Introduction to Non-Fungible Tokens
(NFTs for Creators and Investors)
If you have been reading about the recent rise of cryptocurrencies like Bitcoin and Ethereum you may have heard of blockchains and various other developments such as the recent spike in popularity of certain non-fungible tokens or NFTs.
The difference between NFTs and normal tokens is that in some respects every bitcoin is just as good as any other bitcoin and therefore priced more or less identically. However the same technology that enables bitcoins to be equivalent can also be used to uniquely identify and allow trading of digital “works” which are unique (and therefore non-fungible).
Like all new trends, the current excitement and speculation surrounding NFTs may be creating unwarranted bubbles. Because NFTs like all crypto tokens are intangible and digital ledger entries in the underlying network, it can be hard to understand why anyone thinks they are valuable.
However, intangible things having value is not a new phenomenon. Video gamers, for example, have been buying outfits, weapons, accessories, etc. for their characters that have no value in the “real” world for years now.
Cryptocurrency has transitioned from being a strange fad for nerds and blockchain enthusiasts to a more mainstream acceptance though this transition is still in its early stages. NFTs may have similar potential to go mainstream in some form. In this article, we’ll briefly explore what NFTs really are, who they are good for, and where you can learn more.
A NFT of a GIF of Nyan Cat by Chris Torres sold for 300 Ether (ETH) - about 590K in USD at the time of the February 2021 sale.
What is an NFT?
A NFT is a record that shows ownership of a digital asset. To be “fungible”, a currency must be able to be exchanged for the same portion or total of another person's currency. If I have a dollar bill and trade with you, it doesn’t matter that the serial numbers are different - we both end up with $1.
However, an NFT is more like a unique collectable item - think of it like a digital version of baseball cards for example - if I have a Ken Griffey Jr. 1989 Upper Deck card (frequently sold for under $10) and you have a 1952 Topps Mickey Mantle (recently sold for $2.88 million), they are not interchangeable, even though both are baseball cards. Why one is worth so much more than the other has to do with a variety of factors including scarcity and desirability- ultimately coming down to supply and demand for that particular item.
Blockchain technology is best known for cryptocurrency but there are many other uses. Anything that can be archived digitally can potentially be loaded onto or linked with blockchain technology. NFTs to date have included images, videos, audio recordings, articles, screenshots of tweets, virtual gaming items, and more. NFTs can be one of a kind (i.e. only one was ever minted and sold) or one in a limited edition (multiple copies of the same NFT are released).
Typically, when someone creates and or acquires a NFT, they are purchasing a blockchain based token that points to a file hosted elsewhere. The unique aspect of linking unique content to tokens on a blockchain is that every transaction is timestamped, verified by multiple users, and encrypted. It is very secure.
While the original image, song, video, etc. may still exist elsewhere on the internet, by linking a creative “work” into a blockchain, the creator thereby can make that particular copy unique and more meaningful. This is not that dissimilar from the way things work in the world of physical art in which the authenticity and provenance of a particular painting or object can mean the difference between an object worth tens of million because it can be traced to the hand of a master versus being worth almost nothing though it might be a copy and look just as beautiful if hung on a gallery wall.
It is not just art that NFTs can create value for as illustrated below when Jack Dorsey the founder of Twitter and Square sold an NFT of his first tweet on twitter from 2006 for millions of dollars in 2021.
just setting up my twttr— jack (@jack) March 21, 2006
An NFT of Jack Dorsey’s first-ever tweet sold for $2,915,835.47 to winning bidder Sina Estavi on March 6, 2021.
If anyone else had minted an NFT of the same tweet which is freely viewable - it likely would not have been valued anywhere near the value placed on it when Jack Dorsey himself minted the tweet.
How Creators Can Leverage NFTs
NFTs have potential to create novel long-term monetization opportunities for artists with a loyal fan base. In traditional arenas available to artists, intermediaries take a large percentage of creators earnings (i.e. a record label and management takes most of the money earned from streaming services for musicians). Intermediaries own the content rights (i.e. a record label controls your songs) and how fans see your content (a change to the Spotify algorithm can severely affect your plays).
NFTs allow creators to sell directly to fans and keep a much larger percentage of the profits (say 85%). Also unique is that the NFT can be set up programmatically so that whenever the NFT is sold to someone new (ie traded), the creator can automatically get a percentage of each subsequent sale (often 10%). Each time the NFT is sold, the creator can make more money for having minted this value as an NFT in the first place. This is unique to NFTs because this would be difficult if not impossible to decree in the physical world.
The value of a NFT, at least initially, comes from the underlying credibility or popularity of a given athlete, artist, celebrity, etc. associated with “minting” i.e creating the NFT.
The Jack Dorsey tweet, which anyone can still view on twitter, has authenticity and value because Jack himself offered it up for sale. The American digital artist Beeple spent years building his brand on Instagram before his record setting $69 million NFT sale at Christie’s of EVERYDAYS: THE FIRST 5000 DAYS, a digital collage of 13.5 years of posting daily photos.
A NFT offered by NBA Topshot called Serial No. 1 Legendary LeBron James Moment, sold for $71k because of the value of LeBron James’ brand. Some NFTs, just like physical art, are valuable because some people think they are valuable and are willing to pay for them. In some cases some of these people may just be speculating that they will be able to resell to someone else at even a high price.
Why Some People Seem to Be Purchasing and Valuing NFTs
It’s understandable if you are still not sold on the idea of owning a record of a digital item. Why buy an NFT of Elon Musk’s song about NFTs when you can just view the video on Twitter or YouTube for free?
Some of the reasons may include:
- NFTs are unique and collectible. Some people enjoy collecting NFTs in the same way they buy objects in video games or enjoy collecting trading cards, vinyl records, stamps, etc. The success of CryptoKitties, a game that involves breeding digital cats to create and collect their "digital" progeny, was driven by 1.5 million users who have spent more than $40 million trading digital cats on the platform. While high profile sales like “Dragon” (pictured above) garner news coverage, the average sale price (all-time) of a CryptoKitty is only $14.96.
- Authentic interaction with the creator. Superfans can be motivated by the allure of ownership and the opportunity to directly support or at least own a digital "asset" directly associated with a favorite artist or creator. An NFT is a permanent record of the art or creation. The band Kings of Leon generated over $2 million in NFT sales from their new album “When You See Yourself” in March 2021. The sale ended on March 19th. Fans who missed out will have to find one of these original NFTs at resale - no new NFTs will be released around that album creating some scarcity value perhaps.
- NFTs may appreciate in value. If you buy a painting of a promising new artist at a local gallery, there is always the chance that the artist’s career will take off and you can sell the painting and retire early. A share of Amazon stock has come a long way from its $18 IPO. NFTs offer at least the possibility of gains in the future to the collector. As the creator or a particular work gains popularity the owner may be able to sell their NFT for significantly more than their original purchase price or pass the NFT as an intangible but valuable asset to their heirs. The same can happen in reverse however and NFTs could potentially also lose value.
- NFTs have trading potential. Not everyone buying NFTs is a fan of the artist. Purchasers may just be trying to make a profit by speculating in a new virtual arena. Lindsay Lohan listed her first NFT on Rarible, which sold for 10 Wrapped ETH (about $17k), only to be resold an hour later for 33 ETH ($57k).
Are NFTs an Investment or a Bubble?
NFTs are a nascent, developing phenomenon. Wherever there is speculation and excitement, there is potential for a bubble. The average sale price of an NFT in December 2020 was $126. The average sale price rose to $864 in January 2021 and to over 1k by February. These average prices are far lower than the headlines touting the highest priced NFTs, but they do suggest significant appreciation, at least in the short-term, as more people have become aware of this burgeoning sector.
NFT pricing is likely to be volatile (like cryptocurrency). An individual asset could lose value or the market as a whole could tank. A high risk tolerance is needed to invest in any emerging idea or system and NFTs are still at quite an early stage though as a whole seem to be gaining momentum quite quickly. NFTs could continue to grow into a large market, a lot of uncertainty and innovation still lies ahead.
Just as with cryptocurrency, “owning” an NFT requires someone to have access to a secure digital wallet that can store the cryptographic keys that control transmission of the NFT on its associated blockchain network. Like with cryptocurrency, if you lose access to your digital wallet, you lose access to your NFT.
Currently, NFTs are sold via two kinds of marketplaces. Self-service platforms allow anyone to create and sell an NFT. These platforms allow newer creators whose work could appreciate in the future but also have a high rate of copycats and fakes since they do not restrict any users from using the platforms.
Curated platforms only permit approved creators to mint NFTs. Curated platforms feature high-quality digital art but offer a more limited range of products and come with higher fees for creators.
NFTs are certainly an interesting opportunity for venturesome people who like to get involved into new things and are certainly worth paying attention to as a relatively new development that will probably experience a great deal of further innovation, growth, and perhaps growing pains in the months and years to come.
Dropping NFTs tomorrow at 2pm EST. enter the void pic.twitter.com/l9fNFUCheX— ☘︎𝔊𝔯𝔦𝔪𝔢𝔰 (@Grimezsz) February 28, 2021
The artist grimes sold her WarNymph digital collection featuring a total of 10 artworks created in collaboration with her brother Mac Boucher for $6 million in February 2021. The collection sold out in 20 minutes.
Do you want to read more about NFTs? Here are some additional resources to also read for those interested in learning more:
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Additional Resources If You Want to Learn More About NFTs
There is far too much information about NFTs to discuss in a short article like this one.
If you are a creator or investor interested in NFTs or Crypto
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About the Author
Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.
Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.