What are non-fungible tokens (NFTs)?

What are non-fungible tokens (NFTs)?

Non-fungible tokens, or NFTs, are a relatively new type of digital asset that is quickly gaining in popularity. With CryptoKitties, Bored Apes, and Lazy Lions, the world of NFTs can be an outright zoo for newcomers to navigate – not to mention the flood of questionable NFT projects launched by ‘influencers’ and other individuals lurking in the shadows of anonymity. 

However, it is hard to dismiss this booming category when we consider there was US$21.7 billion worth of NFT sales across the three months leading up to 14 February 2022. Whether you are an advocate or a critic, the rapidly evolving world of NFTs is undeniably intriguing. But with it being such a new concept, many investors struggle to understand it. That’s where we come in. 

This article is intended to be a streamlined and unintimidating summary of what, in the world of bits and bytes, are NFTs?

A graphic of a non-fungible token
Image source: Getty Images

Here are the basics of NFTs 

Now, you might be thinking: Aren’t these token things just like cryptocurrency? While NFTs share some similarities with crypto, there are some essential differences. 

The resemblance is that both crypto and NFTs use blockchain technology to keep track of transactions and ownership. Really quickly – a blockchain is essentially a digital record of information – think of it like a spreadsheet that constantly updates, showing who owns what. But instead of people entering the data, it's all handled by a sophisticated string of computer code. 

So, now we know that both cryptocurrencies and NFTs use blockchains to track who owns them, what exactly do people own in an NFT? 

Let’s break the ‘NF’ away from the ‘T’ to make sense of it all. ‘Non-fungible’ simply means it is non-replaceable, or in other words, ‘unique’. The ‘token’ part merely implies some form of representation. In this case, it takes the form of a digital identifier or code. 

Bringing it back to the beginning then… When we say ‘NFT’, we’re simply referring to a unique digital code created and tracked on a blockchain. 

How do NFTs work?

This is where it starts getting a little more tricky, but we will keep our explanation relatable and try not to fill it with tech jargon. When understanding how NFTs work, there are a few key points to grasp. 

Firstly, what can be made into an NFT and how does someone create one? In short, just about anything you can think of can be made into an NFT. Some examples include: 

  • Tickets/passes
  • Photos/digital artwork/drawings
  • Music
  • Gaming content such as characters and in-game items
  • Virtual worlds
  • Domain names 
  • Twitter posts – yep, we’re not joking.

If you want to create an NFT, you will need a digital wallet with some cryptocurrency in it. Which cryptocurrency is required depends on the blockchain the NFT is created on.

Currently, the most popular blockchain for NFTs is the Ethereum (CRYPTO: ETH) network, so the crypto token used for fees during the creation process would be Ether.

The next step in the NFT creation journey is to jump on the internet and head to an NFT marketplace, such as OpenSea. This is where people can upload their digital file, whether an image, GIF, video, etc. For a small fee, the marketplace will do all the complicated tasks, such as generating the ‘smart contract’. 

Once created – or what is referred to as ‘minted’ – the unique digital asset can be bought and sold while its ownership is indisputably traced on the blockchain. This is made possible by the uniquely identifiable smart contract that is inextricably linked to the digital asset. 

Why are NFTs important?

Some reasons why NFTs are important include: 

  • Improved monetisation of creative content (providing an ongoing income stream for creatives through programmed royalties)
  • Giving participants ownership and a say in the development of projects they are fans of, such as video games, movies, music, and books
  • Creating digital scarcity, which gives our digital lives the same collectability and ‘value’ that our physical lives have
  • Reducing forgeries of physical objects by linking them to an NFT for authenticity
  • Building communities
  • Immortalising items of significance removes the risk of loss through fire, wars, theft, etc.

Another predominant possibility is a major upgrade in market efficiency of real-world items. 

For instance, the traditional art world has long lacked a high level of liquidity. It’s a product of wealthy gatekeepers and middlemen (auction houses) who take a hefty fee to ensure authenticity and provide a means of exchange. 

In contrast, NFTs incorporate built-in authentication while making peer-to-peer exchange much more streamlined.   

ASX companies involved with NFTs

The burgeoning NFT market has spilled over into Australian equities as publicly-listed companies dip their toes into this developing world. 

At this stage, a handful of ASX-listed companies are now involved in the digital asset world to some extent. 

Firstly, Playside Studios Ltd (ASX: PLY) is one of the ASX companies most directly associated with NFTs. The Aussie game developer launched its own NFT project comprising 10,000 unique digital collectibles (BEANS) from the ‘Dumb Ways to Die’ franchise that will be involved in an upcoming metaverse game. 

Beans from Dumb Ways to Die
Source: OpenSea

Other examples of ASX companies testing the waters of the NFT industry include Treasury Wine Estates Ltd (ASX: TWE) and Creso Pharma Ltd (ASX: CPH). The first sells bottles of limited-edition wine through redeemable NFTs, while the second leverages digital real estate in a virtual world as part of its brand awareness strategy.

However, it is a delisted company that could have made the largest imprint on the Australian share market. Animoca Brands, formerly trading under the ticker AB1, has grown into a $5.4 billion NFT powerhouse after being ousted by the Australian exchange operator in March 2020. The company’s valuation has exploded due to the success of numerous NFT businesses that it has invested in, such as Dabber Labs, Axie Infinity, OpenSea, and The Sandbox. 

How to invest in NFTs

Now that you have a grasp of what NFTs are, it might be prudent to learn what is involved in the process of investing in one. 

Typically, there are four main steps in the process of buying an NFT:

  • Buy cryptocurrency for purchasing an NFT
  • Transfer crypto to a digital wallet intended to be connected to an NFT marketplace
  • Choose your preferred marketplace for transacting
  • Research and buy an NFT.

Let’s take a more granular look at how this investing process plays out.

To get started, we need some cryptocurrency that will be used to buy the NFT. Importantly, the specific crypto you will need differs depending on the NFT marketplace you intend on using. Though, with 72% of all NFT sales to date being handled by the Ethereum network, Ether will likely be the token required. 

Getting a hold of the cryptocurrency you need can be done via the plethora of available exchanges, including Coinspot, Swyftx, Binance, and Coinjar. Keep in mind that some of the tokens will be consumed by fees when transferring and transacting.

After purchasing the crypto to buy an NFT, you will want to transfer it over to a digital wallet capable of connecting to the NFT marketplace that you’ll be using. A common wallet used for interfacing with marketplaces is MetaMask. If you haven’t already got a MetaMask wallet set up, there is a handy guide here

Once you have connected your pre-loaded wallet to an NFT marketplace, such as OpenSea, you can begin bidding on and/or buying digital assets to your heart's content. Noting, NFTs can vary significantly in price. From a $23 CryptoKitty to a $3.49 million Bored Ape, and everywhere in between. Accounting for fees, it is probably wise to start out with at least $200 or more to make your first NFT investment. Though, never invest more than you can afford to lose. 

BoredApe NFT
Source: OpenSea
CryptoKitty NFT
Source: OpenSea

 

 

 

 

 

 

 

 

 

 

 

 

 

 

To give yourself the best chance of making a profitable investment, a bit of research is essential. What to look into will depend on the type of NFTs you’re interested in buying. For digital art, much of the research is in the artist, applying many principles of valuing traditional art. Meanwhile, a project offering utility or gaming is heavily dependent on the team behind the work. 

Finally, you have found the NFT you’ve been looking for… Now what? It can be as simple as hitting ‘buy now’. Your wallet will prompt you to authorise the transaction. After confirmation, the agreed crypto amount for the NFT will be deducted from your wallet (along with fees) in exchange for the digital token. Hooray!

What should investors look for when buying NFTs?

Even diehard NFT enthusiasts are wary of the possibility that most NFTs have the potential to become worthless. This is primarily because of the sheer number of NFTs being created, many without the credentials to sustain long term value creation. 

So what are the crucial characteristics to look for in an NFT?
Reputable people behind the project/art

  • A thriving community feeding back into the project
  • Utility (play-to-earn NFT games)
  • A rich history. For example, CryptoPunks are considered one of the first to launch the now popularised project concept of 10,000 unique characters 
  • ‘Emotional stickiness’, as crypto and NFT investor Ben Yu likes to call it. 

According to Yu, If you’re going to feel sad selling it, even for a huge gain – chances are others are going to feel the same way, and thus fewer of that asset will ever go on sale on the market, and as we all know – the intersection of supply and demand is what determines price.”

Lastly, the most important aspect to look for when investing in NFTs is to make sure it is genuine. While the uniqueness of a non-fungible token is indisputable, bad actors and profiteers can create lookalikes in an attempt to deceive buyers. Take a look at the example below from the World of Women NFT collection:

WorldofWomen NFT1
Source: OpenSea
World of Women NFT2
Source: OpenSea

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One of these is from the renowned World of Women project, while the other is a mirrored copycat. One has an offer on it for US$22,890, and the other is going for US$3.76 – don’t be confused and think you’re getting a bargain on an acclaimed project – unless you’re intentionally collecting copycats. 

To avoid being duped, look for the ‘verified collection’ blue check on the NFT collection page. If searching for individuals is more your vibe, popular artists usually wear a blue checkmark badge as well – see below. 

Blue Check for NFT authentication

These precautions should help weed out the potatoes from the Picassos. 

The world of NFTs is vast, but if you have made it here, you hopefully now have a sturdy grasp of all things non-fungible. 

 

Last updated 14 April 2022. Motley Fool contributor Mitchell Lawler owns Ethereum. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns and has recommended Ethereum. The Motley Fool Australia has recommended Treasury Wine Estates Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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