What are NFTs? A Guide for Investors
The cryptocurrency king Bitcoin has had a rough start to the year, down roughly 6.9% since the beginning of 2022, but the non-fungible token, or NFT, market is booming with investors, institutions, companies and celebrities piling into the digital tokens as their value steadily trends upward.
NFTs’ total value grew from $100 million in 2020 to more than $21 billion in 2021, according to a report by TradingPlatforms.
You might have seen some talk about the Bored Ape Yacht Club NFTs, one of the most famous NFT collections, a whimsical series of unique images depicting an ape with different personalities. But now, big brand companies have moved into the NFT marketplace. Luxury car company Mercedes-Benz has collaborated with NFT artists to create an exclusive NFT collection, Nike Inc. (ticker: NKE) acquired digital sneaker brand RTFKT to expand its digital presence, and Walmart Inc. (WMT) may be heading into the metaverse with potential plans to offer its own cryptocurrency and collection of NFTs.
For investors who want a piece of the NFT pie, here’s what you need to know about NFTs and how to manage them:
- What are NFTs, and how do they work?
- NFTs and art.
- Buying and selling NFTs as investments.
What are NFTs, and How Do They Work?
NFTs are nonfungible tokens. Fungibility refers to assets of the same kind that can be traded interchangeably among one another. Bitcoins, for example, are fungible, users can trade one Bitcoin for another, and it will be the exact same asset.
But because NFTs are nonfungible, each token is unique and cannot be replicated. Because of this distinct characteristic, NFTs are represented as tokens on the blockchain representing digital ownership. This record of ownership cannot be changed since its existence is time-stamped on the blockchain.
“NFTs are pieces of information on a blockchain that’s represented in an interactive format with visual representation,” says Nick Donaraski, CEO of blockchain technology, ORE System. For ownership rights, if you purchase an NFT early, that asset is limited and only available through you being the owner. This scarcity, Donaraski says, is what allows for the value of the NFT to grow over time.
Managing NFTs is just like managing cryptocurrency, which can be done on a mobile app or web-based application. With easy-to-use cryptocurrency exchanges like Coinbase Global Inc. (COIN), Binance and FTX, this can all be done on a smartphone, but this could leave your tokens exposed to scams or hacks.
Experts say one of the most important aspects of managing NFTs is keeping their tokens safe. Similar to cryptocurrency, NFTs are held in wallets. Inside the wallet, there’s a unique link that allows the content to be displayed or transacted with. “You can take an NFT from one marketplace to another as long as they’re on the same blockchain and support that type of NFT,” Donaraski says.
Storing or accessing NFTs can be done through a digital or hardware wallet. This is the place where users can hold, receive and buy their NFTs. Digital or online wallets such as Metamask, Coinbase Wallet or AlphaWallet are protected through a long password or seed phrase. This is a private key that is used to authorize transactions. This is a standard way to store NFTs but can be vulnerable to cyberattacks.
Donaraski says password management is of utmost importance and to always protect your private key. “Your private key is your password and you should consider that as important as your birth certificate,” he says. “If someone gains access to private key, they have access to everything that’s in the wallet.”
NFTs and Art
NFTs represent either a physical or digital asset. This can be anything from intellectual rights to a title of ownership to an asset. NFTs have been expanding in the world of gaming, retail, real estate, sports and other areas. As the utility of NFTs is expanding, its adoption and popularity will follow.
But NFTs are particularly known in the context of digital art. Artists create NFTs, which can then be traded on a marketplace. But NFTs can also be leveraged in a number of different aspects.
NFTs are unique due to their verified ownership that cannot be replicated or manipulated. When an item is limited, it becomes more valuable. The NFT market is speculative, with people buying up NFTs because there is the belief that they will later be more valuable to someone else. So people are collecting art NFTs because they think they will be valuable in the future.
NFTs are powered by smart contracts. Specifically, smart contracts are the function that manages the transferability of NFTs. “If you think of blockchain as a computer network, the smart contract is the computer that runs the website,” Donaraski says.
Buying and Selling NFTs as Investments
The traditional principle of investing, buy low and sell high, also applies for NFTs. Market participants can buy in NFTs early and turn around and sell them for a profit. However, “NFTs should be thought of as an investment that could go to zero and is pure speculation,” says Daniel Strachman managing partner of A&C Advisors.
“There are NFTs that you can buy where you can flip right away and others you can hold,” Strachman says.
NFTs are not like a stock or a bond where you know what the intrinsic value of that investment is. They have a market value that’s driven by what the crypto community is willing to pay for them.
Knowing that NFTs are risk assets, investors need to determine the level of exposure to them. “You would have a certain amount of money that you would put into your risk capital bucket, and that would be what you are willing to go to zero or 100,” he says. Another way to think about exposure to NFTs Strachman says is if investors have exposure to cryptocurrencies, NFTs could be a subset of that exposure.
Strachman says investors can think about NFTs as a commodity-like asset similar to silver, gold and art. “When people buy art as an investment, it’s an illiquid part of their portfolio,” he says. “Some would call that a part of a commodity allocation.” One commodity-like aspect of NFTs, Strachman says, is that they are “completely uncorrelated” to any other market out there.
Experts say your individual long-term investing goals should determine the type of NFTs you want to look at. “You have to find NFTs that align with what your portfolio growth is, just like any other investment,” Donaraski says.
Some NFTs can provide investors with greater growth opportunities, depending on their applications, Donaraski says. NFTs with utility, like real estate contracts, will ultimately hold greater value in the future.
An NFT can be a legitimate investment if investors understand what the NFT is being used for. “Making sure that you have something that has utility is a better bet for the long-term life of what an NFT is,” Donaraski says. “If the NFT has utility, whatever the life span of the use case is, is the lifespan of that utility.”
Takeaway
The most important thing before investors go into the NFT market is to do research. It’s no different than doing research on a stock or bond to know what their getting themselves into. Market participants too often get in a craze, Strachman says, which is good for those who sell them but bad for those who buy them. To make better decisions, it’s best to understand what investors are getting themselves into.