The NFT market – The future of trading and collecting

In today’s day and age, digital trading is everywhere. Cryptocurrencies are being mined daily, blockchains and secured wallets are being generated and released left and right. The new trend that has caught the eye of investors is the nonfungible token (NFT) market.

NFTs are digital records of proof that represent all types of creations, including popular memes, famous tweets, master recordings, unique artwork, and even GIFs of NBA’s greatest buzzer-beaters. When an investor buys their chosen digital asset, they are given a NFT that, essentially, provides a certificate of ownership and authentication that says that asset belongs to them now and that it is the original version. The NFT resides on a blockchain, which is an immutable digital ledger. It handles the tracking and management of individual NFTs and protects and authenticates each token. If the NFT owner decides they no longer want that asset, they can sell it to someone else and so on, with every transaction recorded in the blockchain along the way. The emerging market provides seemingly endless opportunities. Like any new “trend,” there are advantages and risks to be considered.

Advantages

Let’s start with some of the advantages that NFT trading has to offer. NFTs can represent a large variety of options, which may appeal to a wide population of investors. By investing, one has the opportunity to not only diversify their portfolio, but to collect and own unique items which can be authenticated and resold.

One of the major advantages that NFTs offer is the potential for collecting. Similar to buying antique cars or Beanie Babies, the market for NFTs can provide individuals a place to collect and trade unique items that may appreciate wildly over time. The NFT market is potentially a massive opportunity to digitally collect and trade in a world that continues to trend toward the digitization of all things.

Another advantage of trading within a blockchain is that each individual token carries a unique identification number which is virtually impossible to duplicate. These security measures provide additional assurances to investors that the tokens they purchase are, in fact, one of a kind.

The NFT market carries a lot of intrigue and potential; however, it is important to emphasize the NFT market is still in the early stages of its development.

Risks and challenges

One of the major challenges facing the NFT market is the lack of a centralized marketplace and a specified blockchain in which all NFTs are handled. Currently, NFTs rely heavily on the blockchain Ethereum, which has its own native currency, Ether, and enables smart contract technology. However, the growing interest in the NFT market has led to increasingly slow handling speeds and higher transaction costs due to the additional usage. As noted by Bloomberg Law, the NFT market has jumped from about $41 million in 2018 to around $338 million as of 2020, representing a significant increase in trading and demand. Ethereum recently mentioned potential network upgrades; however, competitors in the blockchain market have begun to scale up their efforts to potentially become the primary network for selling and trading NFTs. This competition adds another level of complexity to the growing market.

Another major challenge related to the additional competition is that for each blockchain in the NFT market, there will be an individual and specialized “wallet” to be maintained by the holder. Once purchased, the investors hold the ownership rights to the NFT which means they can resell the NFT at any time. The issue that arises is that if an individual holder invests in an NFT that was created on the Ethereum blockchain, then the NFT will require an Ethereum wallet. If the same holder then invests in an NFT that was held on a competitors blockchain such as Near or Flow, then the holder will also require a wallet specific to the Near or Flow blockchain. This would create multiple layers that could confuse or overwhelm holders in the market. The potential risk is that as the market expands and additional competitors are introduced, the complexity and level of expertise needed to manage NFTs and wallets will increase.

One must also consider the potential for fraud or misuse of the blockchain due to the complexity mentioned above and lack of enforced regulations. It was previously mentioned that one of the major benefits of trading NFTs on a blockchain is that it is easy to authenticate and incredibly difficult to duplicate unique NFTs, which reduces the risk of fraudulent activity. (Note, there is an issue with originators versus creators of NFTs, what is fraudulent versus a new art piece, and clarifications are needed to determine who has the right to the content creating the NFT itself. Fraudulent activity within the creation of NFTs could be an intense issue in the coming years.) The blockchain network is still only as effective as you make it. Passwords are available and private identifiers can be used, but if either of those are misplaced or forgotten then the asset held will be lost. There is no way to reset these items. The password or private identifier can also be hacked. If either situation occurs, the digital item will be completely lost and will not be able to be retrieved. This risk emphasizes the importance of security measures and potential regulations that need to be implemented and enforced in the future to ensure the stability of the usage of NFTs on the blockchain. It is important to note that to date, no U.S. regulator has formally asserted jurisdiction over NFTs. Multiple departments have considerations in place over digital assets, but NFT trading is not directly addressed. It is expected the regulating boards will ramp up discussions surrounding NFT trading with the growth of the market. In the meantime, the lack of regulations remains a significant risk to be considered while making NFT-related decisions.

Like any new investment opportunity, there are plenty of risks to consider. The hope is that as the marketplace and demand continues to develop for NFTs, solutions for the above risks will be implemented to minimize them. Making the market more secure should highlight the untapped potential that many believe NFTs hold and bring even more investors into the mix. Even without those changes, it looks like NFT trading may just be the next big thing in investing.

For additional detail and considerations, see the below articles published by Business Insider & Bloomberg Law:

https://www.businessinsider.com/what-are-risks-of-investing-in-nft-2021-3

https://news.bloomberglaw.com/banking-law/nfts-are-hot-but-patchwork-of-laws-rules-needs-watching

For more information on this topic, or to learn how Baker Tilly specialists can help