From tweets to clips of slam-dunks to artwork and paintings, NFTs are a colourful bunch that seem to defy simple categorization. And that’s at least partly the point: “non-fungible tokens” (NFTs) are one-of-a-kind vouchers that represent digital ownership of a unique asset. That asset could be physical, like a painting or sculpture, or an intangible one, like a GIF or a tweet. You can think of an NFT as a kind of cryptographic “ownership title” that can be traded over blockchain (the technology underpinning cryptocurrency).
NFTs have exploded over the last few years, and it’s not rare to see them selling for millions of dollars. Why are they so popular, and can you become wealthy from trading NFTs? Let’s take a closer look.
What are NFTs?
NFTs are digital tokens with special cryptographic data that distinguish each one from every other. NFTs are not equivalent, nor are they directly exchangeable. Each one represents a unique asset, usually an intangible one, but increasingly physical assets, too. NFTs exist on blockchain, and, like crypto, they contain ownership details, as well as details about the NFT’s original creator.
NFTs might be a new phenomenon, but the logic behind them is as old as sports cards and Beanie Babies. “Non-fungible” means that an asset cannot be directly replaced with an identical asset, no matter how alike they seem. For instance, just because you have a pink flamingo Beanie Baby doesn’t make it equivalent to my pink flamingo Beanie Baby: mine is clean and has a tag, whereas yours is tagless and has a stain.
Numerous real-world assets are non-fungible: real-estate, cars, paintings, old wine, and other rare collectibles are unique items and cannot necessarily be exchanged one for the other.
In contrast, a fungible asset is one that can be directly exchanged with another that’s like it. The best example is money. If you had a $100 bill and I had a $100 bill, we could trade bills and still say we had $100 each. Your $100 bill has the same equivalency as my $100: they’re replaceable. The same goes for stock shares and cryptocurrency. If I had 100 Bitcoin and you had 100 Bitcoin, we could trade our Bitcoin and still be filthy rich.
How do NFTs work?
To understand how NFTs work, let’s start with the creation process, which is called “minting.”
Let’s say you’re an artist, and you’ve created a digital graphic that you want to mint into a NFT. To do so, you’ll have to tokenize it, meaning you upload it to an NFT marketplace, give it a name, and include a description (or a link to your website). You’ll pay a “gas fee,” which covers the energy required to compute and validate your NFT, then you can publish it on the open market.
At this point, you can sell your NFT for a fixed price (in crypto), or you can auction it. Whoever buys your NFT will obtain digital ownership over it, and they can turn around and sell it whenever they want.
To be clear, the buyer doesn’t own the original graphic. You do. Just because someone owns an NFT doesn’t give them the intellectual rights to that image. They can’t start emblazoning the image on tshirts and calling it their own. The creator of the image still holds all commercial rights, meaning they can continue to sell their image, even if someone else owns the corresponding NFT.
How can you buy NFTs?
To buy an NFT, you need to have a crypto wallet on an NFT marketplace. Crypto wallets store cryptocurrency, which you need in order to buy NFTs (you can’t use Canadian dollars). Typically, if an NFT is stored on a specific blockchain, you need to have crypto that corresponds to that blockchain. For instance, if you’re buying an NTF that exists on Ethereum, you’ll need Ether tokens to buy it.
Once you buy an NFT, you can turn around and resell it. Of course, you don’t have to sell it. Much like you can showcase your collectibles to the public (think “cabinets of curiosities”), you can display your NFTs on a website. You could even “gate” your NFTs, making people pay an entry fee to see them.
What gives NFTs their value?
Unlike stocks, which theoretically represent a company’s performance, NFTs don’t have a true value. Much like art, their value depends on matters of taste. One NFT may go mainstream, simply because the public loves the artist, or the NFT’s concept, or even the story behind its creation. Conversely, an NFT might have aesthetic value, but because it lacks media hype, it could go unnoticed and so be worth less.
Sometimes, supply and demand can impact an NFT’s price. For instance, the NBA might mint 59 NFTs of LeBron James dunking. Because there’s scarcity built into the NFT, people might be willing to pay a higher price, just to be the one of the few who own it.
Are NFTs the right investment for you?
To be sure, NFTs are a significant evolution in blockchain technology, one that has immense real-world applications. Imagine, for instance, if everyone had an NFT for their passport. We would no longer have to worry about losing our passports, as we would always have a token on blockchain that represented our identities, and the security of blockchain technology could help reduce fraud and identity theft.
NFTs are also significant for artists and creators, simply because they remove the need for an intermediary or agent. An artist doesn’t need a gallery to showcase their works. They can display their art on an NFT marketplace and earn royalties whenever their work is resold.
For the average investor, however, NFTs are most likely not the best place to put your money. For one, NFTs are fairly new, and there’s no telling how the public will perceive them next year, let alone five years down the road. While you might make money on NFTs in the short term, buying and selling them quickly, there’s no guarantee their value will increase over the long run.
They’re also highly speculative. Unlike stocks, you can’t use valuation metrics to decide an NFT’s true value. As subjective as it sounds, you need an “eye” for art and collectibles to make a good NFT investor. If you’re a seasoned collector, you might be able to spot good NFTs from the “pump and dump” schemes.
For those new to investing, a better approach is to buy quality stocks and hold them for the long term. You might also want to buy shares of ETFs or index funds, both of which track a larger market. When you’ve created a principal holding, that is, once you’ve invested in a wide range of companies and markets, you might want to diversify your portfolio with alternative investments, like NFTs.
To be clear, we’re still in the early days of NFTs. While the real-world applications are exciting, proceed with caution if you decide to buy them. They might be a fun collectible to own, but you probably shouldn’t put your entire retirement savings into them.