Are NFTs Worth The Hype? Important Questions To Consider Before Buying

An artist from Wisconsin known as Beeple made international news this year when a piece of his digital artwork sold for $69.3 million at Christie’s, a record-breaking amount paid in a new category of assets called nonfungible tokens (NFTs). Immediately afterward, you could almost hear millions of people around the world simultaneously Googling, “What is an NFT?”

Like most stories related to blockchain or cryptocurrency, this one seemed to bring up more questions than answers. What do NFTs actually do? If you buy one, what exactly do you get, and what is it worth? What are the pros and cons?

This is an emerging technology, and I’ve been asking the same questions myself as I learn more. I’ve put together a basic guide to NFTs from a consumer perspective: what the tech does, how NFTs can be used, and important issues to consider before purchasing.

What Is An NFT? How Is It Used?

Perhaps you were skeptical about bitcoin a decade ago, but now it's worth close to $60,000, and you’re looking at NFTs in a different light. Are NFTs similar to bitcoin? Will NFTs appreciate similarly? Short answers: Not exactly, and no one knows for sure.

A nonfungible token is a cryptographic asset verified using blockchain technology. It represents proof of ownership and authenticity of a digital item — such as a piece of art, music, or literature. Most NFTs are bought and sold with the cryptocurrency Ethereum. “Nonfungible” means that something is unique and can’t be exchanged for something else. Bitcoin, on the other hand, is fungible. You can swap one bitcoin for another with no difference.

NFTs are catching the interest of creators and collectors alike. Musicians, artists, writers, and other creators can sell their work embedded with a unique digital signature that verifies a work’s legitimacy and increases its value for buyers.

NFTs may play an important role in the future of publishing, music, and art. For example, a digital-first edition of a new book from a respected author might be enticing to a literary audience. The publisher could produce subsequent editions, but only the first 10,000 copies would be designated as a first edition by individual NFTs. Musicians are already starting to adopt this strategy. The band Kings of Leon released its new album in March as two types of NFT: one as a deluxe version of the album available for a limited time, and the other as six “golden tickets” that give each owner lifetime access to front-row concert seats.

Potential Issues To Consider

NFTs are still a relatively new type of asset and could introduce unexpected challenges for buyers. Here are just a few issues to be aware of and investigate further before purchasing NFTs.

• There is a limited number of blockchains on which NFTs are currently sold and transferred.
• Artists have intellectual property rights, and sellers and purchasers have rights related to the specific NFTs they own. If someone utilizes your certified NFT, then they may owe you licensing fees.
• Fraud can occur. Anyone could take a photo of an image, put it on a blockchain and sell it. Confirm that you’re buying from the artist or that the seller has the rights to sell the NFT.
• An NFT contains a smart contract — a self-executing contract with the terms of the buyer-seller agreement written into code and stored on a blockchain. Ensure that you’ve captured all of the goals of a self-executing contract and you know what you’re providing in exchange for monetary or non-monetary value. Have you properly obtained your side of the value, and can you prove that you have the rights to it? If you have multiple copyright rights to something, how do you address that?
• The value of your purchase has the potential for dilution, depending on how many times the artist will sell that work. In the contract, define the value of what you are buying and if that changes whether you buy one of the first 10 in a series or the 50th.
• If you purchase a piece of collateral or property, you need to know its value and include it in your tax returns (and potentially your insurance policy). Laws, IRS guidelines, and insurance policies are constantly changing as this new asset class evolves, and they may not agree with you on the value of your NFT.
• Ethereum is one of the world’s most energy-intensive blockchains and brings up environmental concerns. Consider the different factors that contribute to the carbon footprint of NFTs to see if the advantages outweigh the disadvantages.

Questions To Ask

If you’re thinking about buying NFTs, use these questions as a starting point to see if your potential investment is worthwhile:

• What are you getting?
• What can you do with it?
• What rights go with it?
• Do you get copyright?
• Do you get a licensing opportunity? Does that stay with the artist?
• Can you negotiate those terms?
• Is there a limitation on how many times it can be sold?
• If it's a limited production, then where are you within that production structure?
• Once you own it, can you use it as collateral with a lender? If so, what are the potential issues with confirming valuation or filing under UCC Article 9? Will the value change over time??
• What are your legal rights outlined in the smart contract? How can you protect your rights if, for example, someone fraudulently tries to sell your asset and claims ownership rights?
• If you transfer the NFT, what's the cost? Can you renegotiate? If the value decreases, do you have any recourse against the original party that sold you the asset?

NFTs may be a flash in the pan or they may fundamentally change the way we buy and sell creative work. It’s too early to know, but before you jump in headfirst, do your due diligence. Understand what you’re buying as well as the potential risks and rewards.?

This article originally appeared in Forbes on April 26, 2021.