Lately, it seems you can’t swing a bored monkey without hitting the front page of tech news (opens in a new tab)a difficult celebrity interview (opens in a new tab)or a Twitter flame war (opens in a new tab) about NFTs.
Whether you’re all in on NFTs or wish everyone would stop talking about them, it’s pretty clear that these new investments aren’t just a flash in the pan. So it’s worth understanding exactly what these tokens are and how they work. Here’s what you need to know about NFTs.
What is an NFT?
NFT stands for non-fungible token. They are a type of crypto-asset, meaning they are digital assets rather than physical. Although they may have monetary value like any other asset, they are not considered a cryptocurrency.
Non-fungible refers to the fact that each NFT is unique. If you’ve ever taken an economics class, you might remember that “fungible” means interchangeable. For example, you can exchange a $20 bill for two $5 bills and a $10 bill and have exactly the same amount of money.
Cryptocurrency is also fungible. If you have one Ethereum coin, you can exchange it for any other Ethereum coin.
NFTs are not mutually interchangeable. In that way, they are similar to trading cards. For example, if you have a Nolan Ryan rookie card and your friend has a Cal Ripken 2131 card, you may both have valuable baseball cards, but they are not the same.
In other words, NFTs are digital assets that offer exclusive ownership to one person.
Although copying an NFT’s digital file is always possible, the NFT itself offers proof of ownership of the asset, which cannot be duplicated. This makes it similar to investing in art. Van Gogh’s Starry Night, for example, can only have one owner (MoMA (opens in a new tab)), although the image has hundreds of thousands of reproductions.
What are NFTs used for?
NFTs help solve a problem for artists and creators in the modern age. In particular, while creating digital assets enables artists to reach a global audience, the fact that digital assets are easily shared makes it much more difficult for creators to monetize their creations.
The NFT model combines the best of two worlds: the far-reaching benefits of the Internet plus the financial ownership of the physical world.
Artists can use NFTs as a way to sell their art and grow their platform all at once – and buyers can buy NFTs from their favorite artists to support them.
How do NFTs work?
To create an NFT, the creator will link their digital file to a unique token on the blockchain. The blockchain is a decentralized data storage system that anyone can add to, but no one can change – that no person, company or government is responsible for.
It ensures that the data in the blockchain is spread out and virtually impossible to change, so it provides proof of any transactions on the blockchain that have come before.
Most NFTs are stored on the Ethereum blockchain, although other blockchains have also gotten into the game and created their own versions of NFTs.
Why do people invest in NFTs?
There are several reasons why NFT collectors choose to invest in these assets:
- Supporting artists: Buying an artist’s NFT is a way to help them monetize digital assets, which can be challenging to monetize. Additionally, many early NFT adopters were members of the art community who saw this innovation as a new way to invest in art and artists.
- Join a community: Ownership of an NFT gives buyers access to a community of other buyers. Some NFT holders love the feeling of being part of an emerging community.
- Symbolization of status: Like a Rolex watch, an NFT is an expensive and discretionary purchase.
- Speculative investment: According to NFT enthusiasts, value increases even when non-NFT holders use and distribute the digital art that is the foundation of NFT. That’s because the more famous the image or asset becomes, the more value the recognized piece adds to the NFT itself.
What are the disadvantages of NFTs?
NFTs offer exciting opportunities, but also some troubling downsides to this type of investment.
Environmental concerns
NFTs, like cryptocurrency, reside on the blockchain, which uses a system called proof-of-work to verify the accuracy of transactions. This system requires a lot of computing power, which consumes a lot of energy.
According to a 2019 finding from the University of Cambridge (opens in a new tab)Bitcoin’s blockchain (which is just one of many cryptocurrency blockchains) uses as much energy in one year as the entire country of Switzerland.
As of 2019, 63.3% of global electricity (opens in a new tab) was produced using fossil fuels. Using electricity for non-essential purposes, such as the blockchains on which NFTs are based, can be considered an unreasonable demand on our resources.
NFTs are speculative
Like the housing bubble, the dot-com bubble and even the Beanie Baby craze, there is an aspect of “irrational exuberance” to the current interest in NFTs. Like those that came before it, this investment is often touted as a sure thing that can only go up.
And since many people do not understand the mechanics of what an NFT is and how it works, they are vulnerable to investing without doing their due diligence.
The recent fluctuations in the NFT market have made it clear that there is nothing “safe” about NFTs and that even those who understand how this innovation works may not be happy with their investment.
Potential for hacking
Although one of the selling points of NFTs is the fact that it is very difficult to “steal” anything from the blockchain, this does not mean that these assets cannot be hacked. There are vulnerabilities in the blockchain that hackers can and have exploited.
You are also vulnerable to several human weaknesses, such as the ever-present danger of phishing, which is the source of most data breaches.
Additionally, there have been stories of buyers forgetting the password to their crypto wallets (opens in a new tab) and thus lose access to their assets.
Should you invest in NFTs?
Determining whether an NFT fits your investment strategy depends on your risk tolerance, your comfort with new technologies and how much money you are comfortable losing.
Make sure you don’t invest money you can’t afford to lose and do your research before you buy. Seemingly exciting new NFT investments should especially beg you to look before you leap.
