It’s hard to scroll through a news feed, turn on the TV or pick up a newspaper without seeing discussion about cryptocurrency and non-fungible tokens. OpenSea, which claims to be the world’s largest online marketplace for NFTs, says trading volume in January exceeded $3.5 billion! Almost a year ago, Beeple’s Everydays: the First 5000 Days sold for $69.3 million, becoming the most expensive NFT ever sold to one buyer. And in December, almost 30,000 people pitched in to pay a record $91.8 million for an NFT called The Merge.
What in the world is a non-fungible token?
To understand what an NFT is, we first need to understand the difference between fungible and non-fungible. A fungible good is one that can be replaced by another, identical item; it is replaceable, and therefore, not unique. Think of a new jacket that you buy at the store. That jacket has been mass produced, and if you need another size or color, you can replace it. Non-fungible goods, on the other hand, are not replaceable. If you have owned a jacket for many years, for example, that same jacket may not be replaceable — it has become comfortable with wear and it fits exactly the way you like it. While you can buy a new jacket, it will not be the same as the old jacket that you’ve had for years.
All goods in our economy are either fungible or non-fungible.
When you buy the jacket, you probably are using either a credit card or debit card to make the purchase. When you swipe the card, a message is sent to your bank that you are spending money on the jacket. The bank keeps a tally of the ins and outs of your account and will either approve or decline the purchase, based on your balance. We trust that our banks will handle this correctly.
Cryptocurrency works the same way, but the bank is replaced with blockchain technology, a digital ledger that is stored on the internet for everyone to see. Everyone on the blockchain knows all the transacted business and keeps an eye on every transaction handled there. In blockchain lingo, when you make a purchase, you acquire a token (or digital certificate) that identifies you as the owner of that item — a jacket, piece of art or meme, for example. The blockchain verifies that the person buying the token or digital certificate has the currency to make the purchase. Once the transaction is made, the owner’s identity is in the public record, on the blockchain ledger.
The NFT is a certificate of authenticity of ownership, not the actual art itself.
What makes the NFT valuable?
There are tens of thousands of NFTs in existence, representing a variety of topics, such as music, art and sports. Like any piece of art, beauty is in the eye of the beholder. One’s person’s trash is another person’s treasure. Conceptually, owning a piece of digital art is the same as owning a piece of physical art. The main difference is simply that with digital art, the collectible is stored on the internet. The NFT, or proof of ownership, is stored on a computer instead of in your home or safety deposit box.
Many people ask, “What’s the point of owning the digital art if I can just go online and print out a copy?” The difference is that by making a copy, you don’t own the original, something that no one else has. Think of the Mona Lisa. You can go online and print a copy — or you can buy a poster reproduction of the painting to hang in your home. But it is not the original, the one that was actually signed by Leonardo da Vinci.
The digital receipt on the blockchain that comes with an NFT purchase is the only symbol of the work that has financial value.
What are the problems or risks with NFTs?
NFTs primarily use the Ethereum blockchain, and a massive amount of energy is being consumed to power the computers that do calculations day and night to run it. A single Ethereum transaction consumes as much electricity as an average U.S. household uses in one week — the equivalent of 141,000 Visa transactions or more than 10,000 hours of YouTube videos. Ethereum is making a major investment to become more energy-efficient and sustainable.
With NFTs, everything is stored on computers. If the website/gateway or servers were to crash and all data were lost, then everything purchased on the blockchain could be lost and the investment could be potentially worthless. NFTs also can be hacked or stolen, as was the case for a collector who was robbed of $2.2 million in NFTs in a phishing scam.
Another potential hazard is future regulation and taxation. Collectibles are taxed at higher rates than capital gains rates. The IRS has not explicitly said that NFTs are collectibles, but as the government continues to increase regulation on cryptocurrency, we should expect further clarification.
So, what can we learn from all this? The internet is full of stories about people — sometimes acquaintances or friends of friends — who have struck it rich speculating in cryptocurrency or buying and selling NFTs. Speculation is inherent in anything new, and NFTs are no different.
Buying collectibles — whether that means baseball cards, art or vinyl records — is largely a personal decision. NFTs are no different. Like any collectible, an NFT’s value is based entirely on what someone else is willing to pay for it. If you decide to purchase an NFT, it may sell for more or less than you paid for it — or you may not be able to sell it at all. The best way to approach investing in NFTs is like you would any other investment: Do your research and understand the risks.
From a portfolio perspective, we continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, while not making investment decisions based on where we have been. Making market decisions based on what might happen may be detrimental to long-term performance. The key is to stay invested and stick with the financial plan. As we say each week, it is important to stay the course and focus on the long-term goal, not on one specific data point or indicator.
It’s important to remember that panic is not an investing strategy. Neither are “get in” or “get out” — those sentiments are just gambling on moments. Investing is a disciplined process, done over time. At the end of the day, investors will be well served to remove emotion from their investment decisions and to remember that over the long term, markets tend to rise. Market corrections are normal, as nothing goes up in a straight line.
It all starts with a solid financial plan for the long run that understands the level of risk that is acceptable for each client. Regarding investments, we believe in diversification and in having different asset classes that allow you to stay invested. The best option is to stick with a broadly diversified portfolio that can help you to achieve your own specific financial goals — regardless of market volatility. Long-term fundamentals are what matter.
Sources: CNBC, Forbes, Vanity Fair
This material contains an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources.
Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.
Past performance is not a guarantee of future results.
The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.
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