NFT investing exploded in popularity during the pandemic and showed no sign of slowing down in the first half of 2021. Digital art Beeple, Twitter’s CEO Jack Dorsey’s first tweet, and the pixelated Cryptopunks and Bored Ape Yacht Club characters have each been sold as NFTs worth millions of dollars.
This has led many investors, artists, collectors, and speculators to investigate how NFT investing and the NFT market works. While it might not be clear whether the NFT market is a bubble, it certainly holds promise for artists and has applications in the business world.
This article takes a close look at NFT investing and how investors can step into the market.
What are NFTs, and how do they work?
According to BBC, in economics, a fungible asset is something with units that can be readily interchanged and still hold the same value – like money. However, non-fungible assets are assets with unique properties that make it impossible to be exchanged with something similar. This could be something like the Mona Lisa or a Pokemon card.
In the cryptocurrency space, non-fungible tokens, or NFTs, are one-of-a-kind assets that are digitally represented on the blockchain. As with cryptocurrencies, a record of the metadata of who owns the asset is stored on the blockchain. This means that the metadata is available for everyone to verify (transparent), but it cannot be forged or altered (immutable). These assets range from artwork, in-game assets, domain names, collectibles, real estate, media, virtual items, or even identities.
Why would anybody invest in a non-fungible token?
While NFT investing seems like a great opportunity, it is crucial to note that they are different from traditional assets. Therefore, the reasons as to why you might consider NFT investing are also different.
1. Scarcity
Many investors choose to NFT investing due to the scarcity or attribute of NFT assets. NFTs can only have a single owner, and they create a sense of rarity that encourages potential investors to fixate on a particular collection or piece of NFTs. Consequently, this results in a rise in the value of the NFT if others might want to own the same asset.
2. Collectability
Another reason NFT investing is gaining traction is because of the collectability aspect of NFTs. Like swapping baseball cards, NFTs are essentially trading cards for the rich. While there is no inherent value that may come with owning an NFT, the fluctuating prices in the market allow collectors to purchase NFTs when the prices drop and resell them when the prices go up for profit. As such, the NFT market can be considered similar to the art market – an excellent long-term investment.
3. Utility
While most NFTs are purchased for sentimental value, a few NFTs have utility attached to them. For example, owning one of the Bored Ape Yacht Club avatars allows the owner to access an entire society on Discord, where fellow owners, including celebrities, hang out and chat. Moreover, the owners have access to additional limited NFT collectibles that can be resold for a considerable profit.
4. Future Value
The NFT and NFT investing space is just in its infant stages. As more people join the space, the scarcity of popular NFT assets will become more profound. As a result, the asset demand will go up significantly for NFT assets with utility. Therefore, if you have money to spare, NFTs are an excellent long-term investment to diversify your portfolio.
Different ways to invest in NFTs
There are two main ways of investing in NFTs: through NFT stocks and in NFT investing directly through a marketplace.
i. Investing in NFT Stocks
According to Reuters, the first six months of 2021 saw NFT sale volume surge to over $2.5 billion. As a result, many top tech companies took an interest in the space and started exploring how they can leverage NFTs to expand their business architecture. Firms such as Twitter, Drafking, Dolphin Entertainment, and eBay are integrating NFTs into their business. Investing in these companies’ stocks allows investors to invest in NFTs indirectly – without having to own an NFT.
ii. Investing in NFTs directly through a marketplace
The other method of NFT investing is buying directly on a marketplace like OpenSea. Unlike NFT stocks, buying NFTs directly from a marketplace gives you total control and ownership of the NFT. It is crucial to note that this method requires an inherent understanding of blockchain technology and digital wallets.
Steps to Invest in NFTs
Investing in NFTs is relatively easy; follow the steps below and you’ll be able to make your first NFT purchase:
1. Open an account on an NFT Marketplace
An NFT marketplace is a platform where NFTs can be stored, displayed, traded, and in some cases, created (minted). Some of the most popular ones include OpenSea, Rarible, and Superare. Due to a large number of sellers, it’s essential to always vet the seller. Ensure that the seller has previous successful transactions, a high rating, and good reviews.
2. Create a digital wallet
Before making any purchase, you’ll need a digital wallet to store your NFT keys and the crypto tokens that you’ll use to purchase them. Investors can use online non-custodial wallets like Metamask or company-based wallets that are tagged to a cryptocurrency exchange like Coinbase.
3. Fund your wallet
Whether you use a non-custodial or company-based wallet, you will need to connect your credit card, Apple Pay, or any accepted payment method to your digital wallet. This allows you to purchase cryptocurrency tokens using FIAT. Depending on your digital wallet, you may be required to go through a couple of identity verification processes.
4. Buy your first NFT
After funding your digital wallet with crypto tokens, you must connect your wallet to a marketplace. On the platform, you can search through the available NFTs listed to find the NFT you want to purchase. The process is not much different from purchasing on Amazon.
What are the risks of investing in NFTs?
While investing in NFT presents an excellent opportunity to reap huge profits, investors need to be mindful of the risks involved. Here are a few:
i. The Risk of Fraud
Any market with huge returns, especially on the blockchain, comes with some level of risk. While the blockchain does make NFTs more secure, especially the authenticity process, there are still a few cybercriminals who can replicate NFTs. If they do, investors end up buying replica NFTs that do not have value. Therefore, it’s crucial to confirm the authenticity of the ownership metadata of an NFT before investing in it.
ii. Smart Contracts Exploitation
Smart contracts are considered one of the most advanced innovations in the blockchain space. This is because they can automate tasks in a secure and immutable manner. As a result, smart contracts are being used to develop NFTs, as well as in the transaction process, to ensure all the set standards are met. However, poorly coded smart contracts are susceptible to cyber-attacks.
For instance, in 2016, the DAO protocol lost over $50 million due to a poorly coded smart contract that allowed the hacker to exploit the contract and drain money from the project.
iii. Evaluation Mistakes
Currently, the valuation of NFT revolves around creativity, authenticity, and scarcity. There is no standard way to evaluate NFT tokens. This means that most NFTs are valued depending on speculation. This may result in investors buying overpriced NFTs that they will be forced to sell later at a loss.
iv. Blockchain Protocol Risk
The digital world is evolving relatively fast, and other types of NFTs might overtake the ones we consider valuable today. Currently, most NFTs are developed on the Ethereum blockchain. However, there are other platforms like Solana and cardano that are also developing NFTs but with cheaper transaction fees. Therefore, if one of these blockchain protocols replaced Ethereum as a preferred NFT platform, most of the NFTs built on it would be devalued.
v. Legal Risks
There are no clear guidelines as to how to classify NFT assets. Therefore, investing in NFTs may have different tax and legal implications in other jurisdictions. While some countries are lenient on NFT as an asset class, some like the US are more concerned.
Final thoughts
Just because NFTs are relatively easy to buy and can potentially be very profitable, you shouldn’t invest your life savings into them or money you cannot afford to lose. NFTs are a risky investment, and their future is quite unclear. Additionally, we do not have enough history of their performance to determine how they will perform in the future.
With that, it is crucial that investors approach NFTs with caution – do your research, and understand all the risks involved with that particular NFT. Despite this, NFT are a great investment to experienced investors who know the ins and outs of the market.
