NFTs — now you see them, now you don’t
Barry McCall asks if non-fungible tokens (NFTs) are the investment equivalent of emperor’s clothing or a new frontier for people looking for a return on their money
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What have ex-Beatle Ringo Starr, former Chelsea football club captain John Terry, putative queen of pop Madonna, and actress Brie Larson all got in common? They’ve all launched non-fungible tokens (NFTs) for sale to the public over the past year with varying results.
The questions that most people ask in relation NFTs is what are they and why would anyone be interested in buying them. The simplest definition of an NFT is that it is proof of digital ownership of something, typically a piece of art or other media. They are bought and sold exclusively by using cryptocurrency.
But the devil is in the digital detail there. Digital ownership means that you don’t actually own anything in the real world. In the case of a piece of art, you own an online image which you might be able to use as a profile image on a social media platform, but you have no rights to reproduce it as, generally speaking, the copyright of NFT artworks remains with the creator or the vendor if they have already acquired it from the creator.
And that leads us back to the second question — why would anybody be interested in buying anything which they don’t really own? And interest is astonishingly strong.
Among the best-known NFTs out there are cryptopunks — digital images which, to all intents and purposes, look like a young child’s attempt at drawing a postage stamp. Not only do they possess dubious artistic merit but the online image quality itself is very poor with each cryptopunk being just 24 by 24 pixels in resolution.
Initially offered free to anyone who claimed them, the real attraction of cryptopunks for many NFT investors is the fact that they are limited in number to 10,000 and each of those 10,000 is unique. A rare cryptopunk set a new record when it was sold in February for the equivalent of $23.7 million. The lowest price cryptopunk available at the end of June was $51,000. Overall, the total value of cryptopunk sales since they were released into the virtual wild stands at just shy of $2 billion.
There is clearly money to be made but have NFTs any real value as an investment instrument?
“They are worthless but not valueless,” says Brian Lucey, Professor of International Finance & Commodities at Trinity College Dublin. “In a sense, they are a solution looking for a problem. If we didn’t have them, would we have to invent them? One hundred per cent no. If we didn’t have blockchain and decentralised finance (defi) would we have to invent them? Absolutely yes.”
‘Ponzi scheme’
He believes people should be very cautious when considering NFT investments. “If people want to invest, more power to them,” he says. “Does that give NFTs a value? If their value is only the expected price you can get from selling them to someone else, it’s more akin to a Ponzi scheme. People might say that’s similar to gold but there are actually things you can do with gold. You can’t do anything with an NFT. There is no yield or return from them other than what you hope to get by selling them on. Their fundamental value has to be zero.”
That may be the case but it’s still hard to ignore the scale of the NFT market. “The value of the NFT market is now above $40 billion,” says Peter Bennett, head of technology and investment banking with Davy. “That’s greater than the entire global fine art market. There has been a lot of focus on people like Twitter founder Jack Dorsey who sold the first tweet for the equivalent of $3 million. It’s an active market.
“As with most assets, their value depends on supply and demand; what the next person is willing to pay,” he adds. “Because they are frequently regarded as unique in nature, supply is often constrained. Software is replicable innumerable times but NFTs are not.”
That is often referred to as the “greater fool” theory of investments — there is always a bigger fool who will pay more than the last one did for an asset.
Bank of Ireland head of pensions and investments Bernard Walsh sees the emergence of the market in NFTs in the context of what he describes as “the inexorable search for new sources of return for investment”.
“This is a continuous quest on the part of the investment community,” he adds. “It requires a high degree of patience or it’s just speculation. Patience is important. Warren Buffet said that the stock market is a very efficient means of transferring money from the impatient to the patient. In times of high inflation, investors are asking where they can find something doing very well. They are looking for the next big thing.”
And some people clearly think that NFTs represent that new source of return. And their use goes beyond digital art, sports memorabilia, music and brands. Another form of NFT is virtual real estate on the metaverse. “The area that will confuse many is digital real estate,” says Walsh. “Mark Twain said, ‘buy land, they’re not making it anymore’. But he never dreamt of the metaverse. Will we have a digital Bull McCabe claiming moral rights to a virtual field somewhere in the metaverse?”
Dr Richard McGee, academic director of the MSc in Financial Data Science in the UCD School of Business sees applications for NFTs in the arts world. “They can be used for a form of arts patronage,” he points out. “People get digital bragging rights for having supported an artist early on.”
In that instance, artists at the early stages of their careers could sell NFTs to raise funds. The people who buy the NFTs get the satisfaction of supporting a struggling artist as well as the prospect of profit later on when their work becomes more popular.
Mainstream artists are also getting in on the act. “The Kings of Leon released an album via NFTs,” McGee points out. “A couple of extra things came with it making it a collectable.”
“The art world has amalgamated with the world of NFTs, perhaps more so than any other industry,” says Ellen McGrath, senior public affairs executive with Dublin Chamber. “The digitisation of art is reimagining how art is made, consumed, and purchased. In this respect, the landscape of 21st-century art has shifted considerably in recent years. The world of blockchain in general, and NFTs in particular, is accelerating at an unprecedented pace. The year 2021 marked a major stage of growth for the industry, as it continues to make its way into the mainstream. NFTs combine culture with technology, providing exciting and financially attractive ways to make, use, and sell art. However, the NFT space should be approached with caution, given recent reports of fraud in marketplaces, the volatility of the market, and their notably high energy usage.”
NFT market
People should also take some of the stratospheric valuations with at least a pinch of salt, McGee adds. “Some people buy them just to show off. People who made a lot of money in cryptocurrency investments early on are now showing off by buying things like cryptopunk NFTs. But you have to be very careful because people could be buying and selling these things to themselves.”
Sometimes the greater fool can be the same fool, in other words.
Bennett believes the NFT market will mature over time. “This is a new market and the frameworks and protocols for how it operates are still developing,” he says. “NFTs and cryptocurrency are both subject to different rules and regulation and tax in different jurisdictions. If you sell an NFT you could be liable for capital gains tax and in some jurisdictions there are higher rates for collectables. The cryptocurrency that you use is also subject to its own rules, regulations, and tax. You could be caught out by taxes and regulations which not been developed yet. We are looking at the systemisation of a nascent industry.”
Walsh agrees. “It is still very immature as an investment area. What will make it more mature is regulation. In Europe, most pension funds are restricted from investing in unregulated markets including private equity and NFTs. They are ultimately going to be part of the investment ecosystem. The authorities appear to be setting to work on regulating it. There is a bipartisan effort in the US senate to have it regulated by the SEC. If it is being overseen by the SEC that’s a little less onerous than banking regulation. How and where NFTs are going to be taxed is another question to be answered. It’s not Radio Caroline, it’s not going to float away from the authorities forever.”
Bennett also sees NFTs becoming more mainstream. “There is definitely a role for digital assets, cryptocurrencies, and blockchain in the investments markets. Some people are already using NFTs in ways they don’t realise through in-app purchases of gaming avatars. For example, the Roblox game platform has Robucks, a digital currency to buy digital assets. The market will get more sophisticated, more moderated, and there will be rules and regulations around it. It’s here to stay.”
They may be intangible, non-fungible, and worthless with no utility value, but it looks like NFTs are going to be a feature of the investment markets for a long time to come.
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