If you’ve never heard of Bored Apes, Beeple or CryptoPunks, you’re probably not familiar with the wildly popular digital assets known as NFTs.
And you’re not alone, as it seems others are investigating this new way of investing, too: NFTs saw the biggest increase (269%) in searches in 2022 than any other investment, according to a study by brokerage Forex Suggest.
Curious about how they work? Read on.
What Is an NFT?
An NFT is a nonfungible token. “It’s basically a one-of-a-kind digital asset that an individual can own,” says Alana Benson, an investing writer at NerdWallet. NFTs, just like stocks, bonds or bitcoins, can be bought, sold or traded.
NFTs can be pretty much anything digital, like a piece of digital art, sports trading cards, music albums and even tweets.
To understand what makes an NFT unique, you need to know what “nonfungible” means. In a nutshell, it is something that can’t be replaced with something else.
For example, take the painting of the Mona Lisa. Sure, there are plenty of reproductions and online images out there, “but there’s only one real Mona Lisa, and that’s at the Louvre in Paris,” Benson says. So while the Mona Lisa that Leonardo da Vinci painted is nonfungible, so too is an NFT—except it’s digital rather than physical.
In contrast to a piece of art or an NFT, a bitcoin is fungible. If you trade one bitcoin for another bitcoin, you’ll still have the same thing. That’s also true if you trade a $1 bill for another $1 bill.
How Do NFTs Work?
NFTs are part of the Ethereum blockchain, the same technology that is behind bitcoin, ether, dogecoin and other cryptocurrencies.
The blockchain, a decentralized technology that stores data, keeps track of who owns NFTs and who is trading these digital assets. Each NFT is a unique token on the blockchain.
Where Can I Buy and Sell NFTs?
NFTs can be purchased at online marketplaces, private sales and auction houses such as Sotheby’s. “But the average person should start with reputable online marketplaces,” Benson says. This helps you avoid any scammers out there.
Two well-known platforms include OpenSea and Nifty Gateway. Sports fans with a more collectibles-focused mentality might use sport-specific marketplaces like NBA Top Shot. Coinbase Global, a crypto exchange, also has a beta site up and running where you can buy and sell NFTs.
Before you start shopping around for a digital asset, however, you’ll need to set up a cryptocurrency wallet. These wallets enable you to store NFTs as well as house your crypto assets, such as ether (dubbed “ETH”). In some cases, cash or credit cards aren’t accepted for NFT purchases, so you’ll need ether on hand to complete the trade.
Are NFTs Good Investments?
A handful of the most popular NFTs have sold for tens of millions of dollars, including the $69 million paid in 2021 for a piece of digital art by Beeple. And dozens more have sold for $1 million or more.
But it’s a new investment space that is lightly regulated and can be prone to fraud and scammers, Benson cautions. Plus, NFTs are risky, volatile investments.
Why? For one, the value of an NFT is determined solely by how much a buyer is willing to pay for it, not unlike a real piece of art that goes up for sale at an auction.
There is also no true underlying intrinsic value to an NFT, unlike, say, innovative, in-demand products sold by a well-known brand such as Apple—or an actual, physical piece of art.
The NFT market, as a result, has a speculative component to it. “If you buy an NFT as an investment, you are essentially betting that someone will buy it from you for more than you paid for it,” Benson says.
Furthermore, the NFT market, which peaked in January 2022, is now going through a boom-bust cycle like cryptocurrencies. Indeed, there was a 77% drop in the dollar value of NFT trades in the third quarter of 2022 compared to the quarter ending in June, according to an October 2022 report by NonFungible.com, an NFT analytics firm. The report also showed an 84% decrease in profit at resell in the third quarter and a 17% drop in active NFT wallets.
If you’re still curious and want to dip your toes in the NFT pond, tread carefully. Only use a little “fun money,” says Benson—that is, money you are willing to lose. And, as a general rule, investors should have only a small portion of their portfolio (no more than 10%) in highly risky investments like NFTs and bitcoin.
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Adam Shell is a freelance journalist who worked as a financial markets reporter at USA Today and an associate editor at Kiplinger’s Personal Finance magazine.