This article is part of Fortune‘s quarterly investment guide for Q2 2021.
It was the gavel smack heard round the world: Mike Winkelmann made waves in February when he sold, through Christie’s auction house, a gargantuan collage of frequently crass computer-crafted sketches for $69.3 million. The moment signaled the apex of a digital collectible craze. On the auction block were non-fungible tokens, or NFTs, coded references to one-of-a-kind virtual goods that are logged on a blockchain, the distributed accounting ledger that underpins cryptocurrencies such as Bitcoin and, more often, in this case, Ethereum.
NFT mania crescendoed over the past year, like the buildup to an EDM drop, as prices of the cryptocurrencies to which they’re tied soared. Winkelmann, who goes by the alias Beeple, or sometimes Beeple Crap, represents the apotheosis of the trend, but there are plenty other examples of unbridled exuberance. Musical artists ranging from the rock band Kings of Leon to the R&B pop star the Weeknd have sold limited-edition audio tracks for millions of dollars. New York Times columnist Kevin Roose pawned off an op-ed for $804,354.50. Jack Dorsey, Twitter’s founder and chief executive, hocked his first-ever tweet—“just setting up my twttr”—for $2.9 million. (Some of them donated the proceeds to charity.)
Clearly, people can make money selling NFTs. Winklemann, the world’s highest-grossing so-called crypto artist, has off-loaded $115 million worth of works to date, despite self-deprecating disclaimers that “I suck ass.” Meanwhile, Cuy Sheffield, head of crypto at Visa, the payments giant, argues that NFTs present a significant wealth-building opportunity for historically disadvantaged groups. He writes that the advent of the technology “is one of the most exciting new avenues that could spur a Black Digital Renaissance that would create and capture billions of dollars of value for Black communities across the world over the next decade.”
Is this all just a flash in the pan? A cash grab? Or is the world’s sudden infatuation with artsy crypto tokens an early glimpse of fortunes to be made? One must naturally wonder: Can people make money by investing in NFTs?
What is an NFT?
First, people ought to know what they’re really buying.
An NFT is a reference to a given work, not the work itself. Consider the token as a sort of blockchain-based certificate of authenticity, a kind of tradable file representing a global bibliographic entry. Cameron Hejazi, the chief executive and cofounder of Cent, a marketplace for “NFTweets,” compares these items to “the digital analog of the signed baseball card, just for digital content.” Of course, the card is virtual in this case—a string of numbers and letters, a computer coded allusion to something else, whether that be artwork, virtual real estate, tweets, or even, apparently, farts.
If that all sounds like Byzantine vaporware to you, you’re not exactly wrong. Sam Williams, the chief executive and cofounder of Arweave, a project that aims to offer unlimited, permanent digital storage, warns that original pieces of art can vanish from the Internet if not properly secured. That’s already happened to some NFT-linked wares, at least temporarily, such as a video of a spear-wielding, planet-size baby angel created by Grimes, the eccentric singer-songwriter.
Technology aside, NFTs can be thought of financially as collectibles. Advisers call them “alternative investments,” in the sense that they are nonstandard. Experts generally do not recommend them as one’s first line of defense in preparing for retirement. (They tend to recommend stashing the bulk of one’s wealth funds in low-fee, index-tracking exchange-traded funds, or ETFs.)
Nevertheless, some well-to-do people do diversify their portfolios by collecting things such as fine art, fancy cars, premier wines, and other rarities. Other people hoard coins, baseball cards, comic books, etcetera. Often these people are guided by passion, rather than lucre. In that sense, NFTs are to the Internet what postage stamps are to philately in the physical world.
Collectibles don’t always pan out, of course. (Remember Pogs? Beanie Babies?) And how NFTs shake out monetarily in the years ahead is anyone’s guess.
Most people assume some titanic, towering works, represented as NFTs, will account for the vast majority of wealth at the top of the food chain, while a seemingly endless amount of shlock churns beneath. “From tweets to GIFs to video highlights, people may soon discover there is an infinite supply of limited editions, and only a few of these may stand the test of time,” writes Paul Brody, the global blockchain leader at consultancy EY. Still, he believes in the technology behind them over the long haul. Imagine, he says, if access to scarce resources, such as MRI machines, construction equipment, or even payment invoices, was more efficient through NFTs, he says, calling the tech “an essential economic infrastructure with a bright future.”
“While the hype may dissipate in the short term, the technology’s going to be around long term, and the markets will only continue to grow over a long enough time horizon,” says Jesse Walden, founder of Variant Fund, a crypto-focused investment outfit with a special interest in NFT works. Indeed, the market is already showing signs of a drawdown. Yet true crypto bulls might counter that post-mania hangovers are the perfect time to invest, when other people are less interested, and pieces become more affordable.
Just look at what happened in the schizophrenic market for cryptocurrencies such as Bitcoin and Ethereum, after all. Their value lagged for years before rocketing back up to all-time highs recently.
Risk vs. reward
Investing in NFTs is an activity fraught with risk—yet possible opportunity—for the savviest people. But there are hidden costs to consider.
Speculators, beware. A given NFT could run up much more than the listed price because of so-called gas fees, the transaction costs on the Ethereum network, the blockchain system to which most NFTs are tied. You might end up paying hundreds of dollars more than you imagined. (Ethereum is planning to deploy technological upgrades that will reduce the transaction fees in time to come, while other blockchains, like Tezos or EOS, pride themselves on offering cheaper transactional systems.)
Also, there are taxes. Michael Meisler, who leads EY’s cryptocurrency tax center, says that if you quickly flip an NFT, you’ll pay a price. Selling an NFT within a year of purchase likely causes short-term capital gains taxes to kick in, “which max out at ordinary rates of 37%, effectively,” he says. The outcome isn’t much better for long-term holdings. Because today most NFTs are likely classified as collectibles, they get treated specially with a higher-than-normal long-term capital gains rate. Instead of maxing out at 20%, as is the case with stock sales, “you would now have a rate of 28%.”
“There’s no clear guidance on this, but when I look at the facts and circumstances behind an NFT that is sold in an auction house, it suggests that the IRS would assert that it is in fact a collectible, as in, under the definition of a work of art,” Meisler says, noting that this legal distinction entails higher tax rates. But the matter is hardly settled: NFTs representing virtual real estate, or other digital goods, on the other hand, remain an open question.
“I think you almost have to look at the token, look at that digital asset, and almost look through it to see what does it actually represent an interest in, in order to figure out what the appropriate tax treatment might be,” Meisler says.
Some people taking the earliest, most creative approaches to this far-out frontier of investing are turning it into a team sport.
Anand Venkateswaran, an Indian cryptocurrency investor who goes by the online alias Twobadour Paanar, is one of the partners of Metapurse, a fund that specializes in collecting NFTs. Before placing the winning bid on Beeple’s priciest monstrosity, Everydays: The First 5000 Days, Venkateswaran and his partner, Vignesh Sundaresan, who goes by the nickname MetaKovan, laid out millions for other Beeple works. The pair then bundled their haul together with other digital goodies—virtual real estate in video games like Decentraland, techno-tunes by DJ 3LAU—and sold fractionalized shares of the ensemble to the public as yet more tokens. (You can visit parts of that bundle, virtually, here.)
Despite spending lavishly on their immaterial trophies, Metapurse’s so-called B.20 tokens—named after The Beeple 20 Collection it purchased for $2.2 million in December—yielded a tidy profit. The fund created 10 million fractional tokens, reserving a little more than half the supply for itself, setting aside about a quarter portion for collaborators and others, and selling the rest to the public for $0.36 a pop. The price has increased to about $5 today (once reaching a high of just over $27). On paper, that’s a 1,300% markup.
Metapurse claims that it doesn’t expect a financial return from its endeavors. On its website, the fund says that “ROI”—or return on investment—”is not the primary driver of this fund.” It further claims the fund “is unencumbered by the need to flex or to create a financial legacy.”
Venkateswaran, for his part, cautions novices that making money on NFTs “is very difficult. It’s not cut-and-dried. It’s not like you look at an NFT and go, Okay, this one’s gonna make me money, or this one will gain me wealth.” But for those who have an interest, he advises, “the more eclectic your collection is, I think, the better it is.”
All that emphasis on dabbling in NFTs for the love of the game, rather than for the potential upside, may be a tactical choice. If you’re buying and selling fractional shares of NFTs, you could run afoul of securities laws, at least in the U.S. Hester Peirce, the crypto-friendliest regulator on the U.S. Securities and Exchange Commission, warned recently that tokenized shares of NFTs could qualify as unregistered securities, making them illegal under current guidelines. “You better be careful that you’re not creating something that’s an investment product, that’s a security,” she said.
Should you bet on NFTs?
If you think you’ve got an eye for masterpieces unlike anyone else, go ahead and consider starting an NFT portfolio.
Coinbase’s president, Emilie Choi, recently told Fortune that the cryptocurrency industry is “not for the faint of heart,” and her words may ring even truer when it comes to NFTs. Nevertheless, you could attempt to be like an athletics talent scout, trying to identify the next Michael Jordan, and buying that athlete’s early moments—in this case, maybe, as NBA Top Shots—before anyone realizes that person is going to be a star. Or perhaps you could consider yourself a virtual land speculator, like an online version of John Jacob Astor, the early 19th-century American immigrant who became filthy rich by buying up land on Manhattan island. To succeed, you need a keener eye than just about anyone else, a rare talent for spotting trends, and unfathomable loads of luck.
Here are some basic directions on how to get started. First, download MetaMask, a popular digital wallet, as a web browser extension or smartphone app. Next, load up some Ethereum, which you can buy through MetaMask, or transfer some cryptocurrency over from an online exchange, such as Coinbase, Kraken, or Gemini. Then visit an NFT marketplace, like OpenSea, Nifty Gateway, or SuperRare, peruse the inventory, and consider making a purchase. To see a running leaderboard—a list of the top people buying or selling NFTs—you can visit cryptoart.io, a site that aggregates data on the biggest sales, or nonfungible.com, another market tracker.
It’s best to assume the odds are stacked against you as a budding NFT investor—you might have better luck teaming up with like-minded individuals. Either way, it’s most advisable to participate merely as a hobby, using dispensable cash only. NFT collecting ought, at this early stage, to be more prudently considered as spending—supporting your favorite artists, showing off your aesthetic taste—versus investing.
A piece of advice: Don’t overestimate your skills. “The NFT movement is a cultural renaissance. It’s driven by artists. It’s driven by creators. It’s driven by gamers, and so on,” Metapurse’s Venkateswaran says. “Unless you’re comfortable in their company, unless you’re comfortable in their world, you’re going to find it very difficult to pick the right NFTs to back.”
An age-old adage advises people to sell pickaxes—not buy them—during a gold rush. Maybe the same holds true of pixels.
Explore Fortune’s Q2 investment guide:
- 10 stocks fund manager Cathie Wood is buying—and 3 she’s avoiding
- Bitcoin investors: Learn about the Hunt brothers and the silver market
- Why some investors are betting on cash
- How to invest for the 22nd century
- Everything you need to know about buying NFTs
- What the savviest short-seller has in his sights next
- The investment billionaires like Bill Gates are doubling down on
- Coinbase? Bitcoin? The case for making a few wild bets