“What the heck are NFTs? Can you give me the 30-second version?”
An NFT is like a piece of digital artwork converted into a unique code.
The code for an NFT is essentially made up of three smaller codes (plus some other stuff):
- One code represents the artwork itself.
- One code represents the creator.
- And the other code represents the current owner.
Naturally, this makes the code one-of-a-kind, hence its name: a non-fungible token.
When you buy an NFT, a computer program crosses off the previous owner's name and stamps yours on there, so everyone knows it's yours.
NFTs live on a blockchain, which is like a giant Google Doc that the whole world shares. Only special computers can edit the blockchain — and the rest of us can only read it — which is why it's extremely safe.
More: What is blockchain technology and how is it related to investing?
“So if I buy one of these things, do I actually get anything physical from the artist?”
Sometimes the current holder of an NFT gets access to exclusive clubs and events, limited copyright uses of the artwork, or even a chance to meet the artist.
But most of the time, all you're really getting in exchange for your money is that line of code on the blockchain that says something like, “MetaKovan owns Beeple's ‘Everydays — The First 5000 Days'.”
The $69 million NFTCredit: Beeple
So it's basically just a certificate of ownership that lives on the cloud — nothing physical.
“Why would somebody buy an NFT?”
I know; it's hard to learn about NFTs for the first time and not think about The Emperor's New Clothes. I mean, folks are paying hundreds, thousands, sometimes millions of dollars for essentially nothing.
At least with physical art, you get something nice to put in your house.
But people still buy NFTs for various reasons.
- The joy of collecting exclusive art, regardless of medium
- To support indie artists (lots of artists pay their bills with NFTs)
- To be a part of something cool, new and trendy (celebrities will spend $100,000 on an NFT to generate $10 million of free publicity)
- As an investment, albeit a risky and speculative one
- To score the included extras, such as event tickets
#2 is my favorite reason to share with people who are new to the concept of NFTs. It shatters the stereotype of the bored, rich NFT collector. NFTs help a lot of up-and-coming artists connect with a new audience and pay their bills.
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In the future, NFTs could actually become really valuable in other areas beyond art. For example, many envision a time in the future when NFTs are used to easily transfer rights to physical property, like a home, instantaneously and without the need of any middleman. You can learn more about real estate NFTs here.
“Are NFTs really an investment?”
The short answer is: Yes, NFTs are an investment.
But are they a good investment? Well…
I've spoken to a few collectors who are confident that NFT values will skyrocket along a similar trajectory to cryptocurrency. They believe that early adopters like them will be handsomely rewarded once the rest of the world catches on and demand begins to outstrip supply.
After all, that's what happened to Bitcoin. And now some of their friends who mined Bitcoin in college are buying Ferraris with cash.
But the truth is that investing in NFTs is even riskier than investing in crypto for one key reason:
NFTs are, by definition, non-fungible.
Crypto, dollars and shares in a company all have one thing in common. They're fungible, i.e., all the same. Your 10 shares of Microsoft are as good as my 10 shares of Microsoft.
But each piece of art is unique. And, therefore, art values are siloed. When Banksy sets a new record at Christie's, the value of my Z Gallerie wall art doesn't suddenly shoot up overnight.
Plus — and more fundamentally to the principles of investing — NFT investors are banking on the fact that in 5 or 10 years, there will be someone on the other end willing to buy their specific NFT for more than they paid for it, accounting for inflation.
On a speculative investing scale from 1 to 10, on which 1 is a fixed-rate I-Bond and 10 is cryptocurrencies, NFTs are 14.
More: Are NFTs securities
“So why do I always hear crypto and NFTs named in the same sentence?”
Crypto and NFTs are mentioned together not just because they're equally trendy; they literally share a home.
Cryptocurrency and NFTs both live on a blockchain, which as I mentioned, is like a giant Google Doc that the entire world shares. It doesn't quite look like a Google Doc — it's made up of complex code and only special computers can read and write to it — but in practical terms, that's basically what it is.
Now, there are tons of different blockchains out there because they each serve a different purpose. Most NFTs live on the Ethereum blockchain because that specific blockchain was designed to allow for the recording and storage of multiple types of data. By contrast, the Bitcoin blockchain is more like a simplified Microsoft Excel spreadsheet that allows you to record only who owns how much Bitcoin.
The reason NFTs live on a blockchain is because blockchains are like bank ledgers. They're extremely secure and can't be hacked or overwritten. So they're the perfect home for storing expensive digital art (or at least code representing expensive art).
“I read that NFTs are bad for the environment. How can a GIF of a cat be bad for the Environment?”
The program running the Ethereum blockchain is unfathomably complex and therefore needs a staggering amount of computer power to keep it going.
That power drain comes from mining, which you may have heard of. Crypto mining is the practice of contributing computer power to the running of the blockchain. People do it because the blockchain rewards them with cryptocurrency for their efforts.
So the reason an NFT of a cat is so bad for the environment is because the process of creating (or “minting”) an NFT and safely transferring it between owners requires so much computer power that the electricity consumed could power the average American household for a week.
Plus, most of that electricity is coming from coal. So if you buy an NFT tonight, that click will produce more C02 than driving an SUV for 300 miles.
More: What's not bad for the environment? ESGs
“Wait, digital art that kills polar bears? Why hasn’t the government shut them down?”
A lot of governments have.
Countries like China, Qatar and Bangladesh have banned crypto in large part due to its strain on the power grid, which in turn nukes the local NFT market because you need crypto to buy one.
But there's hope for more sustainable NFTs down the line. The team behind Ethereum will soon launch Ethereum 2.0. This is 99.95% more eco-friendly because it vastly reduces the need for computer power to stay running.
“Am I missing out on something here? Should I buy an NFT before my grandkids make fun of me?”
I think your grandkids will be impressed that you know anything about NFTs. Because even five years in, most people don't.
Besides, the actual process of buying an NFT is still a huge pain. You have to get a cryptocurrency wallet, convert cash into Ethereum (the cryptocurrency used to buy NFTs), buy the NFT and transfer it to your wallet. If you really wanna be safe, you need to convert your “hot” wallet into a “cold” wallet that lives on a USB stick.
It's not impossible to buy an NFT, just tedious. And it doesn't help that you're peppered with fees along the way.
So if you want to support an artist, go for it!
But don't worry, Old Crotchety; you're not missing out on anything.
The bottom line
To end on a high note for any NFT collectors out there, my personal takeaway from fielding questions about NFTs is that folks are surprisingly eager to learn about NFTs. I was surprised how many people perked up once they heard the title of my speech.
That bodes well for the longevity of NFTs. As an emergent technology, NFTs aren't so esoteric that normal people give up even trying to understand them.
Folks are seeking that “Ohhhhhh” moment. And I think you and I can give it to them.