What are NFTs and how do they work?
NFTs, or non-fungible tokens, are unique strings of data that live on a blockchain. A blockchain is like a giant, unhackable online ledger for storing data. It can be read and be added to, but never overwritten.
You can think of it like a giant living document that the entire world shares. Those with special technology can add to it, but it’s worth stressing again that it can never be overwritten—only expanded upon.
Now, early blockchains like the Bitcoin blockchain can only store a specific type of data: How much Bitcoin is in circulation, who has it, and how much they have. That’s it. This data was considered “fungible” because all Bitcoins were and continue to be made the same.
Instead of a living document, the Bitcoin blockchain was more like a spreadsheet whose cells only allowed you to enter cash amounts: no free text.
That’s pretty neat, but people started pondering: wouldn’t it be much more useful if we had a blockchain that did allow us to enter free text? Like a Google Doc instead of just an Excel Spreadsheet?
Such thinking gave rise to Ethereum, which arrived in 2015. The Ethereum blockchain allows for the storage of non-fungibles, i.e. unique strings of data. Soon, these non-fungible “tokens” got a slick acronym: NFTs.
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What makes NFTs so interesting?
Naturally, the potential applications of NFTs are virtually endless. Information in the form of medical records, legal data, and more could all be safely stored as NFTs on the Ethereum blockchain.
However, and rather interestingly, one of the very first applications of NFTs was to mint “original” versions of digital works of art.
This is a revelation for creators of digital art and collectibles, because unlike artists in a physical medium, there’s no “original” digital artwork. They put their art online where the world can simply copy and paste it with impunity. The artist can sell licenses, sure, but not the OG version.
Now, thanks to Ethereum and what’s essentially the world’s biggest Google Doc, they can generate what’s essentially a 100% unique “certificate of ownership,” store it on the blockchain for the world to see, and sell it to an eager collector (or investor).
What happens when you buy an NFT?
Let’s say you head to the popular NFT marketplace OpenSea and purchase an NFT. Specifically, Mendel Genesis 713 by artist Remy Bond.
To start, you can’t buy NFTs with cash (yet). Instead, you pay using Ethereum, since that’s both the currency and the gasoline that powers the Ethereum blockchain. Some of your Ethereum goes to paying the artist, some to paying OpenSea, and some to facilitating the transition of ownership to your name.
Your total with fees comes to 0.5 ETH or ~$1,300. What happens next is the NFT is added to your crypto wallet, which is like your personal bank account/vault on the blockchain.
So, do you get copyright access? A physical copy?
Nope! Just a few lines of code on the blockchain that says “Chris owns Mendel Genesis 713.”
That’s it! It’s a certificate of ownership and nothing more. Essentially, bragging rights that you “own” a digital asset. Granted, some NFTs come with exclusive rights to events or other content, but otherwise, you’re mostly just paying for the right to say that you own a digital asset.
That may sound silly to some, but NFTs are taking off. NFT trading volume surpassed $40 billion in 2021, begging the question:
Should you be buying these things, too?
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Should you add NFTs to your portfolio?
To determine if an NFT purchase makes sense for you, let’s look at the five main reasons folks buy NFTs:
- The joy and satisfaction that comes with art collecting
- To support an artist you like
- For the included perks (event access, an opportunity to meet Gary Vaynerchuck, etc.)
- Simple bragging rights (“I own the first ever Tweet by Jack Dorsey!”)
- As an investment
If you’re considering purchasing an NFT for one of the first four reasons, I’d say go for it. All three are totally subjective, so as long as you understand what you’re buying, have fun shopping!
I’d especially encourage you to purchase an NFT if your main motivator is to support an indie artist. That’s because OpenSea is like a giant online art fair; artists have to pay to be there (it costs up to $100 to mint a single NFT), and it takes serious courage for some lesser-known artists to display their wares for the public to browse and judge. For that reason, scooping up their NFT art can seriously make their day (or their year).
However, since this is Moneywise—and not American Art Collector—I imagine you’re at least partly motivated by factor #5.
So, are NFTs a good investment? Let's take a look.
More: Is buying art a smart investment?
Here’s why NFTs are a neat product, but a bad investment
When you buy an NFT as an investment, you’re banking on the fact that someone in the future will buy it at a higher price. That is, a higher price accounting for inflation and NFTs’ notoriously high fees.
However, the bigger issue is that NFT values, are, and will always be, 100% speculative.
At the moment, NFTs’ high sale prices are being upheld by transient and temporary factors. Media hype, investor FOMO, and the perks and event tickets attached to them are driving high sale prices.
But who knows how much today’s NFTs will be worth in two, five, or 10 years?
The honest answer is: nobody. A Snoop Dogg NFT selling today for $12,000 could be worth $1.2 million or $12 in 2025. And it’s virtually impossible to guess which.
And “guess” is the operative word here, because NFTs have no quarterly earnings reports, Price to Earnings ratios or no sector performance analytics.
Seeking “capital gains” from NFT flipping isn’t investing; it’s gambling.
Because of how unpredictable the value of NFTs could be in the future, it makes more sense to invest in crypto than in NFTs. At least crypto is fungible. The very fact that each bitcoin is interchangeable means there will be more potential buyers on the day you decide to sell.
But even the most popular NFTs on the market today may have zero interested buyers in two, five, or 10 years from now. Even still, NFTs’ “low float” aren’t its greatest risk factor.
What are the chief risks of investing in NFTs?
In terms of risk, NFTs make investing in cryptocurrency look like buying shares of an index fund. Here are just some of the dangers to consider before you add NFTs to your portfolio.
Hacks and scams
NFT-related crime is on the rise. A record $7.7 billion worth of crypto and digital assets was stolen in 2021 as cyber criminals came up with clever and insidious ways to part investors from their crypto keys, emptying their blockchain vaults.
Just this January, esteemed NFT collector Todd Kramer lost $2.2 million worth of NFTs overnight when they were stolen from his virtual gallery by a brazen hacker.
In terms of safeguarding investors’ property, “government intervention won’t work because they have no idea how this space works,” NFT collector Amir Soleymani told The Art Newspaper. “If we, as a community, don’t act, any force from outside will destroy the whole ecosystem.”
Fakes and con artists
If there ever was a good NFT to invest in, it would’ve been one by the mysterious UK street artist Banksy. The artist has worldwide renown, a young, technologically savvy fanbase, and has a penchant for multiplying the value of his works—even after they sell.
So who could blame the eager investor who poured $330,000 into an exclusive Banksy NFT? Too bad it was a fake, minted and sold by a hacker.
Sadly, fake NFTs aren’t an anomaly; they’re “rampant,” according to Reuters. OpenSea openly admitted on Twitter that a staggering 80% of the NFTs minted using their tools were fakes. And given how many artists use pseudonyms to sell NFTs, it’s extremely difficult to authenticate NFTs before you buy.
The “risk” of regulation
For the moment, NFTs aren’t regulated as securities by the SEC. But as more and more buyers and NFT marketplaces label them as “investments,” that could change very soon.
NFTs aren’t considered securities because they fail the SEC’s “Howey test,” which states that an asset becomes a security when its sale involves:
- The exchange of money
- A common enterprise (i.e. shared goals between buyer and seller)
- An expectation of profit
When an artist sells to investors, only box A is checked. But when investors sell NFTs to each other, the waters get more murky.
Being regulated in and of itself isn’t a terrible thing, aside from capital gains taxes and increased oversight. However, it’s the market’s reaction to being regulated that presents the real risk. Historically, when 100% speculative assets face increased regulation, prices fall. The threat of regulation in China alone was enough to send BTC plummeting 22% overnight.
Are NFTs worth anything?
If NFTs aren’t a great investment to begin with (and they’re easily faked, to boot), what are they worth?
Well, like most art, they’re worth exactly what you—or someone else—is willing to pay for them. Aside from the handful of NFTs that include event access or some other tangible extra, NFTs have no intrinsic value. They’re paramount to a few lines of code on the blockchain; their value derives entirely from what the market thinks they’re worth.
Raw demand is fickle. It can surge today and evaporate tomorrow. That’s what makes investing in a speculative digital asset—whether it’s NFT art, crypto, or virtual real estate—so tricky.
So does that mean NFTs are just a passing fad, like Pokémon Go and the Harlem Shake?
Are NFTs just a fad?
NFTs certainly check many of the boxes of a modern, passing fad. They’re attracting explosive-yet-unsustainable social media attention, and everyone who understands them either feels FOMO–or rolls their eyes into the back of their head.
And yet, I don’t think they’re a passing fad. Even when the initial fervor tapers off, NFTs will be here to stay. We’re already seeing corporations get involved, and as mentioned above, the applications for NFTs as a technology are virtually endless.
Today’s NFTs are like the 2012 Tesla Model S. Groundbreaking and trendy, sure, but also enduring.
However, even though NFTs are likely to stick around as a product, that doesn’t necessarily make them a great investment.
But if you are keen to profit from the NFT craze, there are better ways.
Is there a way to invest in NFTs without actually buying any?
Keep in mind that NFTs, Ethereum, and Bitcoin all share one thing in common: a home.
Blockchain technology is arguably the better long-term investment, and an early stake in the global expansion of blockchain technology is more likely to provide high returns in your portfolio than a random NFT.
So what, specifically, should you invest in?
A blockchain ETF offers a nice Goldilocks’ choice: diverse, but not diluted. Conservative, but without sacrificing that sweet upside potential.
For more, check out our guide to crypto ETFs.
The bottom line
NFTs are fascinating products and have opened the doors to the vast potential of NFT technology as a whole. Plus, they’ve given indie artists an entirely new stream of income, given celebrities and influencers a novel way to interact with their fanbases, and drawn attention to the digital art medium as a whole.
But an investment in NFTs will never reliably outpace the S&P 500. NFT values are too transient, too unpredictable. Buy them to support your favorite artist if you wish; but don't add NFTs to your portfolio with an expectation to profit.
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