Non-fungible tokens, or NFTs, have been creating a bit of a buzz over the last few months, but what are they, how do they work, what is their value and are they worth it?
As a relatively new and non-tangible asset, confusion can surround NFTs, so Neal Foundley, investment analyst at Equilibrium Financial Planning, answers commonly asked questions to make decisions clearer for potential collectors.
Let’s start with the basics – what is an NFT?
“NFT stands for ‘non-fungible token’, which simply means a one-of-a-kind digital item that cannot be duplicated. In the real world, if you own an original Picasso painting, you have a non fungible asset because each one is unique and there can’t be another original or duplication, versus something like a pound coin that is homogenous and can be traded for another identical pound coin.
“Instead of a tangible asset, NFT owners have a digital asset. For example, the original code to the internet was sold as an NFT for $5.4million, but it could be anything from a Tweet to a mega sword for your Fortnite warrior, a TikTok video or song, or, as is popular at the moment, digital art.”
What happens when you buy an NFT?
“When someone buys an NFT, they obtain ownership in the sense that the digital asset becomes their property. An NFT is basically a digital certificate of ownership bought and sold via platforms and then transacted on blockchains, in the same way that cryptocurrency is traded.
“In reality, an NFT is a string of digital code kept in a cryptocurrency wallet rather than a ‘thing’ that you ever take possession of in real life. Generally, the owner of the NFT will have a limited ability to share or reproduce the item itself.”
How are NFTs valued?
“In these early Wild West days of NFTs, the way to drive their value has been to create some excitement or USP around it. For example, selling a cool digital image or an iconic artefact such as Twitter’s founder’s first Tweet. There have also been celebrity endorsements and other similar tricks to lure buyers in on the basis that there is some cachet or scarcity value that infers higher value.
“The Bored Ape Yacht Club (BAYC) has driven value for its cartoon monkey NFTs by becoming an exclusive club where members create their own buzz. Members of BAYC include Justin Bieber, who spent $1.3 million on his first Bored Ape NFT and $470,000 on his second. He, and other BAYC members, have no idea what the ‘value’ of their certificates of ownership for the cartoon apes are, but they buy them in the hope that someone else will buy it off them down the line for a greater value. This is known as the ‘greater fool theory’, where a full-priced asset is bought in the hope it can be sold to a greater fool down the line, although often unlikely.
“It is also important to remember that the NFT only shows who the current owner is. However, the copyright, and thus royalties from use, remain with the creator of the asset. So, if a Hollywood film was made using an image or song, you as the owner of the NFT would receive nothing.”
How much do NFTs actually sell for?
“There have been claims online that NFTs are selling for tens of millions of dollars, with the record highest sale sitting at $91million. Many high-value NFT claims, however, are likely to be bogus and would-be buyers should be wary – an unsecured loan facility on blockchains effectively allows the seller to loan the money to the buyer, who buys at an inflated price and instantly pays it back.
“Original NFTs are undeniably selling for large sums of money, however analysis by the Financial Times shows that ‘so far, most NFT collectors on the secondary market have yet to recoup the costs of their purchases’.”
What are the risks of buying an NFT?
“As a largely unregulated market, NFT trading platforms are plagued by fraud, scams and market manipulation, especially because the real-world identities of buyers and sellers is difficult, if not impossible, to discover.
“In the digital world, copying something is extremely easy and the buyer of the NFT needs to be sure they are buying something that originated from the creator. Many artists have voiced their concerns over how easy it is for anyone to ‘mint’ a digital file as an NFT, whether or not they have rights to it in the first place.
“If NFT collectors are not aware of tax liabilities that come with collectables subject to capital gains tax, they may find themselves in trouble with the tax authorities.”
What is a utility NFT?
“An area within the NFT space that is growing is so-called ‘utility NFTs’. As the name suggests these are digital assets that carry some underlying utility, benefit or application in the non-digital world.
“Art is pretty subjective, but what if you bought an NFT that, for example, gave access to special online or physical events? It may also allow you early access to content or a limited-edition product or the opportunity to meet your sporting hero. The band, Kings of Leon, released their album in 2021 as an NFT with packages offering live show perks, such as front-row seats for life, or access to exclusive audio-visual art.
“Utility NFTs can provide a bridge between the virtual and physical world and are likely to be an important medium for companies to use to promote goods and services as they develop and grow in popularity.”
Should I buy an NFT?
“As with most investments, the simple advice is to only spend what you can afford to lose. Remember, this is an extremely high-risk investment as it does not physically exist, and as such, there is a real possibility of 100 per cent capital loss.
If you have always wanted to own a certain digital item or a piece of art, then go ahead. It would be sensible to keep some money back for utility NFTs that offer some real-life benefits and therefore may be more attractive for someone else to buy at a profit in the future.”