What began as a pixelated pattern on the Namecoin blockchain back in 2014 has since exploded into a thriving hub of community and creativity that is rapidly emerging as a financial asset class in its own right.
In fact, according to one forecast, the NFT market cap is expected to grow from $35 billion in 2022 to a whopping $80 billion in 2025. With so much excitement and capital flowing into the market, it can be easy to get carried away. However, there’s plenty of risk involved when trading in this relatively new and under-regulated space. What do you need to know about NFTs as a potential investor?
Let’s start out with a basic overview.
What are NFTs?
First things first, a quick definition of fungible vs non-fungible.
Fungible assets are those that are easily interchangeable with other items of the same type and value. Traditional assets like shares, the US dollar, and even Bitcoin fall into this category. For example, if you were to lend $100 to your brother by handing him a $100 note, it makes no difference whether he pays you back with the same note, another $100 note, or two $50 notes. Dollars are dollars and hold the same value everywhere.
Non-fungible items, on the other hand, are non-interchangeable. They have certain qualities that can’t be replicated, making them unique and irreplaceable. Try trading your daughter’s drawing of a cat with the Mona Lisa, for example. Both are undoubtedly fine artworks, but the value they hold is fundamentally different. Other examples of non-fungible assets include real estate, precious stones, and yes, digital tokens on a blockchain such as Ethereum or Solana.
Each NFT on the blockchain comes with its own code. Art is currently the most popular representation of this code, with communities of investors buying into collections of animals, robots, and other “brands” launched by developers and artists. However, art is just one side of the story. Because every code is unique, verifiable, and traceable, NFTs solve two of the biggest obstacles that digital assets have faced so far: authenticity and scarcity.
As non-replicable proof of ownership in digital form, NFTs open the door to all kinds of possible use cases. For example, they might provide access to an exclusive club, act as a ticket for events like concerts and sporting events or be the key to a space in the metaverse. As we continue to move more of our lives into the digital world, the potential value of owning the right NFTs is limitless.
Pros and cons of NFTs as an asset class
Let’s look at some of the most promising reasons to delve into this exciting and dynamic new asset class:
Growth
As a relatively new asset class, the true value of NFTs has yet to be realized. As more people buy into cryptocurrencies and begin to understand the vast potential utility of NFTs, their value will only increase. New, faster, and more environmentally friendly blockchains such as Solana, Avalanche, and the much-anticipated Ethereum 2.0 are set to speed up mainstream adoption and drive even more growth in the sector.
Efficiency
Easily verifiable digital proof of ownership makes markets of physical assets much more streamlined and efficient. Transactions can be made smoothly without the need for intermediaries. This is already helping artists and musicians who are connecting directly with their audiences. Eventually, the use of NFTs can be extended to verify sensitive personal data and quickly identify individuals and organizations.
Security
Blockchain technology works as a transparent digital ledger, where all activity can be seen and recorded. There is no way to delete, hide, alter, or hack transactions, meaning that your NFT is guaranteed to maintain its authenticity and is safe against fraud and theft. This level of transparency and security is uncommon in financial assets and is a valuable builder of confidence.
While these are all good signs for the future of NFTs, investing in them does not come without risk. Let’s look at some of the drawbacks:
Lack of regulation
The NFT market is still evolving and hasn’t been properly regulated yet. Tales of fraud and scams abound, with people buying fake NFTs from counterfeit marketplaces, founders of collections abandoning projects and running off with the profits, wallets drained in phishing scams, and much more. There is no protection for you if things go wrong, so proceed at your own risk.
NFTs are illiquid
NFTs can be difficult to sell. The market is volatile, and trends come and go very quickly, often at the whims of celebrity and influencer approval. If things take a sudden downturn, you might find yourself stuck with a rapidly depreciating asset and very few potential buyers. Take the story of Jack Dorsey’s first-ever tweet for example. It was made into an NFT and bought by entrepreneur Sina Estavi for $2.9 million in March 2021. Seriously pricey, but this is a piece of history, right? The first tweet ever created ought to hold tremendous value to someone. However, when Estavi went to sell the NFT for an expected profit, he found no buyers. In fact, he received just seven offers ranging from 0.09 ETH ($277 at current prices) to 0.0019 ETH (almost $6).
NFTs have an environmental impact
Blockchains require a lot of computational energy to maintain, particularly those that run on a “Proof of Work” (PoW) consensus mechanism. Ethereum is by far the biggest and the most popular blockchain for NFTs and currently runs on PoW. However, newer blockchains such as Solana, Algorand, Avalanche, and the upcoming Ethereum 2.0 utilize a much more efficient “Proof of Stake” (PoS) mechanism, which significantly reduces the need for complex computations. Ethereum’s “merge” to PoS is a particularly significant event in crypto and has been delayed many times, much to the frustration of some. The latest target for its release is September 2022. Keep an eye out for this!
NFT marketplaces
If you’ve weighed up the pros and cons and decided that you’d like to dabble in the NFT market, it’s important to know where to start. As we mentioned, most of the NFT market is currently taking place on the Ethereum blockchain. This means that you’ll first need to buy some of Ethereum’s native currency, ether (ETH).
When you’ve purchased your ether from a crypto exchange such as Kraken or Coinbase, you’ll need to send it to your own crypto wallet. Metamask is the most popular software wallet used on Ethereum and is free to download as an extension on your browser. Software wallets are quick and convenient to use, connecting directly with marketplaces for easy purchases. However, for security purposes, it’s also a good idea to get a hardware wallet. This is a physical device that plugs into your computer and stores your crypto funds offline, preventing hackers from directly accessing them via the internet.
With ETH in your wallet, it’s now time to find your ideal NFTs. Opensea is currently the biggest marketplace and is a good place to start. Here you can find “blue chip” art-based NFT collections such as Bored Ape Yacht Club and CryptoPunks, which currently sell for hundreds of thousands of dollars. These collections have become iconic in the NFT world and offer the highest probability of holding value in the long term. Although no investment can be considered “safe” in NFTs, art-based blue chips are currently the best bet for more cautious investors.
For the more adventurous among you, there are plenty of innovative utility-based NFTs to choose from. These include gamified P2E (Play to Earn) projects, entry to various metaverses, DeFi yield farming opportunities, and much more. Always “DYOR” (do your own research) by checking a project’s website, whitepaper, Discord, and Twitter accounts.
Opensea also offers the possibility to buy Solana NFTs. Solana is a rapidly growing Proof of Stake blockchain that’s known for its speed and affordability. Ethereum’s current network is comparatively slow and much more expensive to use, as users must pay high “gas” fees on each transaction. With daily Solana NFT sales overtaking Ethereum NFT sales for the first time just recently, we might be on the cusp of a major shift in the NFT market.
No matter which blockchain you prefer or which marketplace you choose to buy your NFTs, make sure you research each project thoroughly. Things to look for include an active community, future utility, background of the developers, and current floor price. Most serious projects will provide a whitepaper and roadmap outlining their expected development.
Final thoughts
NFTs are an exciting emerging financial asset class. Their transformational use cases and future growth potential are attracting thousands of new investors every day. However, there’s also a lot of risk involved, so tread carefully in this nascent and volatile trading environment.
Regulation of the NFT market is likely on its way. The extent and effectiveness of this regulation will be key in deciding whether NFTs are a bubble just waiting to burst, or the vanguard of a true revolution in the world of finance.
