Date: 4/12/2022
Body: Everybody has had some experience at an old style arcade, right? For $5, you got a handful of metallic tokens. Each one was of the same value, and looked, felt and behaved the same inside of games. Because they are all the same, and can therefore stand in place of each other, they are considered “fungible” tokens. Land can also have some value, but each piece is unique, so, it is not fungible. In a similar way, works of art are all unique, and therefore non-fungible (Who would ever take a Dali over an original Picasso?) There from, we get Non-fungible property. So, when you try to buy a piece of virtual property, the particular video clip or artwork is like no others, this is now non-fungible just like the land. So, these compositions are referred to as non-fungible tokens
Most usually, these non-fungible tokens are purchased in exchange for Ethereum or other cryptocurrency. In addition to this unique piece of code (really, that’s what this is) there is another piece of code that marks this as unique. Ok, why would anybody want this unique piece of digital art or music, or something similar? Let’s assume that there is a new metaverse, this one for golf enthusiasts, we’ll call this virtual world, The Club. When you join The Club, you can play golf virtually with friends around the world, enjoy virtual table discussions about golf, anything like that. But, to stand out, you can use virtual currency to buy different clothing for your avatar. There might be a very particular outfit that looks very good (to you) confers upon your avatar uniqueness. So, you use your virtual currency for the outfit, and you are guaranteed that nobody else will have that outfit. This outfit is now the non-fungible token. Perhaps you have a digital house, and you wanted to make the inside unique, and saw artwork you liked. Buy it with virtual currency and showcase that artwork in your “house” without any fear of anybody else having it. This is another example of an NFT.
What Are NFTs Used For?
Blockchain technology is very attractive to artists. First, they are able to safely sell their art without the use of an expensive agent or middleman. Second, if setup correctly, the NFT can continue to earn the artist money when it is resold from one buyer to another. Essentially, this is a perpetual royalty. Art, in NFT format, has made its way into advertising too, and the most famous version of this was Taco Bell. Even the NBA seems to be jumping on this bandwagon, as well as other stars. Snoop Dogg has released several art pieces and other unique items as NFTs.
Why are NFTs important?
NFTs are exciting and potentially important. They are important to artists of all types as they can avoid costly agents and register the work on the blockchain. The buyer can identify their version as the original. But, for the average investor, NFTs represent a highly speculative class of investment that should probably be avoided. Because most of these NFTs are within the Ethereum blockchain, the authors suggest that investment in Ethereum itself might be safer. Dr. Ozair of Rutgers Business school reminds us that, “Whether an asset’s value is in a bubble or not is determined in hindsight.” He brings up the point that in Europe these NFTs are just beginning to be regulated, and the U.S. is likely not far behind.
Even so, non-fungible tokens could be an important technological development. In a new digital era that blurs the lines between the physical and virtual worlds, a new way to track digital asset ownership and distribution online will be increasingly important. These blockchain-based tokens could also disrupt financial intermediaries and lower the cost of buying and selling big-ticket items such as autos and real estate. That doesn’t necessarily mean you should invest in highly speculative NFTs, but, at the very least, their development is worth keeping an eye on. Dr. Lenz of Duke University is particularly high on NFTs. According to him, the potential of NFTs is just having its surface scratched. He goes on to suggest that NFTs are currently in “the inverse of a bubble.”
The middle ground seems to be that you should consider investing if you derive emotional benefits from the NFT, and make it not a purely business decision. Perhaps, if you buy a work of art from some celebrity, you get to meet them or get a personalized autograph. If the perks are good enough for you, it could be well-worth the investment.
This is all really slippery. What’s to keep somebody from reproducing it over and over again and diluting the value of my NFT?
In a word, not much. But there is something about having the original, and with an NFT, you can prove it. For instance, there are millions of copies of the soundtrack to Star Wars. Each one is infinitesimally different from the original master possessed by (probably) George Lucas. The copies all sound great, but they are not the original. This is the power of the NFT. Some people might laugh at this but, some NFTs sell for millions of dollars, and that is no laughing matter.
Who cares?
For me, a car is transportation. Get me from point A to point B reliably, and I am happy. But, some people like to evoke their own style by owning, say, a Corvette. In fact, across the nation, there are many Corvette clubs, and the only entry requirement is to own one of these vehicles. Generally, the men and women in these Corvette clubs are rabid enthusiasts of the brand. Would you be surprised to learn that online, there are enthusiast communities too? The first one was organized around cartoon penguins and the general word for these groups are now called “penguin communities” regardless of what the uniting attribute is. The point is, within these online enthusiast communities, the NFTs can be seen to be very valuable.
Are these NFTs just like the Beanie Babies of the 1990s?
Perhaps. I would suggest however, that they are slightly different because there is an entry on the blockchain to register the original work as belonging to you. Beanie babies (and for that matter tulips in that bubble) were not registered. On the other hand, if the format of the code becomes obsolete or the company that makes that software goes bankrupt, the value of the NFT could plunge FAST!!
NFTs are also generally one of a kind, or at least one of a very limited run, and have unique identifying codes. “Essentially, NFTs create digital scarcity,” says Arry Yu, chair of the Washington Technology Industry Association Cascadia Blockchain Council and managing director of Yellow Umbrella Ventures.
OK, I’m psyched! How do I buy these NFTs?
First there’s no reason to yell. Second, go to Kraken, or Coinbase or other reputable cryptocurrency exchange and get a wallet that can hold cryptocurrency and NFTs. Third, buy a good supply of Ethereum which you will use to purchase the NFT. Fourth, do your research very carefully. Consider some of the larger NFT marketplaces like OpenSea, Rarible or Foundation and investigate the offerings and especially the people behind these NFTs. (Please note that the procedure for verification differ markedly from platform to platform.)
Are there any taxes to consider?
Yes. The artist who is selling the NFT will have income tax to pay. The first buyer will have capital gains tax to pay when they resell the NFT (hopefully at a premium.) Beware, if there are other cryptocurrency transactions associated with this, any gain on that part of the transaction will also be taxed at the capital gains rate.
The Verdict
So, it seems that we should consider the middle group. NFTs are an investment. So, if you do have plans to hold the NFT for a while, this could be an opportunity for you. On the other hand, if you do truly get some additional utility from this investment, and the price is right, you are likely to have some great stories as a kind of dividend. Be sure to understand any tax implications, keep the amounts small, and you might go do well with NFTs.
REFERENCES
https://www.theverge.com/22310188/nft-explainer-what-is-blockchain-crypto-art-faq
https://www.forbes.com/advisor/investing/cryptocurrency/nft-non-fungible-token/
https://www.fool.com/investing/stock-market/market-sectors/financials/non-fungible-tokens/
https://www.gemini.com/cryptopedia/nft-non-fungible-token-crypto-collectibles
Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice. Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.