What is an NFT?
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“Verified by an expert” means that this article has been thoroughly reviewed and evaluated for accuracy.
BLUEPRINT
Updated 8:37 a.m. UTC Nov. 13, 2023
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Key points
- NFTs are like certificates of authenticity that represent ownership of digital property.
- NFTs are secured via blockchain technology, making them difficult to counterfeit.
- NFTs have revolutionized the world of digital art but are extremely risky investments.
During a cryptocurrency market boom, non-fungible tokens burst onto the scene. Stories of digital artwork skyrocketing in price overnight whipped NFT investors into a speculation frenzy.
But the crypto winter in 2022 sent many of them running for the exits. NFT trading volume dropped 97% from January 2022 to September 2022.
While the early hype surrounding NFTs has seemingly worn off, enthusiasts say there is value in the underlying blockchain technology that serves as the backbone of the NFT market. They see utility and growth potential in the NFT market that could differentiate it from other collectible fads, such as the Beanie Baby bubble of the 1990s.
But many average investors likely need help to understand what an NFT is and why an online image that can be copied and pasted holds any value. Others may not trust the NFT market, given the 2022 collapse of cryptocurrency exchange FTX and headlines related to various NFT market scams.
The debate over the value of NFTs will likely continue for years. But there’s no questioning the disruptive innovation of NFT technology.
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What is an NFT?
An NFT is a unique digital creation authenticated and verified via blockchain technology. Its non-fungible nature means it is not interchangeable or replaceable. In that sense, NFTs are different from fungible investments like cryptocurrencies and shares of stock.
NFTs represent ownership of digital property, such as a work of art, piece of real estate, song or video. They are modern-day collectibles that exist and are bought and sold entirely online.
Brock Pierce, chairman of the Bitcoin Foundation, said NFTs are essentially a means for verifying and tracking ownership of digital assets.
An NFT is “a ledger to track a chain of custody, like a certificate of authenticity that tracks where assets move,” Pierce said.
NFT transactions and ownership are recorded on a blockchain network, ensuring they are verified and cannot be altered. Because blockchains are public, NFT collectors don’t have to worry about counterfeiting the same way collectors of physical art do.
How do NFTs work? What are NFTs used for?
The most popular place NFTs are created and stored is on the ethereum blockchain. But other blockchain networks also support NFTs.
A creator mints an NFT by using an NFT platform to turn a digital file into a digital asset on a blockchain network. Once the NFT is on the blockchain, the creator can sell it. The fees the creator pays depend on the platform.
Before NFTs, it was difficult to value or monetize digital art because there was no scarcity in the digital world.
In the digital world, art can be reproduced repeatedly and reproductions can be identical to originals, limiting value. But once a piece of digital art has been tokenized into an NFT, it has a clearly defined owner, even if it is subsequently reproduced.
Pierce said NFTs have completely transformed the digital art world, unlocking “tens of billions of dollars for the creator economy, where otherwise digital artists would not have been able to make money because people didn’t value digital art until NFTs were created.”
NFT buyers include collectors and investors looking to profit from the inherent scarcity.
Types of NFTs
Any digital file can be tokenized and become an NFT. But several classes of NFTs have emerged as popular applications for the technology:
- Profile picture NFTs, or PFP NFTs, are used as profile pictures on social media sites. The most famous examples are the Bored Ape Yacht Club PFPs, some of which have sold for millions.
- Art NFTs are tokenized versions of digital art. They can be digital paintings, digital photographs, 3D digital sculptures or any other visual digital creation.
- Gaming NFTs represent specific elements within blockchain-based video games. Players can unlock virtual goods and collectibles, in-game items and skins, and more.
- Collectible NFTs, such as digital trading cards, are created and released in limited quantities to commemorate an event, a person or a theme. They can include NFTs related to sports, politics and memes.
- Virtual real estate NFTs represent digital plots of land in blockchain-based virtual worlds, such as Decentraland. Owners can construct buildings or interact with their property however they want.
Large markets for NFTs also exist in fashion, music and domain names. Some NFTs even have real-world uses, such as club membership and event access.
NFT scams
The NFT market is new and loosely regulated, opening the door for scammers to take advantage of buyers. NFT investors should use only reputable platforms and be on the lookout for common scams:
- Rug pull scams involve cybercriminals promoting an NFT project and making false promises about its value and profits. After they unload their NFTs, rug pull scammers disappear and the value of their NFTs plummets.
- Airdrop scams involve scammers promising to deposit free NFTs into a person’s digital wallet. Once the victim provides their wallet information, the criminals crack into it and steal the assets.
- Pump-and-dump scams involve investors purchasing many NFTs from a game or creator and then aggressively promoting them online, driving up their value. The pump-and-dump scammers then sell the NFTs at the same time for a large profit, leaving other investors with assets that have depreciated.
Andy LaPointe, digital asset advisor at CryptoWisdom.com, said NFTs aren’t inherently bad investments or scams. But he warned that they come with risks, including fake listings and sellers who don’t follow through after money is exchanged.
He said buyers can mitigate those risks by limiting their overall exposure to NFTs.
“NFTs and other digital assets should be considered as ‘alternative’ investments with a maximum of 1% to 3% of an overall portfolio allocation,” LaPointe said.
How to buy NFTs
To buy NFTs, follow these steps:
- Open an account on a crypto platform or exchange.
- Open a crypto wallet.
- Buy ethereum or another cryptocurrency accepted as a payment on an NFT-compatible blockchain.
- Transfer the cryptocurrency to your digital wallet.
- Connect your digital wallet to a reputable NFT marketplace, such as OpenSea, Axie Infinity or Larva Labs CryptoPunks.
- Browse and buy your NFTs.
- Read and understand the terms of the sale, including whether the NFTs have restrictions.
Nicholas Creel, assistant professor of business law at Georgia College and State University, said investors should be extremely cautious in the NFT market.
“While I don’t consider them a scam, I do believe the NFT market is driven almost entirely by people with a get-rich-quick mentality,” Creel said. “As such, you see a remarkable amount of volatility in this market and a lot of people losing everything they put into it.”
Frequently asked questions (FAQs)
Whether NFTs are a good investment depends on factors like the types of NFTs you buy, your investment goals and your risk tolerance. Long-term investors should understand that the NFT market has been around for just a few years, so it’s impossible to know whether buying and holding NFTs over the long term is a good strategy.
At the time of writing, the most valuable NFT collections by trading volume are Bored Ape Yacht Club, DeGods and Mutual Ape Yacht Club. The entry-level price, aka floor price, of the least expensive Bored Ape Yacht Club NFT fetches slightly more than $50,000.
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