Interest in non-fungible tokens, commonly referred to as NFTs, reached an all-time high over the past year. NFTs are commonly produced from digital art, collectibles, fantasy and esports, static images, memes, video clips, audio files, and a growing number of other media. These use cases are trendy and potentially lucrative, luring many celebrities and social media influencers into minting, investing, and promoting NFTs on their social media feeds. Bored Ape Yacht Club’s owners include Snoop Dogg, Tom Brady, Shaquille O’Neal, Serena Williams, Justin Bieber, and Kevin Hart, to mention but a few. This interest among athletes and A-listers also added fuel to the spark of interest among both institutional and retail investors.
NFTs As A Risky Investment Trend – What Investors Should Know
their viral reputation as their artistic content. It’s a fickle market, and value can skyrocket and bottom out within days. Non-high net-worth individuals considering a plunge into NFT investing should note that information on NFTs circulates very differently from that of stocks. One can learn about stocks through market research, brokerage firms, and overall industry trends. Unlike stocks, however, public understanding of NFTs is based largely on social media posts, trends, and word of mouth. Not all of it is reliable, and it is often unevenly distributed and incomplete.
Additionally, because the NFT market is so new, some financial advisors have cautioned their clients to steer clear of NFT investing altogether. Some suggest purchasing NFTs for fun only, rather than their appreciation potential. In other words, don’t bet the house or the kids’ college fund on a flying cat or an ennui-plagued primate. NFTs should not be relied upon for passive income or building retirement funds. Many financial strategists recommend diverse investment portfolios that allocate less than 5% in total to NFTs and never let that investment get in the way of other long-term financial goals.
Best Practices for Investing in NFTs
If you decide that the potential reward is worth the risk, here are some best practices for NFT investments.
- Conduct Your Own Research: Thoroughly research the NFT investments that you are interested in. Research their team, trade history, set up, execution, social engagement numbers, artwork, originality, and rarities to best make informed decisions. See here for an excellent Twitter post on the topic.
- Carefully Vet the Seller: Be sure to perform background research on the person or organization offering the NFT for sale.This is crucial because many celebrities and NFT creators have attracted impersonators who try to sell fake NFTs. Indeed, numerous celebrities and NFT creators have participated in NFT projects that turned out to be complete scams. Learn as much as you can about the seller as humanly possible. Search OpenSea, Foundation, or Rarible, which are the most common NFT markets. Other niche marketplaces exist that specialize in specific types of assets. Also, research niche marketplaces that specialize in the type of NFT that you are interested in.
- Mind the Middle Ground: High-visibility NFT projects are often expensive, inaccessible, and overpriced. Low-end projects are much easier to get into but have limited traction or potential for financial gains. It is best to mind the middle ground when it comes to investing in NFTs.
- Create a Digital Wallet: This is a place where you can ‘store’ your NFTs and cryptocurrency tokens. Various types of cryptowallets exist, but arguably the best method of storage is to spread your crypto assets across different types.
- Fund Your Account: You will need to connect your bank account or credit card to an exchange to purchase or trade cryptocurrencies. Know Your Customer (KYC) and Anti-money Laundering (AML) requirements vary from jurisdiction to jurisdiction, and this may include an identity verification process. Always protect yourself by correctly completing the identity verification process.
- Negotiate Terms:Depending on what’s being sold, deals could include upfront payouts or a royalty on all future sales.
- Guard Against Theft and Fraud: Because crypto is difficult to trace, has no central controlling authority, and is internationally accessible, there are potentially large security risks involving user’s data, crypto, and passwords. Even cash transactions can be compromised. Purchasing cyber liability insurance is one expensive option to minimize theft and fraud. Other ways to prevent theft and fraud include common-sense strategies such as using strong and unique passwords, never (ever!) sharing your keys, avoiding public networks and WIFI, using crypto hardware wallets, and not storing anything in the cloud. Another key point is to review and validate every app and crypto exchange you use for security features and reputation.
- Do Not Infringe on Intellectual Property Rights: Remember that the original NFT creators typically retain the copyright. Thus, buyers and investors own only the specific digital/physical copy that they purchased and the right to display depictions of that copy, unless a creative commons license applies or there is an express transfer of the underlying ownership in the terms and conditions governing the NFT. Intellectual property rights can get complicated. If you are specifically seeking intellectual property rights, you should consult with an attorney who can provide reliable advice.
- Consider the Tax Implications: The IRS currently views crypto tokens as property and not currency, but one thing is clear: NFTs are subject to capital gains tax. But they may not receive the preferential long-term capital gains rates that stocks enjoy. NFTs may even be taxed at a higher collectibles tax rate.
- Consult Experts: Always engage an attorney, accountant, or financial planner to assist in understanding both the short-term and long-term risk and impact of your NFT investments. Gamma Law, a San Francisco-based law firm, has been at the forefront of blockchain, cryptocurrency, and NFT market trends. Gamma Law attorneys specialize in providing sound legal advice for NFT investments.
Despite the popularity of NFT investing, tokens remain, overall, a volatile asset class and are often saddled with high mark-ups, brokerage charges, and other fees. Still, many high-net-worth investors are willing to take the financial risk associated with investing in NFTs. According to a recent worldwide poll conducted by DeVere, out of 450 clients, 26 percent reported the desire to add NFT investments to their portfolios by the end of the 2022 fiscal year. However, as crypto investor Sina Estavi recently discovered, high-value NFTs don’t always maintain their value. In 2021, Estavi bought the NFT of Jack Dorsey’s first tweet for $2.9 million; when he listed it for sale in April 2022, bids failed to reach $14,000. The moral of the story: investors should prepare themselves for the possibility they will lose money invested in NFTs.
If you are considering investing in NFTs, it is wise to consult an attorney experienced in the space to understand how the discussion above may impact you and your investments.
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