What is an NFT?
NFTs (Non-Fungible Tokens) are tokens that can be used to represent ownership of unique items. They are stored on blockchains that certify these digital assets are unique and therefore not interchangeable. Things like art, music, videos, collectibles, even real estate can be tokenized.
While a fungible asset is something that can be readily interchanged, a non-fungible asset has unique properties which means it cannot be interchanged with something else. This uniqueness is why NFTs have value. These “one-of-a-kind” assets can be bought and sold like any other assets.
These tokens can be thought of as certificates of ownership for digital and physical assets.
Although the purchase of an NFT will transfer the proof of ownership to the purchaser, it does not stop people from copying or sharing the digital art. In many cases, the artist even retains the copyright of their work which means they can continue to produce and sell copies. Despite that, collectors often value the “digital bragging rights” more than the items itself and still buy NFTs. And the built-in authentication serves as proof of ownership.
Interest in NFT
Although NFTs have been around since 2014, they only began gaining popularity recently. The market for them exploded as mainstream companies and investors poured money into new DeFi trends.
While anybody can tokenize their work to sell as an NFT, the recent interest in NFTs has been fuelled by several multi-million-dollar sales. The sale of the first-ever tweet by Twitter’s founder Jack Dorsey for $2.5m and the sale of an NFT by digital artist Beeple for $69m are prime examples of the interest NFTs are garnering.
Risks of Investing in NFT
The market for NFT is booming. But that doesn’t mean they’re a safe investment. For all the benefits and hype surrounding them, NFTs come with significant risks to the investor.
The market for NFTs is relatively new and is still maturing. A lot of the NFTs that are being traded do not have an intrinsic value. Retail investors usually get caught up in the frenzy around them and don’t always look for the value. Also, the purchase of an NFT only transfers the ownership of the asset and not its copyright. This would mean that artwork, image or video can still be copied or used by anyone. This has made a lot of people sceptical of the value of NFTs.
Liquidity, the ease of exchanging an asset for cash, is a major factor when considering an asset. But unlike cryptocurrencies and stocks, NFTs are relatively illiquid. While cryptocurrencies and stock can be bought and sold easily, in the case of NFTs every seller needs to find a buyer who is willing to pay a certain price for a particular, one-of-a-kind item. That can put NFT collectors in a tough spot if they spent a huge amount on an NFT purchase and later the market begins to tank.
What most people don’t realize about NFTs is that the token (a record of ownership that lives on a blockchain) and the asset it refers to (a photo, video, or digital art) are usually distinct and are often stored separately. This becomes a problem when a party that issued NFTs goes out of business and stops hosting those digital artworks, photos or videos. The buyer could be left with a token that points to files that no longer exist.
4. Hidden fees
There are several hidden fees that a new investor or creator would be unaware of. Some of the fees are astronomically high that the fees itself can often add up to a lot more than the price of the NFT. Apart from the fee for selling and buying, sites charge a ‘gas’ fee (the charge for the energy consumed to complete the transaction) for every sale. The account conversion fees and fluctuations in the price of the cryptocurrency used should also be taken into consideration.
5. Inexperienced Investors
Today, anyone on the internet can mint an NFT out of literally anything. This has led to a flood of NFTs in the market and there are a lot of worthless NFT tokens out there. It takes a trained eye to pick the ones that are worth collecting and the ones worth investing in. New investors also find the need for upfront money/cryptocurrency as a barrier to entering into the NFT market.
The use of blockchain technology makes it impossible to forge an NFT and makes it easy to determine where it came from. But that does not mean that the NFT market is free from foul pay. Anybody can mint an NFT out of a file that does not belong to them and sell it as their own to unsuspecting buyers. Various types of fraud that are prevalent in other markets also happen in the NFT market. The practice of artificially pumping the price of an asset by opening multiple accounts and trading with themselves, known as wash trading, is historically common in NFTs.
Just like blockchain transactions, NFT transactions are anonymous and irreversible. But that causes a problem: if someone gets into your computer and steals your assets, there is no way to recover the stolen assets. And the anonymous nature of transactions means that it would be near impossible to find the culprit.
The NFT market suffers from massive volatility due to the speculative nature of NFTs right now. The market is also going through a period of price discovery and there are very few mechanisms in place to help people price the assets. The multi-million-dollar sales are just adding to the volatility of the market.
The recent surge in popularity of NFTs has introduced a lot of retail investors to the world of NFTs. But a lot of retail investors make their investment decisions based on emotion rather than sound reasoning and logic. FOMO (fear of missing out) has motivated a lot of them to keep throwing money at every investment without assessing the risks. Some critics point out that this wild market is creating a bubble and leaving the retail investors vulnerable to a market crash.