What is an NFT, and should you be investing in this digital purchasing craze? People want to own something that’s completely unique, and the ability to purchase ownership of online assets opens up a whole new world of possibilities, but it also creates risks.
Here are some of the things you need to know when it comes to digital asset ownership.
What is an NFT?
First, NFT stands for “non-fungible token.” If you’re like most people, that doesn’t help much. Think of it as a digital certificate of authenticity.
To better understand what non-fungible means, it helps to first define fungibility, which is the ability to replace an item with one just like it. Basically, something fungible is interchangeable. For example, when you end up with four quarters, you might not want to carry them around because they are heavy and they jingle, so you might trade them in for a one dollar bill. You have the same amount of money even though you traded metal for paper, four objects for one.
Other examples of fungible items might be frequent flyer miles, bitcoin or casino chips. Each can be exchanged for another item of the same value.
Something non-fungible is the opposite. It’s unique, not interchangeable with anything else. A great work of art has the author’s signature to authenticate it. A collectible car has a VIN number. People can make reproductions of both, but they will never be the original.
With digital assets, it’s possible to track ownership through blockchain technology. This digital string of numbers and letters identifies the original asset and can be traced back to the person who created it, indicate how many times it was sold and who now has ownership. When someone purchases an NFT, the transaction is added to the digital ledger. That makes a digital asset that can be reproduced into something unique and scarce. The token is stored on a secure digital database so people can publicly verify whether or not it’s an original and prove ownership.
A domain name is an example of a non-fungible token because it’s an intangible asset with a verifiable owner and monetary value. It can be transferred, but only with the owner’s permission. There can be only one exactly like it, creating uniqueness and scarcity. Its worth depends on who wants it and how much they are willing to pay for it. Other examples of NFTs are as follows:
- One online resource allows sports fans to purchase the original version of digital basketball highlights.
- An online game lets users purchase digital cats and breed them. Each purchased cat is a unique NFT.
- Auction houses offer digital art and sell the originals, often for millions of dollars.
- VR platforms enable users to buy and trade virtual land.
Be aware of NFT collecting risks
While the idea of owning something original and unique is attractive, and some NFTs will likely grow in value over time, NFT collecting comes with risks. Part of the problem is that digital files can be reproduced an infinite number of times, with every pixel exactly the same as the original.
When you buy an NFT you’re buying a token. The actual asset linked to that token isn’t something you can lock up in a safe. You might receive permission to use, listen to, copy and/or display it, but there’s nothing to stop the rest of the world from making and enjoying copies just like what you paid for. NFTs also come with these risks:
Watch for volatility
The NFT market is so new, it’s hard to establish an asset’s value. For example, with physical real estate, investors look at comparable properties to establish a reasonable value. They factor in a property’s condition, it’s location and other measurable qualities.
That’s much harder to do with virtual property. Location doesn’t matter so much when users can teleport across the metaverse using cartesian coordinates, and there’s not enough history to determine how virtual property value will change over time.
With physical assets, if their value starts to fall, investors can often sell them and get at least some of their money back. However, a digital asset that’s highly sought after today may be old news in the future, and not worth much of anything at all.
Look out for fakes
Just like with counterfeit money and art forgery, scammers sometimes try to rip off original creators and buyers using fakes. Sometimes fraudsters claim they’re the true creator, setting up profiles and accounts to impersonate a celebrity or artist. If you don’t know how to do your research, you could pay big money for a copy or knockoff.
In a new type of art heist, scammers have also hacked NFT creator or owner accounts and stolen their usernames, passwords and other data. They then sell work that doesn’t belong to them as if it were being offered by the rightful owner.
Read the fine print
Some NFTs come with a smart contract containing a transfer clause that requires every time it sells, for part of the proceeds to go to a previous owner or to the creator. If you buy an NFT with the intent to make money on it later, you might not get as much as you hope.
Also, buyers and sellers could be anywhere in the world. Transactions could be governed by global or regional laws that involve trade regulations, anti-money laundering and other regulations.
Be wary of wash sales
Wash sales or wash trading happens when someone creates an NFT, puts it up for sale, quickly buys it themselves for a high price to make it look more valuable than it is, then offers it again at an even more inflated price. If you’re considering an NFT purchase, be wary of sudden, inexplicable value spikes.
7 Tips for Buying NFTs
- Know the platform – Research their practices for finding and removing malicious content.
- Check social media – If you’re thinking of buying an NFT, look for the creator’s social media accounts. Send them a message and make sure they’re the one offering the item or collection.
- Research the item’s history – Suspicious value jumps may indicate wash trading.
- Look for smart contracts – Reach out to the creator if you need verification or clarification.
- Review the chain information – Every NFT page should have a chain info section that shows the NFT’s history.
- Look for the mintable warning icon – This means proceed with caution.
- Stick to what you know – NFT’s are a risky investment, collect in your areas of interest rather than thinking of them as a long-term wealth building strategy.
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