NFTs, or non-fungible tokens, are the new girl in town that everyone can’t stop talking about. Retail investors and aspiring capitalists’ mouths water at the mere thought of NFTs and will attempt to convince everyone around them to do the same. As more reputable organizations have started to acknowledge and integrate the use of NFTs, like Nike, Twitter, Formula 1 and Epic Games, it becomes harder to dismiss NFTs as a simple fool’s paradise. With a huge increase in interest of NFTs, one may wonder what the harm is in trying to join in on its meteoric rise. Like many things in our world, the reality of NFTs is a lot more complicated than it seems.
Before we dwell on the implications of NFTs, what exactly is an NFT? An NFT is a digitized “property” whose ownership can be verified via blockchain technology, allowing it to have a public verifiable record of ownership. Now, the term “property” is used very loosely, with the most common form of current NFTs being image files or PDFs of art. However, that is just the tip of the iceberg — NFTs can be anything digitized or verifiable by blockchain technology, including digital art, videos, music, tickets, real estate, etc. A site selling NFTs called SuperWorld sells virtual real estate based on the real world that is intended to be integrated into their virtual reality simulation. This is just one of the many new versions of NFTs that are popping up, and there are more different forms of NFTs continuing to emerge. What falls under the umbrella of NFTs is still growing and being refined every day, making it hard to clearly define it. The only thing that is a certainty is its authentication through blockchain technology.
NFT collections began to enter the public eye back in 2017, with NFT collections of pixelated animals like CryptoKitties and CryptoPunks garnering attention from small niche groups of blockchain and cryptocurrency enthusiasts. In 2020, with the start of the COVID-19 pandemic and the explosion of cryptocurrencies, NFTs resurged alongside it. In 2020, the market size of NFTs quadrupled that of the preceding year, reaching a market evaluation of $338 million. This rampant growth continued throughout all of 2021, with NFT market evaluation reaching a whopping $41 billion. To put that in perspective, traditional art market sales dropped to $50 billion in 2020. The NFT market continues to strengthen in 2022.
This huge increase in value raises suspicion in regard to the exclusivity of entire NFT marketplace, especially given the amount of public influence from celebrities and the uber-rich investing and advocating it. With the gigantic amount of capital being injected into the NFT market, mass amounts of retail or nonprofessional, investors are trying to join in on the wealth. Many online investors are advocating creating one’s own NFT. The easiest way is to create digital art that can be sold on one of the many emerging NFT marketplaces, or buying a cheap NFT that has the potential to grow.
One of the reasons that online investors are advocating for creating one’s own NFT is an interesting property called smart contracts. A smart contract allows for the creator of the NFT to get a cut of future sales despite selling ownership to someone else, which also allows the NFT to have a clear ownership history. The average cost of creating an NFT ranges from $1 to $500 depending on complexity, and with many of the most expensive NFTs looking like rather simple pieces of art, the cost may not seem too steep. However, the real cost comes in when you have to account for transaction costs. Since most NFTs are built around the popular Ethereum blockchain, which is known to be inefficient, there also comes a transaction cost to successfully give ownership through the blockchain. This cost can add up quickly, and as the price of Ethereum rises, so will the transaction cost.
It is also important to realize that even though some of the NFTs may seem simple to create, they are backed by wealthy and famous benefactors. For example, the Bored Ape Yacht Club NFT collection, one of the most expensive NFT collections in the world, may look like just a simple array of anthropomorphic monkeys in different clothing created by some kid in a basement. In reality, the entire company is owned by multimillionaires with mass public influence, such as Stephen Curry, Mark Cuban and Jimmy Fallon. The walls that stand in the way of creating a successful NFT require large amounts of money and name recognition — things that are almost impossible to the average person. Another demand problem is that NFTs also cause something called “gas wars,” which refer to huge increases in transaction costs when multiple people try to buy the same NFT. This can result in people paying thousands of dollars in transaction costs for an NFT they bid on, which is problematic because people are still required to pay the transaction cost even if they are unable to purchase the NFT. This can result in people paying more in transaction costs than the actual price of the NFT they are trying to acquire. All these hidden costs and pitfalls will not even be attributed to the creator of the NFT, but instead to the owners of these NFT marketplaces.
The real reason that NFTs have grown at such a rapid rate is not because of the intrinsic value that people see in it, or the accessibility of NFTs to the average person. It has been largely due to the hype around the unknown technology and the endorsements from celebrities that has fueled the overvaluation. There are also huge economic incentives by the wealthy to invest in cryptocurrency and NFTs. In current U.S. tax code, a wash sale rule has been implemented to prevent people from using losses on a capital asset to leverage a larger tax cut. However, this rule has yet to be applied in cryptocurrencies, as they are not technically considered stock. Since Bitcoin and other cryptocurrencies have created hundreds of millionaires, people can use this wash sale loophole to transfer over their altcoins into Etherum and buy overvalued NFTs while still being able to take a tax cut. Therefore, those who are wealthy enough to drive up the price of certain NFT collections by buying multiple pieces of the collection at a premium can then market the collection as being on a long-term growth product, in turn attracting other investors.
As seen by the bursting of the dot-com bubble and subsequent stock market crash in 2000, an overhyped evaluation of website-oriented companies can eventually lead to bankruptcy despite a lot of investors. Also evident in the more recent initial coin offering (ICO) bubble in 2017, these bubbles are driven by wealthy investors who are more likely to have already invested and driven up hype in new technologies before public interest peaks. By the time the average person has begun to invest in new technology, wealthy investors have already pulled out and collected their profits.
While NFTs are likely to be important to our emerging virtual economy, the applications for NTFs are far from being properly fleshed out. Right now, NFTs are nothing more than a status symbol without any real intrinsic value. If you don’t already own an NFT, I would suggest to thoroughly research the topic to see who truly benefits from the sale. More often than not, when something seems too good to be true, it is. At the rate that NFTs are growing, it is very unlikely for its market to be sustained. It is also very possible that NFTs are already over the hill in terms of growth. Getting in now could possibly leave you left holding the bag while the people that have sold it to you have already reaped their profits and left you stranded.
This is not financial advice, just a word of caution. If you personally really like an NFT, buy it! Just don’t buy with the expectation it will fund your retirement. If it does, I’ll be happy to be wrong.
Akshay Ma Kumar is a senior majoring in economics.