Caveat emptor: NFTs are a highly speculative asset and should not be considered as a “regular asset class”; invest only what you can afford to lose.
Twitter founder and billionaire Jack Dorsey is selling his — and the world’s — first tweet as a non-fungible token (or NFT), with the current highest bidder offering $2.5 million for the missive.
This could be the beginning of a trend that could see the tokenisation of digital art, in-game items and an assortment of other digital collectibles, paving the way for digital asset ownership unlike anything we’ve seen before.
What Are Non-Fungible Tokens?
A non-fungible token (NFT) is a cryptographic token that represents something unique and has an individual characteristic that sets it apart. Owning an NFT is like owning a one-of-a-kind work of art or a collectible antique. NFTs are unique tokens or digital assets that generate value because of their uniqueness.
Unlike cryptocurrencies, where one unit of cryptocurrency is indistinguishable from another and is exchangeable, NFTs are differentiated by a unique code (think of the barcode at the supermarket) that determines the identity and ownership of the NFT. NFTs are non-exchangeable with one another (fungible), just like how you cannot exchange a Mona Lisa for a Mondrian.
On the blockchain, when you send a unit of cryptocurrency to someone, a ledger entry gets made. In the case of an NFT, a ledger entry is also made, but in that entry, there is also an address to the file, which establishes the ownership of that NFT.
What Are The Different Uses Of NFTs?
NFTs, as a technology, is still in its infancy and thus highly experimental — a perfect breeding ground for the likes of technologists and artists who can come together and explore, invent and express themselves.
As an art form, NFTs challenge the societal definition of what art is, and artists like any other genre aim to break rules and find unorthodox ways of approaching contemporary issues. This can pave the way for gradual societal acceptance of NFTs not just as art but also as a mainstream technology. This will also hinge on the development of NFTs beyond an experimental art form.
When Andy Warhol first turned soup cans and images of Marilyn Monroe into silkscreen prints, he was derided as having made copies of art and cheapened the value of art. Printing technology, like digital technology, has created an abundance of fakes and copies. NFTs help to identify the true source of any piece of work online. For example, you can have many copies of the Nyan Cat, but only one digital version originates from its creator. Because so many people know of the Nyan Cat, it generates a lot of hype (and perceived value) for its image, and nearly $600,000 for the ownership of the original and its rights.
We obviously don’t own the original file
Another use of NFTs is in the gaming world, where purchases of digital items are no longer the exception but the norm. Need a starter pack to upgrade your character in the RPG? Now you can purchase your digital armour, premium cards or avatar and have the possibility of using that across different games, minting it back into the base cryptocurrency or displaying it in a digital gallery that showcases your virtual prowess.
These 2 applications of NFTs demonstrate the true potential of NFTs: online to offline integration. Anything can potentially have a digital copy, but having your digital items stored on a distributed ledger certifying your ownership opens up the playing field for many things to be tokenised and stored under your name. Digital assets could have real tangible value next to their analogous cousins, removing the argument that digital goods are “not as valuable” or have “no real world value” because they are so easily replicated.
Why Are NFTs Generating So Much Interest?
The potential of NFTs are further enhanced when combined with other protocols on the Ethereum blockchain, which allow anyone to issue, own, and trade them. This makes interacting with NFTs more efficient than collecting sneakers, watches or other physical collectibles where you have to interact with buyers and sellers in real life, watch out for fakes and scams, make payment and wait for shipping or do a face-to-face transaction. The main benefits of digital payments, being borderless and significantly easier to transfer, also applies to NFTs.
For example, if you want to create tradable in-game items as a game developer, then you can instantly have them be tradable through protocols that allow for decentralized exchange of NFTs. You don’t have to go to a market-maker or integrate your game with a payment system that potentially eats into your costs.
NFT activity can go well past trading and include actions like being able to borrow and lend, support fractional ownership (e.g. NIFTEX), or use it as collateral in taking out a loan (e.g. NFTfi). The possibilities are endless when you have the ability to combine NFTs with DeFi (decentralised finance) building blocks.
For example, the game Aavegotchi combines DeFi and NFT gaming where each Aavegotchi character represents a user’s collateral that is deposited within the lending platform Aave, but you can also battle the characters, level them up, and equip wearables that change their traits and make them more valuable.
Just Like The Dot-Com Bubble, The Boom In NFTs May Lead To Inflated Prices (And Expectations)
Similar to the dot-com boom of 2001, nascent technology has the capacity to awe and inspire us, getting us excited on all the future possibilities without considering that it might take us longer than expected to get there.
The Internet in the 2000s looks vastly different than what it is now, and it took us decades to see the technology of that era blossom today.
This means that while there might be excitement brewing among those who can see the potential of this technology, there is also the likelihood of a bubble created from the inflated prices where more and more people clamour to join the NFT space, paying larger and larger sums for NFTs that deviate from their original value. The main issue with NFTs for now is that there is no objective way to measure value because they are not backed by anything but the protocols upon which they are built.
$2.5m for the first tweet is sensational news, because it represents that as a society, we may have crossed the chasm and accepted that value can exist in the digital world. However, investors should also understand that this is the by-product of market forces pushing individuals to venture into riskier assets in a low-interest rate, yet inflationary environment.
Investors will have to navigate the overinflated expectations of NFTs and recognise that this is still technology at the early stages of development. As such, many projects and NFTs may be worth millions today but could be worth less tomorrow as society’s perception of value in the digital world changes.
The $1 Trillion Opportunity
Today, the global collectibles market alone is worth almost $400 billion and is set to grow even further. Classic cars, comics books, fine wines and even film props have earned places in collector homes and museums.
Once you add in the total value of all artwork ever produced, the figure likely tops $1 trillion. Rembrandt, a 17th-century artist, created more than 600 paintings in his lifetime, with each typically fetching eight-figure sums.
Now, imagine all these collectibles tokenised and made accessible to everyone on the blockchain… we can start to see the impact this opportunity has.
How You Can Invest In The NFT Phenomenon
If you are already into blockchain gaming — congratulations! You are truly one of the early adopters in the NFT space. If not, you could check out games like Decentraland, one of the world’s biggest blockchain-powered virtual worlds where you can buy, sell and own virtual real estate.
You can also buy NFT collectibles with the expectation that they may appreciate in value like art. To do that, you can either head towards the marketplaces where you can bid for an NFT in an auction to a P2P network where you negotiate for prices.
One of these marketplaces is OpenSea, currently the largest NFT marketplace in the world, where you can shop for all kinds of NFTs online, not limited to art but also trading cards, virtual worlds (Decentraland included) and sports collectibles.
A particular series of collectibles is called CryptoPunks, the first of the NFTs in a limited set of 10,000. They have been featured in places like The New York Times, Christie’s of London, Art|Basel Miami, and The PBS NewsHour, and are among the most sought after of NFTs.
There are 2 main concerns investors should be aware of when investing in NFTs. The first is obvious: the underlying asset must be produced in a limited supply and have significant and growing value. As much as Andy Warhol churned out thousands of silkscreen prints of celebrities for the public, most of those who bought his works were the rich and famous, which increased his works’ appeal.
The second concern pertains to the “counterparty”: NFT buyers need to trust the cryptocurrency system itself. When you invest in an NFT, you’re assigned a token that tells the world you own a specific asset. That’s often done on the Ethereum network, a system that runs the Ether currency. This means that you are putting your faith in the Ethereum blockchain in the hopes that it doesn’t collapse and wipe out your equity in the system.
Finally, you need to be sure that what you are buying is not a copy or a fake. There is, of course, a lot of hype going around blockchain as an authenticator of ownership. But an original of a copy or a fake is still worthless next to the authentic version of a work, so be sure to verify the ownership of these items by checking through the transactions that occur on the blockchain or who the original owner is.
The Big Secret: NFTs Are Only As Good As Their Social Value Or “Underlying Asset”.
The famous Nyan Cat GIF’s sale of $600,000 could have only reached that value because of the meme’s incredible popularity through the years. Similarly, the NBA’s highest-selling NFT was of a LeBron James highlight reel, which sold for $200,000. Less famous players, meanwhile, had reels that sold for as low as $9.
To make money from NFTs, investors need to have a clear understanding and deep knowledge of the genre of NFTs they are investing in. Keen NBA watchers who can correctly identify future NBA superstars could buy cheap highlight reels today and earn millions when the stars break out several years from now.
If you are able to make precise bets on the next Kobe Bryant, you have the potential to cash in on your knowledge of the NBA. However, sports is one of those industries where the player will have to go through plenty of ups and downs, and one injury could rule you out for the rest of your life. For one Kobe Bryant, however, there are thousands of other players who become just another player.
In other words, if you want to invest in NFTs, make sure you’re focusing on your area of expertise. If you’re an avid gamer, look into Aavegotchi or Decentraland. If you’re a sports fan with an eye for talent, then the NBA’s NFTs could be for you. And if you know art or music, then focus on that as your area of expertise.
It’s the same principle that’s held with stocks, bonds or any other asset class for decades — don’t invest in what you don’t understand.