Non-fungible tokens are cool, hip, and kind of edgy. After going mainstream in 2021, their sales hit $25 billion. However, just because their popularity has skyrocketed, especially among high-profile entertainers, sports stars, and celebrities, that does not make them good investments!
Let’s take a closer look at NFTs and why we don’t recommend them.
What is a Non-fungible Token?
The short answer: a non-fungible token (NFT) is a unit of stored data that can be bought and sold. The record of this data is stored on a blockchain, or digital ledger. NFTs are little pieces of computer code that can be purchased, held, or sold.
To help us get our minds around what NFTs actually represent, we will define a few terms:
● Fungible. This is something that can be exchanged or replaced with something like it. A common example of fungibility is cash. A $20 bill can be exchanged or replaced with two $10 bills, four $5 bills, or twenty $1 bills. They are interchangeable and equivalent. Other fungible examples include stocks (shares in a company) and commodities (like steel, corn, gas).
● Non-fungible. This represents something that can’t be replaced or exchanged for something similar. They are unique and cannot be replicated. Some tangible non-fungible examples are real estate, gemstones, and artwork.
Non-fungible tokens are digital and intangible. The pieces of code that represent them are cryptographically unique and assigned when NFTs are purchased. They are not currency, nor are they cryptocurrency.
How NFTs Work
NFTs usually represent something in the real world, such as art, music, photos, videos, and even tweets. They are one-of-a-kind digital creations with a unique underlying code that identifies them. However, most of them exist as either real-life or digital items elsewhere in the world.
Using the same type of software that is used for cryptocurrency, these tokens are bought and sold online. Most are on the Ethereum network, but there are other blockchains that deal with them, too.
NFTs are listed for sale in an online marketplace. Once purchased (normally by using cryptocurrency), the NFT is minted, or mined, by crypto miners using specialized computer hardware and software. The token can then be transferred and stored on an online server.
Good or Bad Investment
This is the question most people ask: should I buy NFTs as an investment? And the honest answer: probably not.
NFTs are like digital collectibles. They could go down the same path as Beanie Babies, Happy Meal toys, and Pet Rocks. The non-fungible tokens are only as valuable as the price someone else is willing to pay for them, kind of like the “greater fool” theory.
There are financial advisors who suggest that if you are on track with your retirement accounts, have your mortgage paid off, have a sizable emergency fund, and still have money left over to play with, then you should go for it. Even if you can check all those boxes, you still risk losing big when purchasing NFTs.
Some reasons that we believe NFTs are not a good investment:
Volatility. Even something as highly regulated as the stock market still poses some risks. However, NFTs are considered highly risky simply because their value is not based on anything measurable and stable. Rumors, speculations, and even a news article can cause the value of an NFT to skyrocket or to crash within a matter of hours. They are considered even more risky than cryptocurrency.
Hackability. Beeple’s artwork, Everydays: The First 5,000 Days, sold as an NFT for $69 million at Christie’s, the British auction house. A few weeks later, the artist’s crypto wallet was hacked into and fake copies of the NFT were put up for sale. Security issues like this and the vulnerability of hackers has caused many traditional artists to steer clear of NFTs. When investors have their crypto wallets broken into or the server where their NFT is stored goes down, they have no recourse to gain back their “investment.”
Environmental Impact. Similar to cryptocurrency, NFTs eat up a lot of energy and are not environmentally friendly. The production of these tokens uses a large amount of electricity and adds to carbon dioxide emissions into the atmosphere. Ethereum, the blockchain where most NFT transactions occur, is gradually switching to a more energy efficient way. Currently, minting a single NFT uses the same amount of electricity that an American household uses over a nine-day period.
No Real Value. NFTs do not have any real value. Unlike real estate, commodities, and jewelry, these tokens do not increase in value. Someone must be willing to pay more than you did for the token in order for it to have any value. If no one is willing to buy it, you are left with a piece of computer coding that is worthless.
Taxability. Yes, the buying and selling of NFTs is subject to U.S. taxes! While the IRS tax code is lagging the recent boom of the crypto market, gains must still be declared and taxes paid. Transactions are taxed as income, short-term capital gains, long-term capital gains, or dividends, depending on several factors. Because the IRS does not have an up-to-date crypto policy, accountants must make educated guesses on calculating the taxes owed.
Final Thoughts
There is a lot of hype about NFTs in the media. The crypto market for these tokens seems to grow in popularity, but there are many problems associated with them that still need to be addressed. Because of their volatile nature, susceptibility to fraud and theft, negative environmental impact, lack of real value, and unclear tax consequences, we do not recommend NFTs as investments.