What in the World are NFTs?

If you are someone who reads the news, you probably have heard the term “NFT.”  If you are like me, you probably were completely lost upon hearing the term.  I feel like every time I look at the news, a new NFT is being sold for millions of dollars.  With so much hype around NFTs, I really wanted to understand what they were and how they work.  Part of me wanted to learn so I can get in on the lucrative market.  But, another part of me just wanted to comprehend why digital images are selling for so much.

Well, if you want answers to what NFTs are and how exactly they work, look no further than this article.

What are NFTs?

NFT is an acronym for “non-fungible token.”  That probably didn’t provide any more clarity as to what they are.  Just hold on, I’ll give more details.

An NFT represents sole ownership of a specific digital asset.  This asset can be an image, a song, a video, etc.  To function, NFTs utilize Ethereum blockchain technology like cryptocurrency.  (I know that sounds confusing, but it’s just good to know).  However, unlike cryptocurrencies, NFTs are not fungible.

When something is “fungible,” it is interchangeable.  For example, if Dunkin Donuts has twelve chocolate-glazed doughnuts for sale, there is nothing different between any of the twelve doughnuts.  They are interchangeable with one another.  This is also the case with cryptocurrencies, such as Bitcoin.  Bitcoin is fungible, meaning one bitcoin is not different from any other bitcoin in circulation.

Thus, if something is “non-fungible,” it is not interchangeable.  That is the case with NFTs.  An NFT is one-of-a-kind, providing unique ownership rights to whoever possesses it.  So, when Twitter CEO Jack Dorsey sells an NFT of his first tweet, the buyer becomes the sole owner of that tweet.  While other people could have images of the tweet in their possession, it is not the original version of said tweet.

Why Would Someone Want an NFT

Well, an NFT allows an individual to have sole ownership of whatever digital good they like.  NFTs can be very beneficial for the creator economy, as anyone can profit from their creative outputs online.  Artists now have a digital outlet to display and sell their pieces of work without having to go through a third party.

How exactly do artists profit?  When someone buys an NFT from an artist, the artist takes anywhere from 85-97% of the revenue from the transaction.  The remaining revenues go towards the platform that the artist is using to sell the NFT.

What is really interesting is that the original artist will continue to receive a commission every time the NFT is sold in the future.  In other words, whenever that piece of art is sold again, the original artist can receive as much as a 10% commission every time. This can also be seen as the new frontier of art collecting.  With the dawn of NFTs, digital art now has the benefit of exclusivity and uniqueness like physical art does.

Let’s Look at the Mona Lisa

For example, let’s look at the Mona Lisa.  Today, the original Mona Lisa painting sits in the Louvre Museum in Paris, France.  In 1962, an insurance policy worth $100 million was taken out on the painting.  Adjusting for inflation, that is worth over $800 million today.  Can you imagine that?  Almost $1 billion dollars for a painting?

Well, here is a copy of the Mona Lisa that I can buy on Amazon for $7.99.  (I wonder which one I’ll buy).

Why is the original Leonardo Da Vinci painting worth nine figures, while a copy is worth less than $10?  In art, there is a significant difference between owning an original work of art and owning a copy of that art.

The original Mona Lisa is worth close to a billion dollars because of the historical and cultural significance of the piece of work.  One of the greatest minds in human history painted it by hand hundreds of years ago.  Today, millions have the opportunity to see a piece of history every day in a museum, which provides Paris millions of dollars annually in tourism revenue.

On the other hand, the painting from Amazon is simply a copy on printing paper with absolutely no cultural or historical significance whatsoever.  Do you see the difference?

This is the case with NFTs.  While there can be copies of a digital piece of art, it will never be the ORIGINAL copy of that work.  Being irreplaceable (even digitally) causes the prices of NFTs to be tremendously high, as individuals want to feel ‘exclusive.’

The Current NFT Market

To say the NFT market is booming would be an understatement.  In August of 2021, there was $1 billion worth of NFT transactions.  In 2020, there was less than $100 million.

You have pieces of digital art selling for millions of dollars on a daily basis.  One of the most notable lines of NFTs is CryptoPunks, which has generated over $1.2 billion to date. 

There are also a number of well-known and respected corporations getting into the NFT space.  Visa and Nike are two brands that have purchased NFTs.  The NBA has released a line of their own NFTs called NBA Top Shot.  Microsoft has included NFTs as awards in their game Minecraft.

The NFT market is really taking off. Many people are seeing the market as a tremendous investing opportunity. But, all of this traction leads to one big question: Is this a bubble?

The NFT Bubble

I’m sorry, but who in their right mind would want to spend millions of dollars on a piece of digital art?

In the Mona Lisa example I used earlier, I said how exclusivity is the main driver for such high prices in the NFT market.  However, it doesn’t really make sense to me.

Exclusivity makes sense when the artwork is physical, like the actual painting of the Mona Lisa.  I cannot copy the history and cultural significance behind that painting.

However, I can take a screenshot of any NFT that is out there and be satisfied with myself.  There is really no advantage to having the ownership rights to some of these pieces of art.

In my opinion, I think NFT technology can be very beneficial for artists, specifically musical artists who often have difficulties with ownership rights of their music.  Having the ability to always see a percentage of revenues for the distribution of your music would be groundbreaking.  Many artists would be able to take control of their work like never before.  This application would not be limited to musical artists either.

Aside from that, this current trend in the market is definitely not sustainable going forward.  Much of the art that is selling for thousands, if not millions, of dollars is overvalued because of the novelty.  Many people are riding the cryptocurrency/blockchain wave at the moment and are eager to throw their money at anything related to either.  This has led to widespread overspending in these markets.  If (God forbid) a recession were to occur, 99% of these NFTs will be worthless.

Dot-Com Bubble 2.0

Again, this is just my opinion, but if you don’t believe me, the same exact thing happened in the early 2000s during the Dot-Com Bubble.  From 1995 to 2000, a tremendous amount of investors were pouring their money into online businesses.  Because of the low-interest-rate environment, many investors significantly overvalued many of these internet startups.  However, as investors began to run out of money to throw at these companies, these startups (none of which were cash flow positive) quickly ran out of funding, causing the bubble to pop.

I think this represents our time now perfectly.  While the majority of internet start-ups went belly up in the early 2000s, the internet is still the backbone of every form of technology today.  Similarly, I see a significant amount of current NFTs being worthless in five-to-ten years but the technology being very valuable.