NFTs, short for non-fungible tokens, have emerged as a novel way for creators to sell and authenticate their digital art, music, videos, and other creative works. They utilize blockchain technology to generate a distinct, highly secure record of ownership and provenance for each piece of digital content. This allows creators to monetize their digital works and collectors to buy and sell them as unique assets.

In the creative economy, NFTs have the potential to disrupt traditional models of distribution and ownership. They allow creators to sell their work directly to fans and collectors, without the need for intermediaries such as galleries, record labels, or streaming platforms. This gives creators greater control over their work and a larger share of the revenue.

The rise of NFTs has caused a significant impact on the creative industry, especially in the world of digital art. Chalmers et al. (2022) explores the potential benefits of NFTs for entrepreneurs in the creative industry. These potential advantages include the ability to create new revenue streams and engage stakeholders in innovative ways. The emergence of fresh sources of income from the NFT market is a positive development, especially during a time when dominant digital platforms have placed creators and rights holders at a notable disadvantage, which in certain instances has resulted in a discrepancy in value that threatens the very existence of artistic creation (Meier and Manzerolle, 2018, Negus, 2018). 

NFT As An Emerging Asset Class

According to multiple studies, the pricing of NFTs differs significantly from that of cryptocurrencies, and there is a weak correlation between the prices of NFTs and cryptocurrencies (eg., Boido and Aliano, 2023, Dowling, 2022). These findings carry significant implications for portfolio management because assets that have a low correlation with existing asset classes and behave differently are highly sought-after for their ability to provide diversification. Thus, for investors seeking to build a diversified portfolio, investing in NFTs could serve as an opportunity for diversification.

NFTs have rapidly become an emerging asset class that has already witnessed record-breaking sales, with some digital art pieces fetching millions of dollars. In September 2021, the total trading volume of the three leading NFT marketplaces – OpenSea, Axie, and CryptoPunks – exceeded $10 billion USD, marking a new all-time high (Das et al., 2021).  The surge in NFT trading has been driven by a number of factors, including increased mainstream awareness and acceptance of cryptocurrencies and blockchain technology, as well as the growing interest in digital collectibles and virtual assets.

It’s important to note, however, that investing in NFTs requires a certain level of expertise and knowledge of the market. The NFT market is still in its early stages, and several factors can influence the pricing of NFTs. These include the quality and popularity of the artwork, the rarity of the token, the perceived cultural significance, and the reputation of the artist. As with any investment, it’s crucial to conduct thorough research and due diligence before making any investment decisions.

Risks Associated With NFT Investing

Investing in NFTs involves certain risks that investors should consider before making any investment decisions. Here are some of thepotential risks:

Limited liquidity: One challenge associated with NFTs is that they can be illiquid, meaning that it may be difficult to buy or sell them quickly at a fair price. The attractiveness of an NFT is hinged on investors’ individual aesthetic preferences. Unlike traditional assets such as stocks or bonds, which are valued based on financial metrics such as earnings or dividends, the value of NFT art is largely influenced by subjective factors such as artistic appeal, creativity, and distinctiveness. Consequently, certain NFTs might find limited interest if their style or content fails to resonate with a broader audience. In instances where there are few prospective buyers, locating a purchaser willing to meet the desired price can be difficult. This predicament often compels sellers to reduce their asking price to attract buyers, potentially resulting in a lower-than-expected return on investment. Moreover, the relatively recent emergence of NFTs as a rapidly evolving asset class can exacerbate illiquidity. As the NFT market continues to evolve without well-established norms or standards for pricing and trading, agreeing on a fair value becomes intricate for both buyers and sellers while predicting future demand for specific NFTs becomes a challenge.

Market volatility: NFT prices can be highly volatile, and they may fluctuate rapidly due to changes in demand and supply, market trends, or sudden shifts in investor sentiment. The value of NFTs is subjective and difficult to measure, leading to swift price swings as buyers and sellers seek a fair valuation for a particular asset. Moreover, the NFT market is new and largely unregulated, making it susceptible to fraud and manipulation, further contributing to market instability.

The collapse of Silicon Valley Bank on March 10th, 2023, had a cascading effect on various financial markets, including the NFT market. This incident underscored the inherent volatility of the NFT market and raised stability concerns. According to Blockchain. News (2023), NFT trading volumes plummeted from $74 million to $36 million, illustrating the profound impact of the bank’s collapse on the NFT market. This notable decline in trading activity was accompanied by a significant decrease in active NFT traders between March 9th and March 11th, reaching their lowest level since November 2021.

According to Yousaf and Yarovaya (2022), trading volume is strongly linked to the returns and volatilities of NFTs, particularly in the extreme upper quantile. Spillover from volume is the underlying factor for volatility during extremely bullish and bearish market scenarios. This suggests that volume data holds valuable information for predicting NFT market volatility in extreme conditions.

Security risks: Centralized NFT marketplaces are susceptible to hacking, data breaches, or other security incidents, which can jeopardize sensitive data or the NFTs themselves. In contrast, decentralized NFT marketplaces employ multiple computer systems or “nodes” to validate transactions, making it more difficult for malicious actors to tamper with the platform. However, it’s important to note that decentralized platforms are not completely impervious to attacks.

In Das et al.’s (2021) paper, the authors identified several security concerns associated with various activities in NFT marketplaces, including user authentication, token minting, listing, and trading. One example of a security concern discussed in the paper is related to token minting, where the metadata associated with a token could potentially be tampered with.

Metadata is crucial information detailing an NFT, capturing its creator, ownership history, location (digital asset link), description, and other pertinent attributes or features. If an individual tampers with an NFT’s metadata, they could alter or erase vital details like its creator or ownership history. Such actions could devalue the NFT or, in extreme cases, render it completely worthless.

Unclear ownership rights: While the ownership of physical assets is usually determined by clear legal frameworks and transfer documents, the ownership of digital assets, including NFTs, is not always straightforward. NFTs often involve complex licensing agreements and terms of use, which can be difficult to understand and enforce. For example, the original creator of an NFT may retain certain rights to the underlying digital asset, such as the right to use it in other works, even after the NFT has been sold to a new owner.

As a buyer, there are several steps you can take to avoid the unclear ownership rights problem in NFTs:

• Research the NFT and its history: Before purchasing an NFT, do your due diligence to ensure that the seller has clear ownership rights to the underlying digital asset. Check the NFT’s transaction history and verify that the seller is the original creator or has obtained the necessary rights from the creator.
  
  
• Review the NFT’s terms of use: Make sure you understand the terms of use associated with the NFT, including any licensing agreements or restrictions on how you can use the digital asset. If you have any questions or concerns, contact the seller or consult with a legal professional.
  
  
• Choose reputable platforms and sellers: Stick to established NFT marketplaces and reputable sellers with a track record of selling authentic and legally compliant NFTs.
  
  
• Consider obtaining legal advice: If you’re making a significant investment in an NFT, you may want to consult with a lawyer who specializes in digital asset ownership and transfer to ensure that you’re protected.
  
  
• Keep thorough records: Maintain detailed records of your NFT purchases, including transaction histories and any associated licensing agreements. This will help you establish clear ownership rights and protect your investment in the long term.

The NFT market, brimming with innovation and opportunity, also reveals pressing issues of equity, inclusion, and fairness. These concerns stem from various factors. Firstly, the digital divide creates an entry barrier for creators with limited access to technology and connectivity, exacerbating underrepresentation. Secondly, the subjective valuation of NFTs based on aesthetics can inadvertently marginalize diverse art forms and voices. Lastly, the absence of standardized protocols for ownership, royalties, and provenance may perpetuate power imbalances, favoring established artists and a handful of influential collectors or investors. The concentration of ownership among a select few can lead to exclusivity and price manipulation, hindering accessibility for a wider audience. Addressing these challenges is vital to cultivating an NFT landscape that empowers a broader spectrum of creators and fosters inclusivity and fairness within the artistic ecosystem.

 

Disclaimer: The Content is for informational purposes only. You should not construe any such information or other material as legal, tax, investment, financial, or other advice.


References:

Blockchain.News, March 18, 2023 Saturday. “NFT Trading Volumes Plunge After Silicon Valley Bank Collapse”.  https://blockchain.news/news/nft-trading-volumes-plunge-after-silicon-valley-bank-collapse#:~:text=The%20drop%20in%20NFT%20trading,March%209%20and%20March%2011.

Boido, C. and Aliano, M. (2023). Digital art and non-fungible-token: Bubble or revolution? Finance Research Letters, 52, 103380

Chalmers, D, Fisch, C, Matthews, R., Quinn, W., Recker, J. (2022). Beyond the bubble: Will NFTs and digital proof of ownership empower creative industry entrepreneurs? Journal of Business Venturing Insights, 17, N.PAG. https://doi.org/10.1016/j.jbvi.2022.e00309

Das, D., Bose, P., Ruaro, N., Kruegel, C., & Vigna, G. (2021). Understanding Security Issues in the NFT Ecosystem. Proceedings of the 2022 ACM SIGSAC Conference on Computer and Communications Security.

Dowling, M. (2022). Is non-fungible token pricing driven by cryptocurrencies? Finance Research Letters, 44, 102097. https://doi.org/10.1016/j.frl.2021.102097

Meier, L.M., Manzerolle, V.R. (2018). Rising tides? Data capture, platform accumulation, and new monopolies in the digital music economy. New Media Soc. 21 (3), 543–561.

Negus, K. (2018). From creator to data: the post-record music industry and the digital conglomerates. Media Cult. Soc. 41, 367–384.

Yousaf, I., Yarovaya, L. (2022). The relationship between trading volume, volatility and returns of Non-Fungible Tokens: evidence from a quantile approach. Finance Research Letters. https://doi.org/10.1016/j.frl.2022.103175

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