Big Story

4 Things You Didn’t Know About NFTs

Kumar Shankar Roy |BL Research Bureau | Updated on: Feb 12, 2022

It’s boom time for non-fungible tokens. Here are the aspects to factor in before you decide to invest

When a market grows 25 times in a year’s time, greed can take centre stage. The sheer craze for NFTs, a three-letter acronym for Non-Fungible Tokens, has led to its global sales hitting $25 billion in 2021, from just $95 million in 2020. And, greed is forcing people to drop any semblance of responsible wagering. The world took its own sweet time to wake up to cryptocurrencies, given their obvious technical nature. But, the mad rush for NFTs, which are arguably more complicated, is downright inexplicable.

NFTs are blockchain-based digital units used to transfer or validate ownership of items. These days everything is being NFT-ed in the hopes of monetisation; expensive illustrations of apes to collectibles such as celebrity autographs, not to forget physical goods such as a case of rare whisky. With artists, musicians, filmstars, sportspersons, brands and big business coming to the NFT arena drawn by the money-making opportunity, it’s boom time for these digital tokens.

With the Union Budget announcing a new scheme of taxation with regard to digital assets including NFTs, the interest for NFTs in India has spiked, with related NFT terms seeing 500-1,000 per cent jump in online search the last few days. Social media channels are being spammed with ‘the next big NFT’ promotions and inboxes jammed with ‘pre sold out’ messages. It is fever pitch in the NFT world.

Here are 4 things you didn’t know about NFTs.

#1 Backdoor entry to cryptos

At BL Portfolio, we have always cautioned the investor about the dangers of crypto investing, we have highlighted that it is an unregulated space driven by mindless speculation. At the time of our September 2021 Big Story, 'Know these risks before you invest in Bitcoin', 1 bitcoin cost ₹35 lakh. Today, its value has dropped to ₹33 lakh. Unfortunately, NFTs are a backdoor entry to the same unregulated crypto world.

Though there are some businesses that claim to allow users to buy NFT with fiat money, these are not mainstream yet. A majority of users in NFT marketplaces have to create a cryptocurrency wallet, link it to the NFT platform and add the necessary amount to their cryptocurrency wallets before they can make a purchase.

So when you read about some obscure wealthy person buying NFTs paying millions, they actually pay in cryptos, not hard cash. For instance, the associated NFT for Everydays: the First 5000 Days, a digital work of art, was sold for $69.3 million (roughly ₹500 crore) at Christie's in 2021. Singapore-based programmer Vignesh Sundaresan, a cryptocurrency investor, paid for the artwork using over 42,000 Ether (a cryptocurrency).

Though speculation is now at the heart of NFT purchases, the popular use case of these tokens in 2020 and 2021 had a more humane angle. The Covid pandemic was the proverbial straw that broke the camel’s back for innumerable artists, musicians and creators. With NFTs, any creation can be tokenised to create a digital certificate of ownership, helping creators get a life-changing price for their art.

Pretty soon, enthusiasts started pitching NFTs as some miracle that can even fix the shattered economics of streaming music. Those pretences are long gone, with NFT marketplaces talking up the market with 50-100x potential return in quick time. When celebrities come and post messages on social media about owning NFTs, do take it with a pinch of salt. Why? Because they could be merely endorsing an NFT or platform in lieu of fees.

Since each NFT is unique and not interchangeable with another digital asset token (i.e., fungible), there is a good benefit in terms of the record of the uniqueness of the NFT. This exists as a cryptographic record on a blockchain, or distributed ledger, and can be readily viewed by anyone who understands tech.

Buying and selling NFTs typically requires incurring fees that can be a significant percentage of the sale, in addition to the complexity of needing to create and fund crypto accounts and wallets. Some platforms offer commissions to grow the NFT user base but most of those payouts are in cryptos. The process of selling an NFT tends to be more costly than people think, because minting an NFT i.e. verifying the ownership and uniqueness, is a costly part of creating such a token. It could cost you $70-100 to create a token. However, lazy minting allows NFT artists and creators to mint their NFTs without any upfront costs. But, that option has to be available with the NFT marketplace and the final price of the NFT will be commensurately higher for the buyer., so NFTs are just a backdoor entry point to crypto world as of now.

Do note that NFTs have lower chance of being outlawed compared to cryptocurrencies as NFTs are less likely to face any major run-ins with governments, if they are de-linked from cryptocurrencies.

#2 NFTs are not like stocks or bonds

With NFTs becoming a hot property, there are many colourful discussions on how NFTs are ‘just like’ equity shares or akin to ‘owning a part’ of a promising artist or musician. This is over-simplification, at best.

The traditional tenet of investing, buy low and sell high, applies to NFTs too. But, NFTs are not like a stock or a bond where you know the intrinsic value of the investment. NFTs have a market value and that is driven by what the crypto community is willing to pay. Once you buy an NFT, you need to find somebody more credulous ho will pay a higher price for it and enable your exit. There is no prominent dividend or interest income from NFTs. Neither are NFTs a hedge against inflation. Due to their short history and unique nature, correlation or lack of correlation to traditional assets is merely conjecture at this point in time.

So, why are people paying half a million dollars for an NFT of an animated Gif of a meme of a flying pop-tart cat, or for an NFT of a single red pixel? Short answer: We don't know. What we do know is that some NFTs have seen unbelievable increase in prices, helping some to flip them for massive profits within a short period of time i.e. hours and days.

The first widespread NFT experimentation happened on Ethereum in mid-2017 with CryptoPunks, which consisted of 10,000 unique collectible digital punks. Today, given their limited supply and strong brand among the early NFT adopters, they are regarded as among the most significant and highly valuable NFTs. But prices of the most sought-after NFTs are highly volatile. The average sale price of a CryptoPunk image rose from around $1,00,000 in July 2021 to nearly $5,00,000 in November. By December 2021, it had fallen to around $3,50,000.

Soon, popular artists started experimenting with NFTs. Digital art has emerged as a natural fit for the proof of ownership, immutability and provenance tracking features of non-fungible tokens. The multi-million deals for works of 'Pak' and 'Beeple' have added to the insanity.

Today, apart from digital art, NFTs are minted for games, music, film, memes, etc. Any object can derive an increase in its value through 3 broad ways; when it generates some form of recurring stable income or when its fundamental value rises or when the object is subject to intense speculation. By taxing them at 30 per cent, the Indian government has put NFTs in the speculative asset category.

If you are buying an NFT associated to a sunrise picture in Mcleodganj or some multi-coloured digital graphic art and hoping to make tonnes f money, you are probably wasting your time. A good investment in NFT arena needs to meet a few conditions such as rarity and programmability. Rarity in NFTs can be either numerical or historical. In addition to allowing artistic or business expression, NFTs can be programmed in any way that programmable software can, for example, ensure artists continue to receive residual or moral rights throughout the lifetime of a work, and not just the first sale.

If NFTs become more mainstream, Indian investors in the foreseeable future can expect some index funds and exchange-traded funds based on shares of NFT economy-linked companies. A few have been launched in the US already.

#3 Hazy rights

The biggest problem of NFTs is rights. As NFTs are supported by blockchain, these transaction records are permanent, verified multiple times and cannot be erased or changed. But the underlying mechanism used for transferring and establishing ownership needs to stand good in the court of law. Additionally, for the NFT ecosystem to be accepted by the masses, it is necessary to establish how NFTs will work with existing Intellectual Property Rights (IPR) in various geographies.

When you buy an NFT, what you get is ownership of the NFT itself. Anything further is decided by the terms of the NFT coded into the token smart contract, something many don’t even read. In the absence of specified rights, if an owner buys a digital art or collectible NFT, in most cases he/she is only buying the right to display the piece of digital art linked to the NFT. The copyright of the artwork remains with the artist, unless it is explicitly specified. This also means that IPR rights remain with the artist.

Several content owners have seen unauthorised NFTs of their work appear. For instance, Nike Inc has accused the sneaker resale marketplace StockX LLC of minting non-fungible tokens that use its trademarks without approval, and selling them at inflated prices. Unauthorised and unapproved branding of NFTs is fraud. So, an NFT buyer must pay a lot of attention to the fine-print. Are you okay as a buyer not to get the right to make copies of the underlying asset, or monetise it in other mediums? You will have to answer this question.

Of course, newer models are developing quickly in NFT space wherein the buyer may also get the right to earn from the investment made in the NFTs. For instance, one blockchain-based music investment platform is allowing fans to invest in music and investees in NFTs issued for such songs will receive a share from royalties every time the music is streamed. Thus, they are stakeholders in money earned from commercial exploitation of the song, though they are not the owners of the IPR.

#4 Scams, frauds galore

Do remember that NFTs -- due to their digital nature of existence -- are being used to scam and defraud the gullible public. Rug pulls, a term for when developers take the money and run, are common in NFTs.

Thousands of investors of a project called Evolved Apes lost $2.7 million (₹20 crore) in October 2021. Evolved Apes was a collection of 10,000 unique NFTs trapped inside a lawless land, but nobody could guess that the developer was taking it too literally!

Within the first fortnight of 2022, creators of Frosties, a collection of animated penguins wearing colourful and quirky clothing, disappeared off the Internet overnight. Investors lost over a million dollars (₹7.5 crore) in that one.

Scams/frauds in the NFT space can be grouped into four buckets.

a) Replica stores: Scammers lure users with legitimate NFT marketplace logo, have a similar website layout, and sell NFTs available on the legitimate store, tricking them into giving away their credentials or payment information.

b) Counterfeit NFTs or fakes: Counterfeit and ‘inspired’ artwork/content is a problem for NFTs. As a buyer, you need to be careful about what you are buying or bidding. It is difficult to verify the seller on many online marketplaces. Unless you are absolutely confident about their antecedents, don’t buy NFTs from people/platforms you know nothing about.

c) Giveaways or airdrops: Scammers target crypto enthusiasts by offering them free crypto/NFTs/tokens related to NFT marketplaces. Scammers use social media platforms such as Instagram, Twitter, Facebook, Telegram and Discord to propagate these scams. Don’t transact with people who come to your personal social media platform chat window with ‘exclusive deals’.

d) Wash trading: This is akin to circular trading, where artificial inflation of prices of NFTs happens by one person who is selling the token between two of his/her own digital wallets. They are then able to sell to someone else at a falsely higher price.

Just like cryptos, NFTs are unregulated. This means your dear investment in an NFT is not controlled or supervised by regulations or laws in India. So, your investment suffers from very weak or nil protection. Courts will, most likely, not entertain you, and ditto for the police. Transacting from NFT marketplaces/platforms is safer and more secure than doing it alone. However, if these platforms are themselves dubious, then there is no hedge. Given the unregulated nature of the entire NFT ecosystem, the untested nature of buyer rights in traditional courts and emergence of various scams, it is best to go slow on NFTs.

Published on February 12, 2022

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