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What are NFTs? Why investors are spending millions on digital art you can view online for free

"I've seen folks asking whether this is historical or hysterical. I think it's likely a bit of both."

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Owning a small piece of the internet has gotten expensive of late. Last week, a video clip featuring former president Donald Trump by digital artist Beeple sold for $6.6 million.

A digital rendition of the popular Nyan Cat meme fetched $590,000. And a six-second clip of LeBron making one of his more dazzling plays sold for $207,000.

All of these sales are part of an explosion in demand among investors for digital collectibles known as non-fungible tokens, or NFTs, which use technology related to cryptocurrency to allow investors to purchase "original" versions of things you see on the internet.

If you're wondering why someone would pay an astronomical price tag for something they could find elsewhere online for free, you're not alone. The flurry of trades in digital collectibles has many experts wondering if this is just another speculative melt-up, akin to the recent frenzies surrounding meme stocks and cryptocurrencies.

But NFTs begin to make more sense as collectibles that could potentially grow in value over time in a world that is shifting increasingly online. "I've seen folks asking whether this is historical or hysterical," says Richard Smith, CEO of the Foundation for the Study of Cycles. "I think it's likely a bit of both."

What are NFTs?

A non-fungible token is a digital asset that's like a one-of-a-kind piece of internet real estate. Unlike other online property, which can be modified or reproduced, NFTs utilize blockchain technology (which you can think of as an official, unalterable internet ledger) to track ownership and to ensure that each piece of content is verifiably unique and indivisible.

Non-fungible means that one NFT can't be exchanged for another, unlike, say, a gold bar or a $20 bill. An NFT is like your mint-condition Princess Diana-edition Beanie Baby: You wouldn't exchange it for any old stuffed animal. But unlike a physical toy, your NFT lives online, so it won't degrade like your Diana bear might have, had you stored it in your mom's basement for the past couple of decades.

What kinds of NFTs are there?

NFTs take many different forms. So far, the most popular NFTs have been images and videos. One of the earliest NFT marketplaces, CryptoKitties, allows users to buy and sell images of unique virtual cats. Traders have also bid up the prices of CryptoPunks, distinct online avatars, the most expensive of which sold for more than $1.5 million in late February, according to the website CryptoSlam.

One major application: digital art. Digital art creators are able to use the technology to retain ownership of their work online because blockchain designates a particular piece as the digital "original."

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Another work by Beeple, entitled "Everydays: The First 5000 Days," is up for auction at Christie's through March 11. The current bid: $3.5 million.

Sports fans are getting in on the action. The most popular platform, NBA Top Shots, allows users to buy and sell videos of highlights from NBA games. Users have shelled out $243 million on what amounts to virtual basketball trading cards in the last month alone.

Your favorite musical artist may soon offer an NFT, too. Rock band Kings of Leon announced this week that they'll offer their latest album as an NFT, making it one of the first bands to do so. Proponents say NFTs may allow musicians to profit more directly from their music, rather than having to rely on meager royalties from streaming services or (in recent times) depressed income from live shows.

What makes some NFTs so valuable?

Unlike issuers of stocks or bonds, NFTs don't generate any earnings or cash flows. You won't earn a royalty for owning an NFT, either — you can go watch NyanCat on YouTube for 10 hours straight without paying a dime to the meme's new owner. Rather, like much of the art market, an NFT's value is driven purely by investor demand.

The demand driving the boom in NFT prices comes down to a few key factors, experts say.

For one, current market conditions have encouraged the "greater fool" theory that has taken hold among investors in recent months, says Smith. This refers to investors piling into everything from so-called "meme stocks" to dogecoin on faith that these investments will go up, and that there will always be another buyer willing to pay a higher price. "There's a good indication that there is a lot of speculative excess at work here," he says. "There's been a pretty big disconnect between prices and fundamentals."

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But while some buyers are hoping to turn around and sell their NFTs to make a quick profit, others see the value in holding a rare digital collectible, says Brady Dale, a senior reporter at cryptocurrency site Coindesk. "Everyone knows Ansel Adams. He sold his photos in galleries and did limited runs," he says. "We all agree that the ones printed by his hands are worth more than the posters with the same image hanging in college dorms. NFTs are the same thing."

A similar principle applies to the videos distributed by NBA Top Shots. The NBA licenses video clips to Top Shots parent company Dapper Labs, which distributes slickly produced highlights in limited batches. Think of it as a trading card for the new generation of collectors.

"The young people getting into these are digital natives," says Dale. "They don't want to trade in cardboard. They live online and like the idea of collectibles online, especially since, in this case, you can prove the scarcity of certain highlights."

Are NFTs worth investing in?

If you're looking to get into NFTs to turn a profit, you may have trouble getting your money in and out. For now, most NFTs are tied to the Ethereum blockchain, meaning you'll have to use the associated cryptocurrency, ether, to pay. "Getting into the NFT market with Ethereum is going to be daunting for most people," says Dale. "Even if the NFT is inexpensive, you're still likely to pay $20 to $100 in transaction fees to make the purchase go through."

You can buy ether through exchanges such as Coinbase and Bitstamp, at which point you'll want to store your coins in a digital wallet.

The young people getting into these are digital natives. They don't want to trade in cardboard. They live online and like the idea of collectibles online.
Brady Dale
senior reporter, Coindesk

The more fan-friendly NBA Top Shots will let you fund your Dapper account with your credit or debit card, but users that have turned a profit have reported issues when it came time to withdraw profits they'd earned.

If you can get past the mechanics of buying and selling, you then have to weigh the risks of investing in a speculative asset, says Smith. "Just because there's market hysteria going on doesn't mean you shouldn't take part in this space," he says. "You just do it with money you can afford to forget about for five years."

In other words, don't invest any money in NFTs that you wouldn't be comfortable gambling with. As Smith points out, a gamble can pay off big: "Look at bitcoin. Five years ago it was trading in the low 400s. If you had $10,000 in play money back then, it'd be worth $1 million today."

But just because a speculative bet can pay off big, doesn't mean it will, Smith adds. "You need to be thinking, 'My life isn't going to change if this goes down 90% and doesn't come back for five years, or ever,'" he says. "That's the nature of speculation."

And if you're buying art hoping it will appreciate in value over time, make sure you, well, appreciate it yourself, says Dale. "If you're buying digital art as an investment, the principle needs to be that you're buying things because you actually like them," he says. "Otherwise, it's probably not worth it to get involved."

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