What you need to know about NFTs
NFTs (non-fungible tokens) are a hot topic alongside cryptocurrencies. They seem to have nearly exploded overnight. NFTs are used to purchase digital assets from art to scribbles, toilet paper, and even food – some selling for millions of dollars.
So are NFTs worth your time, money, or the hype? Some advisors and analysts are convinced this bubble is bound to pop, much like the dot-com hype or Furbies. Others firmly believe NFTs are here to stay and will dramatically impact the future of investing.
So what is an NFT?
NFTs are digital assets that represent physical or real-life objects such as art, music, videos, etc. They can be bought and sold online, often with cryptocurrency, and they are typically encoded with the underlying base software as many other cryptos.
Cryptos have been around since 2014, but they are gaining popularity because they are becoming a viable way to buy and sell original digital works. Since November of 2017, upwards of $174 million has been spent on NFTs.
NFTs are made in limited quantities that can be tracked with unique identifying codes, which helps make them valuable. This is one of the most significant differences between other digital assets or creations, typically in an infinite supply. The idea is that by decreasing the supply, the asset’s value will rise, assuming the asset is in demand.
Before NFTs started to gain popularity, they were digital assets that had already existed in one form or another, such as iconic video clips from NBA games or popular digital art on sites such as Twitter or Instagram.
Mike Winklemann, sometimes known as “Beeple,” a famous digital artist, created a series of 5,000 daily drawings “EVERYDAYS: The first 5000 Days”. These drawings created possibly the most famous NFTs as of right now. They sold for a record-breaking $69.3 million.
Anyone online can view the individual images or the entire collection of images and even screenshot them, so what is the point in owning them? NFTs allow the buyer to prove and own the original item. Within their makeup, NFTs contain a built-in authentication to serve as proof of ownership.
Are NFTs different from cryptocurrency?
NFTs are typically built using the same type of programming as cryptocurrencies such as Bitcoin or Ethereum, but the similarities stop there.
Physical money and cryptocurrencies can be traded or exchanged for one another. This is also known as being “fungible.” They will always stay the same value or remain equal in value – a dollar will always be worth a dollar. The consistency in value creates a trusted and consistent means of conducting transactions on the blockchain.
NFTs do not carry the same value. Each individual NFT has a digital signature which makes it nearly impossible to trade or exchange. Winklemann’s EVERYDAYS would not necessarily equal another NFT.
How do NFTs actually work?
NFTs live within a distributed public ledger that records transactions, also known as a blockchain. These are also the process that makes cryptocurrencies possible. NFTs are typically held within the Ethereum blockchain; however other blockchains support them as well.
NFTs must first be created or “minted” from digital objects that represent a tangible and intangible item that can include any good such as:
- sporting highlights
- virtual avatars
- video game skins
The list of possible NFTs is almost endless. Jack Dorsey, the co-founder of Twitter, sold his first tweet as an NFT for upwards of $3 million.
NFTs are also unique in that they have exclusive ownership rights meaning they can only have one owner at a time. Their unique data makeup allows for an easy way to identify ownership and transfers between users. They can also have unique information stored inside them from the owner or creator. For example, an artist can include their signature inside the metadata of the NFT.
How do you buy NFTs?
If you want to create your own NFT collection, you first need to set up a few things.
First, you need to get a digital wallet that will allow you to store your NFTs and cryptocurrencies. You would most likely need to purchase cryptocurrency, but it will depend on what currencies your NFT provider accepts. Cryptocurrencies can be purchased on platforms such as Coinbase, Kraken, EToro, or even PayPal. When looking into buying cryptocurrencies, you need to research all fees and expenses as most exchanges charge a percentage of your transaction.
Across the various platforms, the verification process for creators and NFT listings are not consistent. Opensea and Rarible, for example, do not require owner verification for NFT listings. It is always important to do your own research before buying, as these platforms and others are hosts for thousands of NFT creators and collectors.
Are NFTs a good investment?
Just because NFTs are popular and you can buy them does not mean you should. NFTs are a risky investment at this point as their future is still uncertain, and regulations are not completely solidified. Investing in NFTs right now is an extremely personal decision. It is important to remember NFT’s values are based solely on what someone else is willing to pay for it. Demand will always drive the price instead of fundamental, technical, economic and other indicators, which generally influence stock and bond prices.
All this to say, an NFT could resell for less than the purchase price, or not at all if no one else wants it.
Another consideration is NFTs are subject to capital gains taxes similar to when you sell stocks for a profit. Because they are considered collectibles, they might not receive the preferential long-term capital gains rates stocks do and could possibly be taxed at a higher rate. At this point, the IRS has not ruled what NFTs are considered for tax purposes. Not only are the NFTs subject to capital gains, but the cryptocurrencies used to purchase NFTs can also be taxed if they have increased in value since the time of purchase.
With all this in mind, NFTs should be approached like other investments: do your research, understand the risks- and if NFTs seem like an investment you want to make, proceed with caution.