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The explosion in the value of cryptocurrencies like Bitcoin has had an interesting side effect: Surging demand for NFTs, or non-fungible tokens. Investors everywhere are asking themselves whether owning the digital rights to street art, LeBron James slam dunks or Jack Dorsey’s first tweet can possibly be worth the eye-popping valuations they’re fetching in the market.
From a certain point of view, the value of NFTs is in the eye of the collector. After all, owning a totally unique object—the ultimate criterion for every true collector—may be worth nearly any expense if you want it badly enough.
But let’s say you’re not a collector who absolutely must possess the latest digital art work of Beeple, the artist whose EVERYDAYS NFT fetched $69 million, but rather a humble investor who’s curious about the potential return on investment of NFTs and their FAANG-like growth. The byword is caution.
Think of NFTs like purchasing a vintage sports car or a historic mansion. Without thorough due diligence, it’s very hard to know whether you’re buying a rare item of value or a lemon that will make you deeply regret taking the plunge. To put it another way, it’s very challenging to differentiate between fool’s gold and the real deal, especially when the NFT market is in the throes of a massive bubble.
But not all NFTs are over-inflated bubble assets, and not all assets caught up in a market bubble are bound to be a bust. Take the dot-com bubble. Sure, there were world-famous losers like Webvan and Pet.com, but there were also gems that delivered outstanding long-term value to those who managed to hold on through the storm or to buy cheap at the bottom. Shares of Amazon peaked at $113 in 1999—and after the bubble burst, they plummeted to $5.51 in late 2001. Today, Amazon is trading above $3,000 a share.
Another thing is clear about the NFT market: As the popularity of non-fungible tokens boomed in early 2021, their relative scarcity helped them appear quite valuable. But like the podcast craze before them, just about everyone and their mother is coming out with NFTs now. That’s making it much more difficult to separate tokens with Amazon-like potential from the hucksters peddling yet another dot-com-era disaster.
Given this high level of uncertainty about NFTs valuations, it might be more prudent to take a venture capitalist approach: Don’t buy the flavor of the month; rather hedge your bets and invest in a portfolio of assets—just like VCs investing in a broad selection of promising startups.
Even if you diversify your NFT portfolio by purchasing a variety of tokens, the relatively underdeveloped market may still make it challenging to identify those with long-term growth potential and those that end up as the next Quibi. Given the undeveloped, highly speculative nature of the market, even if you buy many NFTs, it’s best to limit your overall NFT exposure to a relatively small percentage of your total portfolio—and to be prepared to lose most, if not all, of the money you put in.
Perhaps the most reasonable approach to investing in NFTs, then, is not to consider them investments at all, but to buy tokens that are related to your personal interests or hobbies. If you’re a huge Kings of Leon fan, grab up one of the NFTs the band released, including one that offers a set of front-row seats at each tour for life. If you love street art, go forth and collect the hottest new work on Rarible. Own NFTs purely for your own enjoyment, and consider the money spent as a great way to support the artists, players or other creators you care deeply about.
Of course, eventually, the market will separate the wheat from the chaff. And that means that the long-term potential of NFTs is still worth considering. NFTs today are often no more than a digital analog of a real asset. But they could be so much more. Remember newspaper web pages in the early days of the internet? Back in the 1990s, they were nothing more than a delux screenshot of a physical paper, a digital copy of their real-world counterpart.
Fast-forward to today. Technological progress means news websites have far more interactive and programmable features than your regular newspaper. That’s a similar level of potential that many believe NFTs may possess—that they could offer advanced features that aren’t readily apparent to us today.
For instance, we already know the blockchain database technology that powers them creates potential anti-fraud applications. Each NFT has a record of its origin and everyone who’s ever owned it, which will likely make it easier to spot forgeries going forward. In addition, many NFTs are already turning the payment model for art on its head by providing royalties to artists on each future purchase, which means for the first time many creators will directly benefit from the appreciation of their work over time. But these aspects are just the tip of the proverbial iceberg. As our lives become even more digital-first, there’s truly no telling what functionality might emerge that goes well beyond ownership of digital artwork.
Finally, as long as there are people flush with cryptocurrency that is experiencing soaring valuations, it seems obvious that the demand for NFTs will remain elevated. But just like the stock market, it’s not always clear what the correct asset is to buy right now.
Retail investors motivated by FOMO—fear of missing out—are throwing money at every investment they can think of in the hope that it turns out to be the next GameStop, Dogecoin or maybe Rembrandt. This wild market suggests that buying NFTs for short-term gains means leaving yourself vulnerable to strong risks of a market crash.
So avoid getting caught up in the buying frenzy and overpaying for an NFT with few prospects beyond the speculative mania of the moment. And if you really want to buy, treat NFTs as a collectible—just one you can’t really hang on your wall without the help of a nice, big flat-screen monitor.