What You Need To Know About Non-Fungible Tokens (NFT)
Even if you do not know what NFTs are, you’ve probably heard about it given its rising popularity lately. Just three years ago, the NFT market cap was at USD$42mil. Fast forward to the end of 2020, its value has jumped 705% to USD$338 mil according to NFT tracking site NonFungible.
What is an NFT?
‘Non-fungible token’ or NFT is a digital token that allows the buying or selling of digital assets. Each NFT is tied to a unique one of a kind asset that is irreplaceable and inseparable once the transaction is recorded in the blockchain. Examples of NFT include, but not limited to, drawings, music, animated GIFs, video, in-game purchases, and even concert tickets.
An example of an NFT that sold for millions is from Twitter founder, Jack Dorsey, who sold an autographed version of his first tweet for US$2.9 million.
How does an NFT work?
Imagine yourself as an artist. You upload your unique artwork to the internet where people can freely screenshot, copy and use your art without crediting or paying you royalties as the creator.
Let’s say you made a painting today and decide to turn it into an NFT. Your artwork is “tokenized” into a digital token with a unique serial number and an owner’s name. This makes it valuable as there is only one such token in the world.
An NFT is like owning the original manuscript for the first Harry Potter book. While the text may be reproduced and copied millions of times and shared around the world, you have a digital certificate proving that yours is where all those copies came from.
These tokens can then be traded for money or other valuables, with each transaction being recorded on the blockchain as a record of everyone who has ever owned it.
How are NFTs traded and sold?
The first thing you need to know is that NFTs are traded using cryptocurrency via a blockchain. The reason for this is its traceability and authentication. With cryptocurrency, every transaction is recorded and verified through the blockchain.
The main function of blockchains is to verify the authenticity of each NFT transaction, so both the buyer and seller of the asset will be able to differentiate between an authentic and fake NFT. As soon as the blockchain captures the transaction, the ownership of the token is immediately transferred to the buyer, which then cannot be erased, modified or replaced.
Some popular cryptocurrencies used today are Bitcoin, Ethereum, Dogecoin and many more – but so far, most NFT transactions utilise the Ethereum blockchain for the purpose of verification and data-storage. However, Tron and Bitcoin cryptocurrencies have also created NFTs in their respective blockchains.
Who holds the ownership of an NFT?
What you get after the transaction of an NFT really depends on the agreement between you and the owner of the digital asset. Normally, the owner sells the token along with the ownership of that asset.
However, there are owners that only sell the digital tokens. These are owners that still want to hold the copyrights of the asset. In this case, you do not own the original piece – and you are not subject to the profit or losses made from the original asset – unless you have an additional agreement with the owner of the digital asset.
How is an NFT valued?
Traditional art such as the ones in museums have very high value due to authenticity, history, sentimental value or some form of tale behind it. Like art pieces in museums and galleries, NFTs are valued the same way. The deeper value and uniqueness of an NFT are subjective though. What is valuable to you may not be for others.
The NFT that you buy might stay relevant between one to five years from now. In this case, you can hold the NFT until you find the highest bid for it and sell it back for profit.
What are the Risks of Investing in NFT?
1. The Way NFTs are Valued
One of the risks in the NFT market is the price uncertainty. This is due to the decentralised nature of cryptocurrencies. Typically, NFTs are valued by these criteria:
● Seller credibility
● Uniqueness of the NFT
● Artist’s digital creativity
● Amount of supply of the NFT
● Historical or aesthetical value
2. Counterfeit NFTs
If you own a digital asset and would like to put it up in the marketplace, chances are there will be people who will try to counterfeit your NFT to profiteer and dupe potential buyers. This risk factor is highly stressed by Nadya Ivanova, the COO of L’Atelier BNB Paribas. According to her, “anybody with internet access could fake an NFT.” There have been cases where sellers of an NFT pretend to be the owner, and therefore sell the replicas instead.
To protect your work as an owner, you could place a watermark, signature or a form of digital authentication so buyers can identify the original artwork. As a buyer though, it is always recommended to buy NFT through the right channels and only deal with the real owner of the digital asset.
3. High ‘gas’ fees
Processing an NFT transaction in the blockchain involves different types of costs, one of which is a gas fee. The same way cars need fuel to function, ‘gas’ is a unit of measurement used to calculate the amount of power required to compute a transaction in the blockchain. Another purpose of gas is to deter spammers from jamming the blockchain network – as both the buyer and seller must cough up the gas fee. Cost of the fee depends on a few criteria:
● Traffic in the blockchain at the time of transaction
● Size of the NFT
● Time taken to process your NFT
Due to the increase in NFT popularity and blockchain activity, you can expect gas fees to go up. Expect to spend a chunk of your money in paying for gas fees, transaction fees, as well as crypto exchange rate fees. However, if the asset has the potential and uniqueness that could cover your costs, maybe investing in NFT is for you.
4. You may lose your NFT
Not all NFT are stored the same way. Although most NFTs operate using the Ethereum blockchain, that doesn’t mean that they’re stored there. In fact, most NFTs only have links to the asset which is stored elsewhere online. This is due to a few factors – either from image resolution being too high, or the file size being too big to be stored in the blockchain.
You risk losing your NFT if the application or platform used to store the assets ceases to function or its usage gets banned. As of today, the NFT industry is still searching for a solution to this problem.
Should you use NFTs?
While NFTs carry many risks, they still provide opportunities for digital artists to make a living. Whether you should be investing in NFTs depends on what you can get out of it.
Buyers and collectors
You may be tempted to buy NFTs published by your favourite artists – whether it’s digital art, songs, or just pictures. This may be especially tempting for super fans and collectors as you would be the only one who could use that asset on the internet.
Digital asset creators
If you’re the kind of person that makes digital art for a living, NFTs are an additional opportunity for you to earn from your work. After creating an NFT, you have the option to claim future royalties on it. What this means is that you will be paid a percentage of any future sales of that NFT, ensuring that you will still be able to earn from your work.
However, you should take time to understand the legal standing of you being able to claim royalties and ownership of your NFTs.
At the moment, NFTs are similar to the coming of the internet in the early 2000s. A majority expected it to be a temporary trend, with few being able to foresee it exploding into the greatest step into the era of globalisation ever seen.
That said, it is important to be cautious and do your own research for anything to do with the world of blockchain. As always, it is a case of caveat emptor – let the buyer beware – when you start to invest or trade on the NFT market.