If you’re not familiar with the acronym NFT you will be. Non-fungible tokens or NFTs are cryptographic assets on a blockchain with unique identification codes and metadata that distinguish them from each other. It’s technical, I get it, but getting to understand this neophyte asset class could be worth your while. Let’s see if we can simplify this in plain English. Think of it as a certificate, such as an auto or real estate title stating the legal owner of a car or home, except that an NFT is proof of ownership in digital form. Starting to see it? Cryptocurrencies like Bitcoin and Ethereum have gone from relative obscurity to being ubiquitous. Those who arrived at this knowledge early in the game, perhaps five years ago or so, turned a $400 investment in Bitcoin into $40,000 today. Not too shabby. That one hundred times growth is why cryptocurrencies and the like are now starting to enter the discussion of whether they should be considered an asset class and allocated to your portfolio.
I’m not here today to sell you on cryptocurrencies or not, as in general it is a personal binary decision, but want to inform you of this sector, if you will, that is Non-Fungible Tokens. To begin, if you haven’t heard of NFT’s you’re hardly alone, especially if you’re a baby boomer.
The young and technical are aware of this first, and are actually putting cryptocurrencies and NFTs in their IRA’s. But don’t laugh boomers, this is something you probably should be doing too. I’m not saying to get out of bonds and cash, which you should primarily be in over 55, but you might want to take a portion of your risk capital and invest it here.
The history of asset classes derives from basic supply and demand and economic need. Someone creates something useful and then people realize these can be monetized. Commodity futures, for example, were invented as a way for farmers to lock in prices ahead of a harvest. Seventy years later, the global derivatives market is worth hundreds of trillions of dollars. This pattern repeats itself again and again in different and diverse markets like music royalties and currently sports betting. NFTs are just the latest group to the party. What perhaps makes the emergence of NFTs more profound than other alternative asset classes is the timing. History again shows us that in times of crisis and need new asset classes emerge. Now, the nascent ecosystem around NFTs is growing rapidly. What makes it so interesting is that it reflects the historical pattern of innovation-then-investment that leads to a new asset class.
Let’s take a look at the numbers behind NFTs. As of year-end 2021, there were roughly 7,000 different types of cryptocurrencies worldwide. According to data from Dune Analytics, OpenSea, the largest NFT marketplace, generated approximately $2.7 billion in volume in January 2022. It is on its way to surpassing the $3.4 billion record it reached in August last year.
So what’s the difference in fungible and non-fungible in regard to these assets? Fungible items are things like the dollar, physical money, or a gallon of oil that can be traded or exchanged one for another. NFTs are not commodities like the dollar or oil or even Bitcoin. They create value by being inherently unique and one of a kind. By creating a system of verifiable digital ownership NFTs fundamentally changed the market for digital assets, creating the possibility for new types of transactions. Where many people are skeptical is with trying to understand the value that is attached to each NFT. A work of art was recently sold at Christie’s Auction House for $69 million. While the number is large by any measure, what was unique about it was that it was for the NFT representing the art itself. The arts and other sectors like them can always be hard to value, regardless if it is the underlying work itself or the NFT. This will always be the case and will be inherently risky. For the average investor, this type of NFT is speculative at best and doesn’t have a place in your portfolio. However, real-world applications of the technology underlying NFTs is a different story. It’s all about blockchain technology, authentication, and security. Nike, for example, owns a patent on NFTs to authenticate sneakers as unique items. The secondary shoe business is $9 billion annually. Currently Nike doesn’t get a cut of this. However, by creating product NFTs, code can be written into the blockchain that follows the product and its resale. Every time a new sale is made Nike could get a cut. This revenue stream is available to all sellers who have a secondary product market. Look at cars or real estate. Blockchain based tokens could be used to guarantee ownership of physical property and cut out expensive intermediaries who traditionally handle titling services and related legal documentation. Real estate is also active in using NFTs to create 3-D images that allow sellers to virtually visit a property online without actually having to see it. Needless to say this has had a huge benefit during the Covid environment.
Among the flood of new companies joining the crypto and NFT boom it will be those that can solve actual business problems and that are sound financially that will be attractive to invest in. According to the Harvard Business Review, the companies that have been successful thus far have a few things in common. “They make meaningful use of the NFT technology itself, leverage a community of users, generate confidence that they can continue executing on the project to maintain ongoing community engagement, offer accessible “on-ramps” for new users, and are able to weather crypto market swings.” It will pay to be diversified in this asset class as you can’t be sure which new ventures will survive. But it only takes one Amazon in the portfolio at the right time to create generation wealth.
