What Is an NFT? Non-Fungible Tokens Explained

What is NFT? Explaining Non-Fungible Tokens

Non-fungible tokens (NFTs) seem to be everywhere these days. From art and music to tacos and toilet paper, these digital assets are being sold like the exotic Dutch tulips of the 17th century – some for millions of dollars.

But are NFTs worth the money or the hype? Some experts say they are a bubble about to burst, like the dot-com craze or Beanie Babies. Others believe NFTs are here to stay, and that they will change investing forever.

What is an NFT?

An NFT is a digital asset that can come in the form of art, music, in-game items, videos, and more. They are bought and sold online, often using cryptocurrency, and they are generally encoded with the same underlying software as many cryptocurrencies.

Although they have been around since 2014, NFTs are gaining notoriety now because they are becoming an increasingly popular way to buy and sell digital artwork. The NFT market was worth $41 billion in 2021 alone, an amount that is approaching the total value of the entire global fine art market.

NFTs are generally one-of-a-kind, or at least one of a very limited run, and have unique identifying codes. "Essentially, NFTs create digital scarcity," says Arry Yu, chair of the Washington Technology Industry Association Cascadia Blockchain Council and managing director of Yellow Umbrella Ventures.

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This stands in stark contrast to most digital creations, which are almost always infinite in supply. In theory, cutting off the supply should raise the value of a given asset, assuming it is in demand.

But

Many NFTs, at least in these early days, have been digital creations that already exist in some form elsewhere, such as iconic video clips from NBA games or securitized versions of digital art that are already floating around on Instagram.

Famous digital artist Mike Winkelman, known as “Beeple,” crafted a composite of 5,000 daily drawings to create perhaps the most famous NFT of 2021, “EVERYDAYS: The First 5000 Days,” which sold at Christie’s for a record-breaking $69.3 million.

Anyone can view the individual images – or even the entire collage of images online for free. So why are people willing to spend millions on something they could easily screenshot or download?

Because an NFT allows the buyer to own the original item. Not only that, it contains built-in authentication, which serves as proof of ownership. Collectors value those “digital bragging rights” almost more than the item itself.

How Is an NFT Different from Cryptocurrency?

NFT stands for non-fungible token. It is generally built using the same kind of programming as cryptocurrency, like Bitcoin or Ethereum, but that is where the similarity ends.

Physical money and cryptocurrencies are “fungible,” meaning they can be traded or exchanged for one another. They are also equal in value – one dollar is always worth another dollar; one Bitcoin is always equal to another Bitcoin. Crypto’s fungibility makes it a trusted means of conducting transactions on the blockchain.

NFTs are different. Each one has a digital signature that makes it impossible for NFTs to be exchanged for or equal to one another (hence, non-fungible). One NBA Top Shot clip, for example, is not equal to EVERYDAYS simply because they are both NFTs. (One NBA Top Shot clip is not necessarily equal to another NBA Top Shot clip, for that matter.)

How Does an NFT Work?

NFTs exist on a blockchain, which is a distributed public ledger that records transactions. You are probably most familiar with blockchain as the underlying process that makes cryptocurrencies possible.

Specifically, NFTs are typically held on the Ethereum blockchain, although other blockchains support them as well.

An NFT is created, or “minted,” from digital objects that represent both tangible and intangible items, including:

Graphic art
GIFs
Videos and sports highlights
Collectibles
Virtual avatars and video game skins
Designer sneakers
Music

Even tweets count. Twitter co-founder Jack Dorsey sold his first-ever tweet as an NFT for over $2.9 million.

Essentially, NFTs are like physical collector’s items, only digital. So instead of getting an actual oil painting to hang on the wall, the buyer gets a digital file instead.

They also get exclusive ownership rights. NFTs can have only one owner at a time, and their use of blockchain technology makes it easy to verify ownership and transfer tokens between owners. The creator can also store specific information in an NFT’s metadata. For instance, artists can sign their artwork by including their signature in the file.

What Are NFTs Used For?

Blockchain technology and NFTs afford artists and content creators a unique opportunity to monetize their wares. For example, artists no longer have to rely on galleries or auction houses to sell their art. Instead, the artist can sell it directly to the consumer as an NFT, which also lets them keep more of the profits. In addition, artists can program in royalties so they will receive a percentage of sales whenever their art is sold to a new owner. This is an attractive feature as artists generally do not receive future proceeds after their art is first sold.

Art is not the only way to make money with NFTs. Brands like Charmin and Taco Bell have auctioned off themed NFT art to raise funds for charity. Charmin dubbed its offering “NFTP” (non-fungible toilet paper), and Taco Bell’s NFT art sold out in minutes, with the highest bids coming in at 1.5 wrapped Ether (WETH) – equivalent to $3,723.83 at time of writing.

Nyan Cat, a 2011-era GIF of a cat with a pop-tart body, sold for nearly $600,000 in February. And NBA Top Shot generated more than $500 million in sales as of late March. One LeBron James highlight NFT fetched more than $200,000.

Even celebrities like Snoop Dogg and Lindsay Lohan are jumping on the NFT bandwagon, releasing unique memories, artwork, and moments as securitized NFTs.

How to Buy NFTs

If you are keen on starting your own NFT collection, you will need to acquire some key items:

First, you will need to get a digital wallet that allows you to store NFTs and cryptocurrencies. You will likely need to purchase some cryptocurrency, like Ether, depending on what currencies your NFT provider accepts. You can buy cryptocurrency using a credit card on platforms like Coinbase, Kraken, eToro, and even PayPal and Robinhood now. You will then be able to move it from the exchange to your wallet of choice.

You will want to keep fees in mind as you research options. Most exchanges charge at least a percentage of your transaction when you buy crypto.

Popular NFT Marketplaces

Once you have your wallet set up and funded, there is no shortage of NFT sites to shop from. Currently, the largest NFT marketplaces are:

• OpenSea.io: This peer-to-peer platform bills itself as a purveyor of “rare digital items and collectibles.” To get started, all you need to do is create an account to browse NFT collections. You can also sort pieces by sales volume to discover new artists.

• Rarible: Similar to OpenSea, Rarible is a democratic, open marketplace that allows artists and creators to issue and sell NFTs. RARI tokens issued on the platform enable holders to weigh in on features like fees and community rules.

• Foundation : Here, artists must receive “upvotes” or an invitation from fellow creators to post their art. The community’s exclusivity and cost of entry – artists must also purchase “gas” to mint NFTs – means it may boast higher-quality artwork. For instance, Nyan Cat creator Chris Torres sold his NFT on the Foundation platform. It may also mean higher prices – not necessarily a bad thing for artists and collectors seeking to capitalize, assuming that demand for NFTs remains at current levels, or even increases over time.

While these platforms and others host thousands of NFT creators and collectors, be sure to do your research carefully before buying. Some artists have fallen victim to impersonators who have listed and sold their work without their permission.

In addition, creator verification and NFT listing practices are not consistent across platforms – some are more rigorous than others. OpenSea and Rarible, for example, do not require owner verification for NFT listings. Buyer protections appear slim at best, so when shopping for NFTs, it may be best to keep the old adage “caveat emptor” (let the buyer beware) in mind.

Should You Buy NFTs?

Just because you can buy NFTs, does that mean you should? Yu says it depends.

“NFTs are risky because their future is uncertain, and we don’t have a lot of history to judge their performance,” she notes. “Since NFTs are so new, it may be worth investing small amounts to try it out for now.”

In other words, investing in NFTs is largely a personal decision. If you have money to spare, it may be worth considering, especially if a piece holds meaning for you.

But keep in mind that an NFT’s value is based entirely on what someone else is willing to pay for it. Therefore, demand will drive the price rather than fundamental, technical, or economic indicators, which typically influence stock prices and at least generally form the basis of investor demand.

All of this means that an NFT may be resold for less than you paid for it. Or you may not be able to resell it at all if no one wants it.

NFTs are also subject to capital gains taxes – just like when you sell stocks at a profit. Since they are considered collectibles, however, they may not receive the favorable long-term capital gains rates that stocks do, and could be taxed at a higher collectibles tax rate, although the IRS has not yet ruled on what it considers NFTs to be for tax purposes. Keep in mind that the cryptocurrencies used to purchase the NFT may also be taxed if they have gained in value since you bought them, meaning you may want to check in with a tax professional when considering adding NFTs to your portfolio.

That said, approach NFTs just as you would any investment: do your research, understand the risks – including that you might lose all of your investing money – and if you decide to take the plunge, proceed with a healthy dose of caution.