You know you’ve reached mainstream consciousness when South Park roasts you and NFTs have definitely reached that point. There was even an (unsubstantiated) rumor that the Bored Ape Yacht Club NFT project would have a presence during the Super Bowl halftime show, but that never materialized. With “NFT” being Collins Dictionary’s 2021 word of the year, NFTs are likely here for a while as a new type of asset connected to the volatile world of cryptocurrency. But what exactly is an NFT and how can investors strategically add them to their portfolios?
What is a Non-Fungible Token (NFT)?
An NFT is thought to be a digital image saved on the blockchain, but it’s really more of an authenticity verification mechanism. The actual image is hosted on a server outside the digital wallet of the NFT owner, who is really buying a code that points in the direction of the NFT. Think of it like the certificate of authenticity that comes when you purchase an item autographed by Tom Brady. The certificate verifies that Tom Brady is actually the one who signed the item. Your NFT verifies that you made your purchase from a legitimate source. You can right-click the image all you like, but no one will pay for it if it lacks the certificate of authenticity.
Some of the most popular projects can be found selling for absurd sums on marketplaces like OpenSea. Many of these projects are for profile pictures on social media, known as PFPs. One of the first and biggest NFT success stories were the CryptoPunks, a series of 10,000 unique digital images with different traits and characteristics. The original drop of CryptoPunks was a free distribution to anyone who wanted one – they’re now selling for more than $250,000 minimum.
Examples of other popular and successful NFT projects include:
- PFP Projects: Bored Ape Yacht Club, Doodles, DogePound, Cool Cats
- Virtual Worlds: Decentraland, The Sandbox, Somnium Space
- Collectibles: NBA TopShot, Zed Run, Rarible, Azuki
How do NFTs Work?
The key word of NFT is ‘fungible’, which is another way of saying replaceable or equal. For example, every Bitcoin mined in existence is exactly the same. If two people each own a single Bitcoin, they can be sure that each coin will have the same price and functionality as the other. A Bitcoin here is the same as a Bitcoin halfway around the world.
An NFT is ‘non-fungible’, which means each NFT is a unique code with a particular set of data. Even NFTs of specific pieces of art have their own code. For example, digital artists like Beeple will often sell their artwork as limited edition NFTs which point back to the same image. However, each edition has its own serial number and data to signify its uniqueness. The artwork may be just one singular image, but the NFTs will all be different..
What are NFTs used for? The previously mentioned Bored Ape Yacht Club project has Ape Fest: parties in various locations and, believe it or not, on yachts for holders. Few NFT projects in the metaverse are like Rolexes and Ferraris in the real world. But many NFT project developers want to dig deeper than just flashiness symbols of wealth. For some projects, NFTs provide a ticket to access certain community perks and features (like exclusive premium NFT drops in the case of NBA TopShot). Other NFT projects want to use digital avatars in video games, allowing players to compete and trade with each other using digital items they own exclusively.
Remember, NFTs are still in their infancy and while it’s hard to argue with the success and money flowing in, many of these projects will be duds. The NFT landscape also tends to attract pump and dump scammers like moths to a lightbulb. Investing and trading NFTs involves lots of research – you can’t simply buy an NFT because someone with a lot of Twitter followers is promoting it.
How to Buy and Sell NFTs
NFT’s can be minted from a project’s site with priority normally given to members on the whitelist or those part of the project from an early start. However, most projects offer chances to join the whitelist prior to mint date through various forms of interaction and publicity. If the mint date has passed or you unfortunately weren’t able to mint the NFT, there are secondary marketplaces, outlined below, from which you can purchase it. To access an NFT marketplace, you’ll need a digital wallet to connect and cryptocurrency to purchase the assets. Top digital wallets include Metamask, Math Wallet, AlphaWallet, Trust Wallet, and Coinbase.
Transferring NFTs from wallet to wallet will include a transaction fee, which is known as the ‘gas fee’ on the Ethereum blockchain. This fee varies depending on the congestion of the network, but it can be quite high during periods of high traffic. However, some marketplaces have now been designed specifically to avoid gas fees, although you won’t find any commission-free NFT trading platforms just yet.
- OpenSea: The highest volume marketplace where most of the popular NFT projects like Bored Apes, Crypto Punks, and Decentraland are sold. You can search NFTs by category like art, collectibles, sports, or virtual worlds. Easy to use and connect via MetaMask. Fees include a flat 2.5% fee on all transactions, plus gas fees and creator fees depending on the NFT being sold.
- NiftyGateway: Owned by cryptocurrency exchange Gemini, NiftyGateway has drops from renowned digital artists like Beeple, Fvckrender, Trevor Jones, and more. Users don’t need a digital wallet to purchase NFTs on NiftyGateway and transactions can be performed with credit cards, cash balances, or crypto. NiftyGateway charges a 15% fee on all sales, but purchases are free from transaction charges. And no gas fees!
- Dapper Labs: Built on the Flow blockchain, Dapper has two different NFT marketplaces: NBA TopShot and UFC Strike featuring NFTs of athletes from each sport. Like NiftyGateway, Dapper Labs provides the digital wallet for their NFTs and purchases can be made with credit cards and crypto alike. A flat 5% fee is charged on all transactions, but no gas fees are charged on either marketplace.
- DraftKings Marketplace: Sports betting site DraftKings jumped into the NFT ring last year with collectibles from popular athletes like Tom Brady, Wayne Gretzky, Tiger Woods, and Simone Biles. The marketplace is hosted by sports collectible company Autograph and runs on the Polygon blockchain. All sales come with a flat 15% fee, but you can purchase NFTs with your DraftKings Sportsbook or DFS balance.
How is an NFT Different from Cryptocurrency?
NFTs and cryptocurrencies both use blockchain technology to signify unique ownership of a digital item. For cryptocurrency, that means keeping a ledger of transaction data to verify who owns what. But cryptocurrencies are fungible, meaning that individual tokens are interchangeable. The Ethereum you own is no different than the Ethereum your neighbor owns.
NFTs, however, point to a specific image or item that can’t be replaced with something else. Blockchain is used to verify transactions and guarantee authenticity, but each NFT is unique, even ones that point to the same piece of art or image.
Of course, as far as the IRS is concerned, NFTs and cryptocurrencies are the same. The US considers both to be property under tax law, which means capital gains rates apply.
NFTs combine the world of art and collectibles with digital technology like blockchain and cryptocurrency. An entire network of NFT trading marketplaces have cropped up in very little time and large amounts of private and public capital are being invested in this rapidly-growing space. But while some NFTs have been winning lottery tickets for crypto traders, others have been full-fledged scams that crashed in price while developers disappeared with the money. Proper research and discretion is crucial if you want to come out ahead when trading NFTs. The safest projects will have known backers, quality roadmaps, and utility in mind for the community. On the other hand, if it seems like a naked cash grab, it probably is.