What are NFTs?

A Newish Kind of Investment

Investments can take on various forms. From stocks, bonds, and mutual funds, to private equity, cryptocurrency, and now NFTs.

NFTs explained

Though NFTs have been around since 2014, they have seen rapid growth in the past year. NFTs, or non-fungible tokens, are digital assets that represent real-world objects such as art, music, and videos, like sports clips. Tweets and memes have also been turned into NFTs. Twitter (NYSE:TWTR) founder Jack Dorsey sold an NFT of his first tweet for $2.9 million.

While NFTs share similarities with cryptocurrency, they are not mutually interchangeable. Each NFT represents a unique underlying asset with a distinct value. In contrast, fungible tokens, like Bitcoin (CRYPTO:BTC), all hold the same value, are interchangeable, and can be exchanged one-for-one.

People buy and sell NFTs online using cryptocurrency. NFTs are typically one-of-a-kind, or one of a limited run. The owner of an NFT owns the original item, which contains built-in authentication that serves as proof of ownership.

How does an NFT work?

An NFT is built using the same kind of programming as cryptocurrency. It exists on a blockchain or public ledger, which allows for verifiable ownership. An NFT can be a digitized copy of a physical collector’s item or can exist solely in the digital realm. So, if you’re purchasing an NFT of a painting, instead of getting the painting, you get the digital file, also known as a token, of the painting and exclusive ownership rights. Only one person can own an NFT at a time. Owning an NFT allows you to invest in something without needing to physically own or store the item, making it easier to buy and sell NFTs in the open marketplace.

Why the sudden rise in NFTs?

The bottom line: Money. Artists no longer have to place their pieces in galleries or auction houses. Instead, artists can sell their art on the intranet directly to consumers. This lets an artist keep more profits and even allows an artist to program in royalties to ensure they receive a percentage of the sales whenever the art is sold to a new owner.

Beyond art, NFTs are making a splash in the gaming community. Typically, gamers use the digital assets bought inside a game while playing the game, but the asset itself belongs to the gaming company. With NFTs, ownership of the asset shifts to the buyer. Now, players can buy and sell across the gaming platform and see added value based on who has owned them along the way.

NFTs are also being used for branding and revenue streams for companies. The NBA is selling digital collectibles in the form of trading cards embedded with iconic basketball moments. Ralph Lauren (NYSE:RL) has been selling branded digital apparel in virtual worlds. Nike (NYSE:NKE) has acquired a startup specializing in NFT-based digital sneakers and Adidas has created a line of virtual gear for the characters of Bored Ape Yacht Club.

There are various other benefits to NFTs: NFTs can be a valuable investment. A CryptoPunk NFT was sold in February for 8,000 Ethereum tokens, equaling over $23 million. The original owner sold this NFT in 2017 for just $1,646. That’s a huge return on investment!

Additionally, the NFT marketplace is large with a small barrier to entry. Small investors who want in on the action can purchase a portion of an NFT, like a percentage of a cryptocurrency.

Criticism of NFTs

Criticism of NFTs include environmental concerns, excessive fees, fraud, and lack of perceived value.

• Environmental concerns: The proof-of-work protocol required to verify blockchain transactions on networks such as Ethereum (CRYPTO:ETH) consumes a large amount of electricity. To combat the environmental impact of NFTs, some NFT technologies use validation protocols that use less energy and some artists have decided against selling some of their work to limit carbon emissions.

• Fees: Some platforms charge artists and buyers fees for listing, claiming, and secondary sales. Platform fees allegedly range between 72.5% and 157.5%, with the average fee settling at 100.5% of the price. In such cases, artists pay more money in fees than they make in sales.

• Fraud: Fraud can take several forms. Fraudsters have sold art as NFTs without the artists’ permission and plagiarized NFTs. “Sleepminting” allows someone to mint an NFT in an artist’s wallet and then transfer it to their own account without the artists’ knowledge. Recently, Bored Ape Yacht Club’s Instagram account was hacked, sending out fraudulent links to mint “land” in OthersideMeta, compromising the wallets of those who clicked the link, and stealing NFTs. Employees and other insiders of NFT marketplaces can engage in insider trading by purchasing NFTs before they are launched to the public.

• Lack of perceived value: How valuable is your NFT if someone can use it freely without your consent? Especially for pre-existing items that are turned into NFTs, like Jack Dorsey’s tweet, there is little perceived value to owning the NFT of the item. You do not have to own the NFT to reference, use, or share it without recourse. This attitude has spawned the downward valuation of NFTs and precluded sellers from earning high dollars from the resale of these digital assets. In fact, the person who bought Jack Dorsey’s tweet tried to resell it in April 2022 for $48 million. But after an auction that lasted a week, the highest bid offered was a mere $280.

Parting Thoughts

As with any investment, you should proceed cautiously. Do your research and know that NFTs, like cryptocurrency, and even stocks, are a speculative investment. The value of NFTs is fairly subjective and based on the value of the media they represent. At least with a stock, you have an ownership stake in a business and a claim on future profits generated by the business.

Having information at your fingertips is easier than ever. Enroll in Robbins LLP’s free investment monitoring service, Stock Watch, for notifications of corporate misconduct impacting the value of your investments, advice on how to hold corporate officers and directors accountable for their misconduct, and to receive information about class action settlements.