The crypto industry has been on a roll for some time now, with massive year-over-year increases in trading volume and value of cryptocurrencies. The widespread adoption and acceptance of crypto into mainstream culture is proving that crypto is here to stay.
Perhaps one of the most compelling examples of the crypto industry explosion into the broader market is NFTs – or non-fungible tokens.
If 2020 was the year of blockchain, bitcoin and altcoin investment, 2021 was absolutely the “year of the NFT”. We are only beginning to scratch the surface of what crypto capabilities will emerge in 2022 and beyond, but NFTs are an excellent example of where crypto trends are headed.
With all of this in mind, lets dive into an exploration of NFTs: what they are, how their rise in popularity came to be and the risks investors need to be aware of.
What are NFTs?
Non-fungible tokens (aka NFTs) are one of a kind, unique digital assets. Traditional and crypto currencies like cash and bitcoin are fungible – meaning their value is interchangeable and consistent. If you have one five-dollar bill and exchange it at the bank for another, you will get back a bill of the same value. Similarly, if you own one bitcoin, it’s value in the open market is the same as any other bitcoin.
NFTs on the other hand are non-fungible, meaning no NFT is interchangeable with another, and the value of a given NFT can be wildly different from one token to the next.
NFTs typically represent purely digital assets, like digital artwork, images and video, video game items – essentially anything that lives on the internet (including Tweets) can in theory be turned into an NFT. However, real-world assets also have the potential to have an NFT assigned to them, allowing for decentralized ownership records to be managed in the digital space.
Decrypt does an excellent job of explaining and visualizing NFTs:
How did NFTs become so popular?
NFT popularity reached a fever pitch in 2021 that is likely to continue in 2022 – but NFTs have actually been around for some time. ARTnews estimates that NFTs originated around 2014, however, the “OG NFTs” that have now reached icon status were created in 2017 and entitled “CryptoPunks”. There are 10,000 unique CryptoPunks that were created as part of this series, and many are now worth over $1 million dollars each. What’s really wild is that CryptoPunks were originally available for free, with their value increasing over time as they traded investors’ hands.
Bored Ape popularity and the $69 million dollar sale of artist Beeple’s Everydays: The First 5000 Days NFT seemed to grab the attention of both the public and investors alike. In the blink of an eye, YouTubers like Jake Paul, thought leaders like Gary Vaynerchuk, organizations like the NBA and even public figures like Melania Trump have all been trying to get a piece of the lucrative NFT pie.
How are NFTs made, bought and sold?
Given their popularity, it seems NFTs are here to stay – but how does one go about creating an NFT in the first place?
Making, selling and buying NFTs is surprisingly simple using the various NFT marketplaces that are now widely available, with some of the most popular being OpenSea, Rarible and Zora. All you really need is a crypto wallet and a digital currency like Ether to get started.
NFTs need to be “minted” on a blockchain to appear on a given marketplace. The Ethereum blockchain is typically used because of its smart contact technology that allows NFT creators and marketplaces to set built-in terms for NFT sales and purchases – things like how much creators will make in royalties for future sales. These smart contracts are automatically executed when a particular action (like a sale) occurs.
You can turn virtually any digital file (.JPEG, .GIF, MP3, etc.) into an NTF by uploading it to a marketplace and minting it on your blockchain of choice. This entire process of minting is taken care of by the marketplace, so even those without coding or extensive blockchain technical knowledge can create, sell and buy NFTs easily.
How do NFTs gain and retain their value?
Despite being relatively easy to get into NFTs, not everyone can command high selling prices for their creations. In fact, the average NFT sells for just $15.
A big question in many people’s minds is how can a digital asset that can be screenshotted and reposted all over the internet really be worth anything at all?
The answer comes down to our collective socially agreed upon ideas about what constitutes art and the value we place on ownership, authenticity and originality. Without getting too philosophical, the value of the most popular NFTs comes from the same principles that apply to the sale and ownership of traditional art.
That pseudo-impressionist print from Ikea in your living room is not the same thing as an original Monet or Renoir, and that is how we value art in a nutshell: the original is always worth more than the copy.
This idea also applies to NFTs – owning an authentic piece of digital art means something because we all agree art has an intrinsic value. The common example you’ll hear compares screenshotting an NFT to going to the Louvre and taking a picture of the Mona Lisa. You can put it on display, but it will never hold the same value as the original. Similarly, a copy of a Bored Ape doesn’t have the same value or prestige that comes with owning an authentic version.
As for which NFTs become popular and which do not, much like traditional art, that is a bit of a mystery. In both instances, tastemakers and those with social influence play a big role in determining what art takes off and what falls flat.
What are the risks of NFTs?
With all of the excitement around NFTs, it’s important to remember that there are material risks to investing in purely digital assets.
It’s important for would-be investors to take note of these risks before getting into buying and selling NFTs. Anyone interested in dabbling in this space trend should apply the same prudent advice to purchasing an NFT as you would any other investment: only put into it what you’re willing to lose. Some risks to be aware of are highlighted below.
Your NFT is not actually stored on the blockchain
Storing NFTs on the same blockchain where they are built is expensive, so investors need to understand that the token you own on the blockchain and your NFT are two separate things.
The token associated with your NFT declares your ownership and holds all of the transactional information and any smart contract details attached to your NFT. The actual visible NFT file is hosted on a marketplace or website. If that website becomes defunct, the URL link breaks or gets destroyed, your NFT is gone. Your ownership record will still exist on the blockchain, but the asset itself could potentially disappear into thin air.
Storing NFT files in a secure, decentralized way is a solution to this problem that is coming, but for now it is a risk to be aware of.
The NFT market is volatile and still young
Some experts believe that the NFT boom may eventually bust, which means there is a risk of overpaying for something that may not increase in value or even retain the value of the purchase price.
Certain NFTs are spiking in cost, but some present a challenge in that once you buy them, it could be a long time before you can resell that same NFT for a profit. Investors need to be prepared to sit on an NFT for the long haul in order to see a return on their investment (and be realistic about the possibility that you may never be able to resell it).
Beware of price manipulation scams
Novice investors should be aware of how NFTs can have their prices inflated. One of the founding principles of blockchain technology is based on the anonymity of users and decentralization.
Although you can see how many times an NFT has been traded and its transaction history, it is possible for scammers to create an NFT and create multiple accounts where there buy and sell the NFT between them. Thus, giving the impression that the NFT is being sold at increasing values.
If an unsuspecting buyer then purchases that NFT at a premium and it turns out to not hold its value, there is no recourse for the buyer. You can’t identify the seller or report them to a centralized authority because, well, blockchain is designed to protect the identity of its users and is not managed by any one party.
What does the future hold for NFTs?
Practical applications for NFTs beyond digital art are already being explored, with some of the most compelling solutions being to streamline supply chain management, shipping and logistics.
In fact, EY Global Consulting is already deploying this technology on behalf of one of their clients to track the ownership, transaction history and secure location data for rare fine wines by tokenizing individual bottles and cases using the Ethereum blockchain and smart contracts.
For financial services providers, it’s important that front line staff be informed about NFTs and prepared to answer investment questions from customers about the current investment climate and if NFTs are a sound piece of a long-term investment strategy.
Despite the risks, it appears NFTs are here to stay and will be deployed in broader business applications in the future.