What are NFTs, and why are they worth investing in?

2021-12-22News

Written by: David Bailey-Lauring

A digital-only artwork by Beeple sold at Christie's auction house for a whopping $69m. However, the bidder will not get a physical piece of artwork like you'd usually expect.

Instead, the winning bidder will receive a unique digital token known as a non-fungible token (NFT).

If Bitcoin is the digital answer to currency. Then NFTs are the digital answer to collectibles.

However, despite the enormous amounts quoted and traded, some believe that NFTs are a bubble that will burst soon.

Many-many NFTs
Credit: Beeple

What is an NFT?

NFT is short for 'non-fungible token'.

A fungible asset is a unit that can be interchanged with the same value it initially held, much like money is today.

People can exchange two 10 euro notes and receive a €20 note in return; the value remains the same, whether as two banknotes or one = €20.

However, a non-fungible unit cannot be interchanged with something else. It could be a car, a house, or a piece of artwork like The Last Supper.

It is one of a kind.

You can take a photo or buy a copy, but it will never be the original.

Non-fungible tokens are 'one-of-a-kind' assets that can be digitally bought and sold like any other asset.

These digital tokens can be surmised as certificates of ownership for virtual or physical assets.

Pop NFT

How do NFTs work?

One-of-a-kind assets are what make them highly valued. Think of an artist painting like the Mona Lisa; fraudsters cannot duplicate the original. Thus it has become very valuable and can fetch large sums of money if sold.

However, others can quickly and endlessly duplicate digital files with a digital asset - they create a 'copy.'

To ensure originality, a piece of artwork can be 'tokenized' to create a digital certificate of ownership that could be bought and sold and guarantees that the token holder has the original.

Much the same as cryptocurrency, the record of who owns what is stored on a ledger known as the blockchain.

Fraudsters, hackers, and those wishing to copy files cannot forge the records because the ledger is maintained by thousands of computers worldwide.

Furthermore, NFTs can contain smart contracts that could reimburse the artist for any cut if the token is sold as part of a future sale.

If anyone can copy digital art, won't it lose its value?

It depends on your perspective.

Beeple's $69m artwork has been copied and shared across the internet, with millions viewing the artwork itself.

Even the artist himself retains the copyright ownership, so he can produce more copies if he wishes.

However, the buyer or holder of the NFT owns the 'token' that proves they own his original work. Think of it like they have the only copy of an autographed artwork.

Because of this, prices for NFTs have skyrocketed.

How much are NFTs worth?

Recent headlines of multi-million-dollar sales have fueled interest in the NFTs, not only for digital artwork.

Twitter's founder and CEO, Jack Dorsey, has promoted an NFT of the first-ever tweet, with bids beginning at $2.5m.

Musician Grimes sold some of her digital art for more than $6m.

Even the animated Gif of Nyan Cat - a 2011 meme of a flying pop-tart cat - sold for more than $500,000!

However, as with cryptocurrencies, there is so much written about how they will always rise in value, yet market saturation could quickly implode because it is so easy to create an NFT.

Could this dent demand for NFTs?

Is investing in NFTs worth it?

Because of the high sums mentioned above, NFTs attract investors considering the resale values that all artwork pieces can command.

As with physical artwork, it owns the art itself does not make the holder rich. It sells the art to the highest bidder willing to pay for it enriches the holder.

However, because NFTs are a relatively new investment class, not all understand the potential (or lack thereof) value.

Unlike the stock market, it is hard to price digital art, where the stock price is how much the investment is worth. Especially as NFTs are often very illiquid.

Investors can buy a stock at a specific price and then sell it when it's at a higher price, making them a profit in the process.

With digital art, though, its value depends on how much someone is willing to pay for it, making NFTs a precarious investment.

NFTs are highly speculative because it's hard to determine how much a tweet, meme, or image is worth to someone else. What may seem valuable to you at the time is worthless to others, meaning you may not be able to sell the NFT at all.

NFTs are interesting, although they are not suitable for all investor types. Those who wish to consider this alternative investment should only buy what they can afford to lose.

When your portfolio bulk is invested in lower-risk ventures, you can get curious about whether you have some funds to spare to invest in NFTs.

Alternatively, you can observe others attempt to monetize NFTs from the sidelines before deciding to venture into this investment strategy.

Cartoon of a guy spilling money

Are NFTs just a bubble?

Digital artists have always struggled with copyright and plagiarism of their artwork.

Artists can add their artwork to social media platforms and online galleries to make a profit.

However, the caveat to this ease is that it only takes a few clicks for others to copy and download the work for private use without compensating the artist.

As discussed above, NFT solves this problem by acting as a virtual certificate of authenticity. Essentially it ties the original digital artwork with the token, thus giving the digital image a higher value than an artist's signature on the physical artwork.

The certificate of authenticity or token cannot be forged or copied by anyone as it exists on the blockchain.

And yet, there are concerns that this precarious and speculative bubble could crash despite this authenticity, bringing down inflated investor prices with it.

Digital artwork relies on manufactured digital scarcity - if there is less of something unique, like an NFT piece of work, the price remains high because it is 'one-of-a-kind.'

But should artists decide to sell multiple tokens on one piece or not, the market cares for digital scarcity (think music downloads). The price of NFTs could drop for prospective collectors or buyers.

The future of NFTs

Much of the generated value in NFTs is indeed speculative.

The biggest cryptocurrencies, Bitcoin and Etherium, and even the gimmick Dogecoin, began the same way. Two of them (Bitcoin and Etherium) have become global mainstays of currency exchange.

What may seem ludicrous to pay for a digital token is now the norm.

NFTs can provide long-term value creation for artists and businesses in the long term.

Gaming companies and even the NBA have devised ways to use NFTs for their profitable benefit.

NFTs may be viewed as a bubble, but they are here to stay.