NFT? WT-Heck?

By HMA Team on March 25, 2021

The Essential Rundown on this New Asset Class

A new acronym entered the investment arena about a month ago when artist Beeple captured headlines. The artist sold a piece of digital artwork at auction for a record-smashing $69.3 million. What made this possible? A somewhat recent advancement in the tracking of digital images called the “NFT,” or non-fungible token. Here’s the essential rundown on what it is, how it works, and where it might fit into an investment portfolio- or not! Read on to learn the basics and wow your friends with your newfound expertise!

What it is.

Let’s start at the beginning with the definitions of “fungible” and “non-fungible.” The word “fungible” just means that an item can be exchanged for other items of the same value. For example, a $5 bill can be exchanged for five $1 bills. Same value. Bitcoin is fungible. It can be exchanged for another Bitcoin which has the same value. Shares of stock from the same company and of the same asset class are fungible. “Non-fungible” means a thing cannot be exchanged in this way. For example, there are many prints made of famous Cézanne paintings, but only one original of each. The original is non-fungible. The prints cannot be exchanged for the original, because they are not as valuable.

A non-fungible token (NFT) is like a certificate of ownership that is linked to a digital image. The NFT tracks ownership of the image through blockchain technology. The owner of the digital image can then use the NFT as proof of their ownership and the purchase price should they wish to resell the piece.

How it works.

According to Fordham Law School professor Donna Redel, “The underlying thing you’re buying is code that manifests as images. You’re buying a different format of art.”

This code is located on a thing called blockchain, a recordkeeping system that entered the mainstream when Bitcoin became a household topic of discussion. Blockchain is a specific type of database that keeps an unalterable, chronologically timestamped, (usually) decentralized record of transactions. The (usually) decentralized nature of the database allows for transparency of the data held therein, making it searchable and the transactions held on it to be easily verifiable. When a person purchases a digital piece with an NFT attached to it, the transaction is coded in the blockchain. The token records all of the data relating to the digital asset, like the artist, purchase price, buyer, and anything else considered relevant.

Transactions of this nature have been around since at least 2017, when a game called CryptoKitties allowed players to trade NFT-coded digital kittens over the Ethereum blockchain. Since then, all types of images have been bought and sold using NFT technology. Sports clips and images have been wildly popular. Twitter CEO Jack Dorsey recently sold an NFT tweet for $2.9 million.

What could possibly go wrong?

Let’s not get it twisted. Just because an NFT is attached to a digital image, copies of that image can still circulate on the internet, just like owning an original Picasso doesn’t keep other people from obtaining a print. In addition, artists can attach NFTs to copies they make of their own work. So, just because a digital image is attached to an NFT doesn’t mean it’s a one-of-a-kind piece. Lastly, NFTs can be attached to knock-off art, just like the fakes that already exist in the fine-art world. For example, NPR reported in a March article that several NFT digital images that resembled work by famous artist Banksy sold for about $900k and later turned out to be fakes.

Let’s also not forget about the speculative nature of investing in NFT images. When you buy a stock, the price of that stock is essentially a present-value calculation of anticipated future cash flows. The company that issued the stock also has tangible and intangible assets that can be translated into dollar value. When you buy a digital image, even if it is an original, it is a piece of code. The only thing driving the price is what others are willing to pay for it. If popularity drops, there could be very little left to support the price of that asset.

Due to the highly speculative nature of NFT collectibles, we’re not recommending our clients jump on the NFT bandwagon. Similar to our investment recommendations regarding other types of collectibles, we think this asset class is best entertained by people who have a sincere interest in or passion for the artwork. That way, there is genuine enjoyment of the item and pride of ownership after the purchase. Both of which, in our opinion, hold their own type of value that cannot be eroded by market price fluctuations. Of course, we are here to answer any questions you may have about NFTs, or any other asset class, and whether they might have an appropriate place in your long-term investment strategy. Keeping you informed: That’s HMA!