January 15th, 2022

Understanding NFTs and How to Invest in Them

non fungible tokens

Dear Retail Investor,

At this point, you’ve likely heard the term “NFT” thrown around enough to have a vague idea of what they are.

Some kind of digital art thing? The latest crypto craze? A speculative frenzy?

Correct. 

But did you also know that the NFT marketplace is now worth over $22 billion, up from just $100 million in 2020, and that the collective value of the top 100 NFTs ever issued is almost $17 billion?

They are everywhere, with Hollywood, sports celebrities and big brands like Coca-Cola and Nike having hopped onboard. 

NFTs are quickly making their way into mainstream investment circles, bringing with them the potential to disrupt entire industries . . . 

It all started 10 years ago

The idea behind NFTs started back in 2012 – 2013 with “colored coins,” which are tokens issued on the Bitcoin blockchain that represent ownership of a real-world asset.  

The colored coin idea spurred interest in digital ownership, and in 2016 the movement captured memes, including the famous Rare Pepes—a modern twist on the famous Pepe the Frog meme that was one of the first digital art experiments on the blockchain. 

Cryptoart was then born, allowing creators to submit and sell their artwork. This led to many fads, and then in 2021 the NFT market exploded into the mainstream.

The NFT craze has since seen art pieces fetching millions of dollars in online auctions. One well-known example that got the ball rolling was a piece known as Nyan Cat, an animated GIF of a cat with a poptart body and rainbow jet stream . . . that sold for $US 580,000

You can now buy not just digital art, which is still the most popular NFT, but also GIFs of famous athletes, music, tweets, video game items to customize your favourite characters, domain names, trading cards, collectable items—and much more.

But what exactly are NFTs?

NFTs, or non-fungible tokens, are digital assets stored on a digital ledger (blockchain) that act as secure documentation of ownership. 

They are essentially a digital stamp that verifies that an online asset is original. 

Being “non-fungible” means they are not interchangeable in the same way, for example, as a cryptocurrency is because they have unique properties. 

And when you buy one, the computers in the crypto network record the transaction on a blockchain and this makes it part of a permanent public record.

What are the benefits?

As ethereum.org points out, NFTs solve the need to replicate the properites of physical items, like scarcity, uniqueness and proof of ownership, in the digital world. 

They tokenize things like art and collectibles, by creating a unique identifier that cannot be copied, substituted, or subdivided, and that verifies ownership. 

And one of the biggest benefits of NFTs is that they cut out middlemen, limiting fees from art brokers, auction houses, etc. 

The NFT market is also more efficient and more liquid than many other methods of transferring assets, and as a result could spell considerable disruption. 

There are a range of new uses emering—from real estate titles to redeemable marketing certificates, and even NFT-based carbon credits.

How do you invest in them?

Before jumping in and buying a handful of NFTs, it’s important to note that they are a highly speculative asset. 

Most investors buy NFTs in the hope they will rise in value, and in many cases they are purchased mainly for bragging rights. 

The asset they contain can be copied quite easily because this is the internet, after all (though the stamped original will always remain the original). For instance, an image, a GIF or a song can all be downloaded from the web. They can also be stolen if you are not careful with your NFT wallet. And they don’t provide steady cashflow to the buyer, as stock dividends and real estate investments can (however the creator of the original NFT can earn royalties from each re-sale – more on that below). 

That said, they are a new asset class representing the ongoing evolution of uses for the blockchain and they deserve a closer look, perhaps not so much for what they currently do, but for what they could accomplish in the future. 

If you want to get your feet wet, there are a couple of approaches you can take: buying NFTs directly or buying them indirectly through stocks of companies involved in the space. 

Buying—and making—NFTs

Buying an NFT is fairly straightforward. All you need is to have a cryptocurrency wallet (preferably Ether, as it encompasses most NFTs). You then familiarize yourself with an NFT marketplace, such as Open Sea (the largest) where you can buy or sell your own NFTs. 

Some of the most prominent collections to check out are CryptoPunks, the Bored Ape Yacht Club, and Doodles—all of which sell for at least US$15,000.

Once you purchase your NFT, you will be given an access code. And that’s it. You now own your very own NFT. You can keep it or sell it (hopefully for a profit) if you wish. 

Another way is to create your own NFT and sell it. If you are art savvy, you can take a stab at making what may be the next Nyan Cat. 

You can sell your NFT or even choose to make 10% in royalties every time someone resells it. 

Or you can just buy NFT adjacent stocks

For those who can’t be bothered buying NFTs directly, which is most of us, a better and perhaps less risky approach is investing in companies involved in the space. 

A lot of large companies have been jumping onto the NFT bandwagon over the last year, hoping to capitalize on the momentum. 

In May 2021, eBay (NASDAQ: EBAY) began selling NFTs on its platform

Gamestop, the original meme stock, recently mentioned that it’s getting into the NFT space. This sent the stock sharply up, as investors anticipate a new direction for the brick-and-mortar company looking to reinvent itself. However, it remains to be seen if a Gamestop NFT marketplace can compete with the likes of Open Sea, which is currently valued at over $13 billion. 

Plenty of video game developers and publishers, who already earn the majority of their revenue from selling in-game items and content such as character skins and accessories, are naturally looking to include NFTs that represent these digital in-game items as a way to open up new revenue streams. 

Take-Two Interactive (NASDAQ: TTWO), which recently acquired mobile game developer Zynga, has made clear it is exploring ways to incorporate NFTs into its games in the future.  

Ubisoft (EPA: UBI) announced in December 2021 that it will integrate NFTs into its game Ghost Recon Breakpoint. The NFTs, called Digits, will be in the form of in-game accessories and upgrades which will be available for purchase on its new platform, Ubisoft Quartz. Players may buy and resell the Digits, and ownership is recorded on the blockchain. Although the stock took a hit after the announcement, it has recently bounced back.

There are also plenty of smaller companies and microcaps offering unique exposure to NFTs, but most of them are fairly speculative in nature, so be sure to do your due dilligence. 

Galaxy Digital (TSX: GLXY) is a small-cap financial services company serving the entire crypto industry. It serves institutions, has investment banking operations, and has a mining segment where it mines for Bitcoin and finances other mining stocks. 

It also has a business segment that offers exposure to NFTs, having invested in NFTs themselves as well as several companies operating in the space. The stock has seen a fairly large drawdown lately, down almost 50% from its 2021 highs.

Fad or future?

If this all sounds a bit ridiculous, it kind of is. 

While some NFT buyers are collectors and fans, many are just trying to make quick money on the latest trend. 

The insane prices NFTs have fetched are very reminscient of the meteoric—and highly volatile—bull runs we have seen in crypto. 

But many disruptive technologies start out this way.

Think of Facebook, which was basically a university networking toy when it first came out, and struggled to adopt a solid monetization strategy after its IPO. Nobody questions its value now, not to mention how it changed the way we live and interact.

NFTs may present a world of opportunities, as they move from the experimental stage to disrupting long-established industries. 

The technlogy behind them, which includes storing and validating sales on a blockchain, is sure to have a big impact going forward. 

Either way, investors would be wise to at least follow this asset class. And if you are feeling wild, go buy a meme or two. 

-Dear Retail Investors Editorial Team

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