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NFTs Are Hot, But Not For Timid Buyers

On March 11, a piece of digital art sold at auction for more than $69 million. That sale brought wider attention to the phenomenon of nonfungible tokens, commonly referred to as NFTs.

“Everydays: The First 5000 Days” is a piece by Mike Winkelmann, an artist who goes by Beeple. It is a collage of the images he has posted online daily since 2007. Yet all the component parts are still easy to find online, as originally posted on Beeple’s Twitter and Instagram accounts and reproduced elsewhere. If you can see the art for free, why pay $69 million?

An NFT makes a digital asset unique. While a copy of a JPG image file and the original are generally indistinguishable, an NFT can serve as a sort of certificate of authenticity, providing the token-holder the assurance that he or she owns the original piece. It is the difference between owning a certified Monet and a skillful reproduction, if that reproduction were identical in every detail but the signature. Anything digital can, in theory, be sold as an NFT: images, videos, items in video games, tweets. (Some companies have experimented with using NFTs to authenticate real-world items too, but this approach is rare thus far.)

To understand the idea behind NFTs, it is important to understand fungibility. If you and I are both holding $20 bills and we drop them on the ground, we will bend down and pick up whichever is closer. Neither of us knows, or cares, whether we retrieved our original bills or swapped; every $20 bill is worth $20, and neither of us has lost anything no matter which bill we grab. Traditional works of art are a classic example of nonfungible assets. Even if two paintings are appraised at the same dollar value, most owners would care if they got the wrong painting.

An NFT is stored on a blockchain, like bitcoins or other cryptocurrencies. Most existing NFTs are stored on the Ethereum blockchain, though other blockchains can also support them. By its nature, a digital ledger is designed to be unfalsifiable, since records of transactions are public and rewriting one is obvious to everyone viewing the blockchain. This is what makes it appealing for NFTs. A blockchain has a built-in mechanism for authenticating transactions.

Yet an NFT does not (at least so far) give you the legal right to stop reproduction of the asset in question. For one thing, owning a piece of art does not make you the owner of the intellectual property involved. If you buy the first tweet from Twitter co-founder Jack Dorsey, you have the bragging rights to owning it. But the tweet itself will presumably remain on Twitter for anyone with an internet connection to look at whenever they like – not to mention screenshots, embeds, local saves of a page or the information on it, or any of the other ways internet users can duplicate content.

As Jake Brukhman, founder of cryptocurrency investment company CoinFund, told NPR: “You’re not buying the picture. You’re buying the property rights to the picture.” Whether that is valuable to you in a digital world is a question you must answer for yourself.

While NFTs are not new, they are drawing new focus. When they first emerged in 2017, NFTs were mainly for cryptocurrency enthusiasts. A Beanie Baby-like craze for digital CryptoKitties led collectors to scramble for blockchain-certified images of cartoon cats. While that craze has died down, it suggested that an appetite for NFTs as collectibles existed. The company behind CryptoKitties, Dapper Labs, recently collaborated with the NBA to offer “digital highlight chips” designed to function like the 21st century version of baseball cards. The price of a LeBron James highlight reel reportedly reached into six figures.

Pros And Cons Of NFTs

NFTs offer some real advantages to artists. Depending on the type of work they create, a digital token may offer a way to sell work for which there would not otherwise be much of a market. Depending how the NFT is set up, an artist may also receive a percentage every time an NFT-certified piece is sold or changes owners. This can give the artist an ongoing stake in a work that grows more popular over time. And in most cases, as with the sale of more traditional artwork, the artist retains intellectual property rights. The person who bought Kings of Leon’s album “When You See Yourself” as an NFT owns the equivalent of a first-edition album pressing but is not entitled to share the album’s royalties.

For buyers, the upside of an NFT purchase is murkier. Collectibles, by their nature, are worth what someone will pay for them. This is true of an NFT, a sculpture or a rare postage stamp. But with physical items, owners have the satisfaction of exclusively owning something rare or one-of-a-kind. NFT owners can only say the same in the most abstract sense. The digital item itself may well be available elsewhere. For example, “Nyan Cat,” an animated image of a flying cat-Pop Tart hybrid, went viral in 2011. It existed on hard drives and websites worldwide both before and after the sale of a “remastered” original as an NFT. The one-of-a-kind item the buyer can claim is the token itself – a bit of data living on a blockchain.

Collectors should also bear in mind that not every NFT is a one-of-a-kind item. Some creators sell a run of a certain number of editions, and while each has a unique digital signature, the digital asset in question may be one of several copies. Fraud is also possible. For example, some NFTs resembling works by Banksy sold for hundreds of thousands of dollars before they were determined to be inauthentic. While the blockchain that hosts your NFT can confirm you own it, there is some level of trust involved in the proposition that the token corresponds to the art or other digital item you expect it does. If you buy through a reputable dealer – the well-established auction house Christie’s handled the Beeple sale – this is likely not a major risk. But most buyers lack the know-how to personally verify that a string of digits on a blockchain corresponds to what they think it does. It is important to be clear exactly what you are buying if you choose to purchase an NFT.

Matters get even more complicated if a buyer considers an NFT an investment. This mechanism is only a few years old, and it is far too soon to guess whether NFTs are a fad. There is a real chance that NFT owners could end up holding a token that no one is willing to pay much for, let alone more than the original purchase price. Buying art as an investment already carries a variety of risks related to valuation and changing tastes. Buying NFTs compounds these, at least so far, with a smaller pool of buyers and an uncertain future as a market. And most people buy NFTs with cryptocurrency, building in an extra layer of volatility.

If you want to support an artist whose work you value, or if bragging rights matter to you, buying an NFT may be no worse a decision than bidding high on an item at an auction. Or collecting high-end sneakers. Or paying for the concept of a banana taped to a wall. But those hoping to use NFTs as investments should think long and hard about the risks before going any further. Like any volatile asset, with an NFT there is no guarantee a future buyer will want to pay more than, or anything close to, your original purchase price. Proceed with caution.

Managing Vice President Paul Jacobs, of our Atlanta office, is among the authors of our firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. He wrote Chapter 12, "Retirement Plans"; Chapter 15, "Investment Approaches And Philosophy"; and Chapter 19, "A Second Act: Starting A New Venture." He also contributed to the firm’s book The High Achiever’s Guide To Wealth.
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