NFT’s, or non-fungible tokens, are the latest craze in the blockchain mania. NFT’s are a new asset class that has become popular in the past few months because it can represent ownership in collectible items like art, sports clips or memorabilia.

To understand NFT’s it’s worth understanding the name. Non-fungible means that each token is unique and cannot be traded for another token. In the case of Bitcoin or Ethereum, every token is the same and they are interchangeable between each other. My Bitcoin isn’t any different from your Bitcoin.

In fact, the most popular form of NFT’s run on the same Ethereum blockchain that backs the actual crypto currency of that name. These are the ERC-721 standard as well as the ERC-1155 standard. The former was popularized when the online game CryptoKitties went viral using the Ethereum blockchain. NFT’s in this game are used to represent in-game assets and are controlled by the user rather than by the game developer. The novelty to CrytpoKitties is also that you can merge digital assets to form a different asset which may represent a “child” in the video game. Other important characteristics that are noteworthy include:

• Non-interoperable – Remember that these are unique tokens. You can’t use a CryptoKitty character on a different game like CryptoPunk.
• Indivisible – NFT’s cannot be divided into smaller denominations.
• Indestructible – The NFT’s cannot be destroyed, removed or replicated. The ownership is also immutable which means the owner actually possesses NFT’s not the companies that created them. This is different than say, buying a song from the iTunes Store where you don’t actually own what you buy, you are just purchasing the license to listen to the music.
• Verifiable – The historical ownership data is stored which can be traced back to the creator making things verifiable.
• Royalty Potential – One feature that makes NFT’s unique is the potential for the original creator or owner to attach royalties to when the ownership is passed on. This can be a fixed percentage of the value, say 1%. So if I create a song for example and release it only via NFT’s every time someone sells the NFT linked to that song I will receive a 1% royalty on the sale. This is where the potential for artists is attractive as it lets them create a theoretical stream of income from their work.

Applications

I like the analogy of NFT’s being like concert tickets. Each has a unique identifier yet represents something that has value. Another is to think of NFT’s as a digital baseball card or Magic the Gathering digital card, if you are old enough to remember those. They can be traded amongst enthusiasts and based on how rare they are and their following, can increase in value. Are you starting to see where this could go?

William Shatner, the iconic actor of Star Trek fame released 125,000 NFT’s last July which were linked to digital memorabilia of his including photos of him with actor Leonard Nimoy and and an x-ray of his teeth. The batch of NFT’s sold out in 9 minutes. If it’s true that they sold for $1 each, then this was an issuance that quickly netted the star $125,000.

A number of enthusiasts have delved into the crypto memorabilia space and have dabbled in everything from cards of famous soccer players to digital race cars in video games. As momentum and visibility of NFT’s increase, the prices of these assets is rising.

Take for example the case of a mysterious crypto collectible buyer named Mr. Karrupu described in this omr.com article. All that is known about Mr. Karrupu is that he is a a tech enthusiast who clearly has a lot of cash and has been outbidding a number of others to acquire fantasy soccer sports cards as well as digital sports cars in the game F1 Delta Time, one of which he bid up to EUR 64,000.

Buyer or Issuer?

Besides being a new stream of income for celebrities as well as an asset for speculation of collectors, artists can easily issue their own unique NFT’s linked to their work and then receive royalties from it.

An article by digital artists and professor Anne Spalter describes the process here. She describes the process as follows:

Join me by doing the following: open an account on Coinbase (or another exchange of your choice), link your bank and transfer in at least $100 in funds. Convert it to ethereum. Open a Metamask account, copy the address from it and go back to Coinbase. Transfer your ethereum to your Metamask wallet. You are now ready to create a piece of crypto art……..Once you “mint” a piece – the NFT word for adding it to the blockchain – anyone can see the work (imagine Instagram but with purchasing capabilities). But although anyone can see the piece and link to it or even download it, it is only owned by one person at a time. Its blockchain instantiation is an un-misplace-able certificate of authenticity. This ownership, the purchase price and any subsequent owners and acquisition prices are visible and travel with the piece. This contributes to a level of market transparency that has never existed in the traditional art world.

I think this is a great opportunity for artists and many of them are right to jump on the trend but just like anything else, corporate America has seen this trend coming for some time and jumped on it.

Nike has created official NFT’s linked to shoes, sports card company Topps has brought back not only sports cards but mainstays of the 80’s and 90’s collectible universe with digital recreations of the Garbage Pail Kids and KOG’s similar to the 90’s collectibles POGs and which will be used across a number of different digital games.

We are just starting to see the tip of the iceberg in crypto collectibles and I anticipate many more items, both digital and real being linked to crypto in the coming months.

Risks for Investors

NFT’s right now have some echos of the first time cryptocurrencies got hot. In 2017, a number of celebrities including DJ Khaled and Floyd Mayweather listed their own cryptocurrencies linked to nothing other than….well nothing. It was a blatant scheme to just steal cash from unsuspecting retail investors and the SEC eventually made these celebs give back the money and pay penalties.

But just like I have been saying that the stock market now is looking very similar to the bubble we saw in the late 1990’s along with that bubble came a parallel bubble in collectables which I was also caught up in.

At that time, sports cards were very hot and many of the NFT’s being issued are following the same model of selling sports card by selling bundles or “packs” of NFT’s at a time and hoping collectors start to gravitate towards a few of them and bidding the price up. At the time you could find shops that would specialize in selling sports cards all over the US as the shops became de facto brokers in the sports card market, building up an investor of cards and selling them to collectors (mostly kids like me) for a profit.

Despite the ethical issues I see now when I look back on it as this being a way of getting around the law to take money from unwitting children, it very clear that the sports card bubble was highly correlated with the stock bubble. Once the bubble burst around the year 2000 in stocks, sports cards were no longer fashionable. Collectors realized that the manufactures had been essentially diluting the value of their own brand by printing ever more fancy cardboard cards and selling them.

Many of us who collected at that time stashed out cards away in the hopes that they would later be valuable. My niche was basketball. I recall checking the value of my prized possession, a mint condition Kevin Garnett rookie card in the mid 2000’s and was disappointed to see the card selling for as little as $10. I was surprised to see it on sale recently in mint condition on E-Bay now going for $1,800.

The point of this is not to show off my gains but rather to highlight that collectibles remain a highly correlated asset to the bubble of the stock market just like sneakers, Bitcoin and NFT’s currently are.

The risks are much the same that I described in the high end art market analysis I featured in my review of masterworks mainly:

• High Correlation to the Stock Market – Beware for when the bubble bursts, you will want to offload these assets as quick as possible and may not be able to because…
• Illiquidity – When you try to get rid of stocks, at least you know you can get rid of them quickly, but what about a signed Tom Brady helmet? It’s tough to say that the item could be monetized quickly especially if it isn’t linked to someone famous like Tom Brady.
• Price Transparency – One of the go to resources in the 90’s for sports cards was Beckett’s Price Guide, which can be found in its current digital form here. It was an open secret though that the publisher was probably manipulating prices himself. It’s too easy for someone with this type of market power to build up his own investors and pump it up via their own guide. You should be looking at every celebrity and online guru in this way who is pumping NFT’s. It’s very possible they are just hyping up certain digital assets to potentially offload them to the unwitting masses.

If I can make a bit of money as kid then surely others can do it as adults investing through NFT’s. As always, the key is to understand the type of risks you will be taking when going into this space. We are still in the early stage and the Wild West of NFT’s which offers many entry points. Although newly novel for artists, overall it remains a speculative market similar to high end art or Bitcoin carrying a lot of risks with likely very high correlation to the stock market. If you are a collector, you have a new method to verify your most treat sites items. If you are a speculator, it’s yet another avenue to get potentially burned by insiders.

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