the internet.”

In fashion, NFTs have a wide range of use cases, ranging from product authentication (see “Product Passports”) to serving as collectable pieces in their own rights. With consumers seeking to collect and invest, digital fashion creators such as The Fabricant, DressX and RTFKT are finding audiences for digital clothing authenticated by NFTs. Meanwhile, some companies are tapping into the excitement around NFTs by experimenting with alternative engagement models: Adidas attracted headlines when it collaborated with The Fabricant and model Karlie Kloss to launch a competition for creators to make their own NFT versions of the WindRdy parka jacket.

In 2021, there was a wave of NFT engagement among luxury players, often via the gaming universe. For its 200th anniversary, Louis Vuitton launched a video game with collectible NFTs partially designed by Beeple. The game contained NFT art that could be acquired by players in a story echoing the journey of the brand’s founder. Burberry created NFTs within the Blankos Block Party game, featuring digital vinyl toys that live on a blockchain. Adorned with Burberry’s TB summer monogram, the limited-edition Burberry Blanko Sharky B NFT can be purchased, upgraded and sold. The collaboration also includes branded in-game NFT accessories, including a jetpack, armbands and pool shoes.

Beyond gaming, Farfetch has partnered with digital fashion platform DressX. Dolce & Gabbana collaborated with Unxd, a curated marketplace for digital luxury and couture, to create an inaugural nine-piece collection of NFTs sold alongside physical couture.

With no shortage of marketing hype, there are indications that digital fashion assets can generate significant revenue streams. Dolce & Gabbana’s collection fetched the equivalent $5.7 million. Still, monetisation opportunities are likely to be contingent on the psychology of scarcity and limited editions driving NFT mania — together with the security of authentication and the potential for community-building that they provide. The most likely fashion segments to lead the way are luxury and streetwear.

What is undisputable is that fashion industry leaders are interested in exploring the potential of virtual fashion.

“We say to any fashion brand we work with: it’s experimental. It’s not always going to work and we can’t guarantee it will work,” said Amber Slooten, co-founder and creative director of The Fabricant, a digital fashion house that helps brands create their own virtual products and has worked with brands including Adidas, Marques Almeida and Buffalo London.

Amid the hype, there are also reasons to exercise caution. One concern is the environmental impact of the blockchain technologies that underlie NFTs and, in particular, the energy required to validate transactions. Cyber security is also a potential cause for concern (see “Cyber Resilience”), with counterfeiting and security breaches a significant threat. A recent cyber attack on the artist Banksy’s official website caused a collector to pay £244,000 ($334,000) for a counterfeit NFT.

“To assume that… NFTs or more generally blockchain won’t be an incredibly volatile environment for the next five years is to have forgotten the lessons of history when it comes to the internet,” said Ken Seiff, a managing partner at Blockchange Ventures, a venture capital firm investing in early-stage blockchain technology.

At a minimum, fashion’s foray into the metaverse promises new routes for consumer engagement. This will support creative branding strategies, enable immersive consumer experiences and generate excitement among highly sought-after consumer groups.

Looking ahead, the buzz around NFTs will continue to build as increasing numbers of fashion brands seek paths to differentiation and launch creative experiments. As consumers spend more time interacting online, their interest in collecting and displaying digital objects is likely to deepen. However, they will also seek out opportunities for co-creation and will expect brands to engage with digital assets in a format that is native to the spaces they inhabit, rather than content that repeats across channels.

The crypto fashion opportunity will demand significant investment, experimentation and a new playbook. Brands will need a strategic mindset and a willingness to develop partnerships and harness a variety of talent to deliver high-quality content, either in-house or via third-party collaborations. In an arena characterised by a large amount of hype, it will pay to seek out business cases that spark excitement but remain on-brand.

To do this, it may be necessary to take a new lens on ROI, focusing on less measurable benefits such a brand awareness and marketing impact, as well as setting flexible targets that are calibrated to potential, rather than focusing exclusively on the bottom line. Flexibility will be key, and brands should remain cautious in deploying their capital. However, the risks should not deter them from engaging with this rapidly growing digital universe.

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Editor’s Note: This article was amended on Dec. 19, 2021, to clarify Farfetch’s collaboration with DressX.