What is an NFT? A 2024 beginner's guide

Non-fungible tokens (NFTs) have become ubiquitous recently, spanning various domains from art and music to even unconventional items like tacos and toilet paper. Their sales parallel the frenzy around exotic Dutch tulips in the 17th century, with some fetching millions of dollars. However, the debate persists: are NFTs genuinely valuable or just inflated by hype? While some experts liken them to past bubbles like the dot-com craze or Beanie Babies, others argue that NFTs represent a transformative force in investing that's here to stay.

Understanding Non-Fungible Tokens (NFTs)

An NFT represents a digital asset, encompassing various forms like art, music, in-game items, videos, and more. Transactions typically occur online, often using cryptocurrency, leveraging the same underlying software as many cryptocurrencies. While they have existed since 2014, NFTs are now gaining significant attention, particularly for buying and selling digital artwork. In 2021, the NFT market surged to a remarkable $41 billion, approaching the total value of the global fine art market. NFTs are typically unique or part of a very limited edition, each possessing distinctive identifying codes. Arry Yu, chair of the Washington Technology Industry Association Cascadia Blockchain Council and managing director of Yellow Umbrella Ventures, describes NFTs as creating digital scarcity, a departure from the typical infinite supply of digital creations. This scarcity theoretically elevates the value of a given asset, contingent upon demand.

However, many NFTs, particularly in these initial stages, consist of digital content already present in other formats, such as iconic NBA video clips or digitized versions of artwork circulating on platforms like Instagram.

Renowned digital artist Mike Winklemann, also known as "Beeple," assembled a compilation of 5,000 daily drawings to produce one of the most prominent NFTs of 2021, titled "EVERYDAYS: The First 5000 Days," which fetched a record-breaking $69.3 million at Christie's auction.

Individual images, as well as the entire collage, are freely accessible online. So, what motivates individuals to invest millions in something readily screenshotable or downloadable?

The allure lies in NFTs granting ownership of the original piece, coupled with inherent authentication features providing proof of ownership. Collectors place significant value on these "digital bragging rights," sometimes valuing them even more than the item itself.

What are the applications of Non-Fungible Tokens (NFTs)?

How do Blockchain technology and NFTs provide artists and content creators with novel opportunities for monetization? For instance, artists are no longer dependent on galleries or auction houses to sell their work; instead, they can directly market it to consumers as NFTs, allowing them to retain a larger portion of the profits. Moreover, artists can embed royalties into their NFTs, ensuring they receive a percentage of sales each time their work changes hands—a feature particularly appealing as artists typically do not receive ongoing proceeds after the initial sale.

Art is not the sole avenue for generating income through NFTs. Companies like Charmin and Taco Bell have leveraged themed NFT art auctions to support charitable causes. Charmin introduced "NFTP" (non-fungible toilet paper), while Taco Bell's NFT art quickly sold out, with top bids reaching 1.5 wrapped ether (WETH), equivalent to $3,723.83 at the time.

Examples abound, such as the sale of Nyan Cat, a popular 2011 GIF featuring a cat with a pop-tart body, which fetched nearly $600,000 in February. NBA Top Shot amassed over $500 million in sales by late March, with a single LeBron James highlight NFT selling for over $200,000.

Even celebrities like Snoop Dogg and Lindsay Lohan are embracing NFTs, releasing unique memories, artwork, and moments as securitized NFTs.

What sets NFTs apart from cryptocurrency?

NFT, short for non-fungible token, shares a foundational programming basis with cryptocurrencies like Bitcoin or Ethereum, but their similarities largely end there. Unlike physical money or cryptocurrencies, which are fungible and can be interchanged or traded, NFTs possess unique digital signatures that prevent them from being exchanged or valued equally. Each NFT is distinct, making them non-fungible. For instance, while both an NBA Top Shot clip and EVERYDAYS are NFTs, they cannot be equated in value solely because of their NFT status. Moreover, even within the same category, such as NBA Top Shot clips, individual items may not hold identical value.

How does a Non-Fungible Token operate?

NFTs are hosted on a blockchain, a decentralized public ledger for recording transactions, commonly associated with enabling cryptocurrencies.

Primarily, NFTs are stored on the Ethereum blockchain, although other blockchain platforms also support them.

NFTs are generated, or "minted," from digital assets representing both physical and digital items, including graphic art, GIFs, videos, collectibles, virtual avatars, designer sneakers, music, and even tweets. For instance, Twitter co-founder Jack Dorsey auctioned his first tweet as an NFT for over $2.9 million.

In essence, NFTs resemble digital versions of physical collectibles. Instead of receiving a physical painting to display, the buyer obtains a digital file.

Ownership of NFTs is exclusive, with each NFT having only one owner at a time. Blockchain technology facilitates easy verification of ownership and seamless token transfers between owners. Furthermore, creators can embed specific information, such as signatures, into an NFT's metadata, enabling artists to authenticate their work digitally.

How does one go about purchasing NFTs?

If you're interested in building your own NFT collection, what are the essential steps to take?

Firstly, you'll need to obtain a digital wallet capable of storing NFTs and cryptocurrencies. Depending on the currencies accepted by your chosen NFT provider, you may need to acquire cryptocurrency such as Ether. Platforms like Coinbase, Kraken, eToro, and even PayPal and Robinhood now offer options for purchasing crypto using a credit card. After acquiring cryptocurrency, you can transfer it from the exchange to your preferred wallet.

Considering fees is crucial during your research process, as most exchanges impose transaction fees, typically a percentage of your transaction, when purchasing crypto.

Is investing in NFTs a good idea?

Is it wise to invest in NFTs? According to Yu, the answer varies.

"NFTs pose risks due to their uncertain future and lack of historical performance data," she emphasizes. "Given their novelty, it might be prudent to start with small investments to test the waters."

In essence, the decision to invest in NFTs is highly personal. If you have disposable income, it may be worth considering, particularly if a specific piece holds sentimental value.

However, it's essential to recognize that an NFT's worth is solely determined by the willingness of others to pay for it. Consequently, pricing is influenced by demand rather than traditional indicators such as fundamental, technical, or economic factors, which typically influence stock prices.

This dynamic implies that an NFT could potentially resell for less than its initial purchase price, or in some cases, might not find a buyer at all.

Furthermore, NFTs are subject to capital gains taxes, akin to selling stocks at a profit. Since they're categorized as collectibles, they might not qualify for the preferential long-term capital gains rates enjoyed by stocks and may even face higher tax rates specific to collectibles, though the IRS has yet to provide definitive guidance on the tax treatment of NFTs. It's advisable to consult with a tax professional, especially considering that the cryptocurrencies used for NFT purchases may also be subject to taxation if they've appreciated in value since acquisition.

In summary, approach NFTs with the same diligence as any investment: conduct thorough research, acknowledge the associated risks—including the possibility of losing your entire investment—and exercise caution when making decisions.

Top NFT platforms

After setting up and funding your wallet, you have numerous options for browsing NFT platforms. Presently, the most prominent marketplaces for NFTs include:

While these platforms host numerous NFT creators and collectors, it's crucial to conduct thorough research before making purchases. Some artists have encountered issues with impersonators listing and selling their work without authorization.

Moreover, the verification processes for creators and NFT listings vary across platforms, with some being more rigorous than others. Notably, platforms like OpenSea and Rarible do not mandate owner verification for NFT listings. Given the limited buyer protections in place, it's advisable to exercise caution and adhere to the principle of "caveat emptor" (let the buyer beware) when shopping for NFTs.