Valuing the Virtual: Are Non-Fungible Tokens Fad or Future?
July 21, 2021
Twitter CEO Jack Dorsey sold his first tweet as a non-fungible token (NFT) for $2.9 million. Thousands of pieces of virtual NFT real estate have sold this year for an average of $2,000 per property. A Christie’s auction set a new record in March 2021 for for highest NFT value: $69 million for a digital artwork file. The price exceeded that paid for physical works by many of the world’s greatest artists.
Are these signs of a passing fad or a glimpse into the future?
NFTs are creating new markets in the digital sphere, with the legitimacy and ownership of a piece of digital media verified by an electronic certificate. These certificates are stored on blockchains, a shared digital ledger that allows online transactions to be recorded over a network of computers.
“It’s supply and demand at work. NFTs’ fundamental rarity drives up their perceived value,” says Haley Chow, senior consultant, IP Solutions at Aon. “NFTs have become a virtual extension of markets that thrive on scarcity.”
WHY IT MATTERS
The digital verification of the NFT is what makes each one “non-fungible.” That code means each is one of a kind. In that respect, they differ from other digital assets such as Bitcoins, which could be substituted one for another.
NFT “minting” creates a permanent record of the asset on a file that can be viewed and verified by other computers on the network with access to the blockchain, without threatening the NFT’s integrity.
Permanence Holds Promise
The new digital assets could provide new marketing opportunities for businesses. Earlier this year the National Basketball Association launched an NFT product it calls Top Shot, digital trading cards that capture game highlights.
The band Kings of Leon became the first to release an album as an NFT, with various versions offering features such as enhanced artwork or seats at live concerts.
And despite certain copyright challenges in their creation, NFTs may offer advantages for artists regarding royalties and resale. “With NFTs and smart contracts programmed into transactions, a copyright authority could permanently link the transfer of ownership and the commission payment,” says Chow.
Buyer Beware: The Digital Downsides
NFTs carry risks for creators and buyers. NFTs created from works of art, for example, don’t bring with them the copyright of the original. The creator might subsequently create a similar work based on the original.
As alluded to above, Chow says copyrights might also be violated in the creation of some NFTs, particularly when the NFTs are based on materials whose proper ownership is difficult to determine.
“For NFTs that include sound recordings or parts of other copyrighted works, attempts to sell the NFT might violate rights,” says Chow. “For certain types of copyright, especially around music composition, it can be difficult to identify rights ownership. Determining the correct parties to authorize the initial sale may never occur, and both buyer and seller risk the invalidation of their transaction by the true rightsholder.”
NFTs’ digital nature also brings cyber security risks. “NFTs are stored on the blockchain, and many people store their private ownership keys in their ‘personal wallets’ on their computer, like any other file,” says Vanessa Leemans, chief broking officer, Cyber Solutions EMEA at Aon. “Once a key is stolen, there’s little chance of getting it back.”
Leemans says trading these digital assets can also bring risks. “Deposits are often made into ‘hot wallets,’ similar to virtual savings accounts, that are connected to external servers and not as hacker-proof as the actual blocks within the blockchain.”
Other concerns include the vulnerability of third-party vendors in the NFT ecosystem, as well as data privacy requirements in case of a breach, says Leemans.
There’s also the risk for those acquiring NFTs as investments. If this is an NFT bubble that ultimately bursts, buyers might find themselves holding digital assets worth far less than what they paid.
The Quest for the Rare
Where there’s a premium on rarity, NFTs’ one-of-a-kind pedigree may give them staying power. Despite NFTs’ current fad status, the interest in these virtual assets appears to be real. And while there are risks, NFTs may well provide real opportunities for businesses as well.
“Ready or not, NFTs are bringing scarcity-based markets into the digital age,” Chow says.