What are NFTs?
Separating the fungibles from the tangibles
Digital assets have been attracting the attention of investors after a collage of Instagram postings and the first ever tweet triggered multi-million-dollar bidding.
The boom in the online art world has seen Grimes, the musician partner of Tesla billionaire Elon Musk, achieve $6m for one of her digital artworks and an eye-watering $2.9m was achieved by Jack Dorsey for his first Tweet. But the jackpot fell to Mike Winkelmann, known as Beeple, who secured the third highest sale value by a living artist when a collage of 5000 Instagram posts, bundled as a single JPG file, was sold for $69m.
Known as Non-Fungible Tokens - or NFTs - these are crypto-assets comprising unique metadata to guarantee provenance and safeguard against forgery. While an NFT may be a high value piece of artwork, it is the same technology used to hold images, videos and music on a computer to validate rights and ownership.
Held securely using blockchain technology, each NFT contains ownership details for easy identification and transfer between token holders, and owners can add further metadata or attributes, such as an artist adding their signature to the metadata for a digital artwork. NFTs may also be combined to create further, unique NFTs. This separates them from fungible tokens like cryptocurrencies, where each unit will always have the same value as another unit, and no unique value can be made by adding units together.
Both NFTs and cryptocurrencies use the same Blockchain technology, which is effectively a digital ledger shared and verified across innumerable computers worldwide, protected by complex cryptography to make it secure and resistant to fraud. While the technology is playing an increasingly important role in securing cyber transactions, it is not guaranteed foolproof, and this, together with the uncertainties around valuations, authenticity, copyright and trademarking make investment in NFTs potentially high risk.
Explained corporate legal solicitor Mark Poulton: "We have seen the price of digi-currencies soaring and crashing over recent years, and now sales of digi-artwork by Beeple and Elon Musk's musician partner Grimes are flying high. But all these digital investments are likely to be more of a gamble than going for the real thing.
"This is a very young market, where sustainability of value has yet to be proven. Approach with caution' and don't invest money you might need tomorrow is a good guideline."
Understanding some of the stress points where investors may be wrong-footed:
While the acquiring owner of a physical painting may expect to put it on display to the public without worrying about intellectual property rights, the law has not yet been tested by the purchasers of digital art who wish to display their treasures to the world.
Owning an NFT does not automatically give the right to exploit it through reproduction, display or distribution. The rights granted by the NFT will be unique to that token and copyright must be expressly provided for and agreed by the original author. It's an approach that reflects the need to safeguard against the potential of infinite reproduction, which is implicit in digital assets, to make them more closely aligned to physical works of art. Similarly, while trademarks and publicity rights are well established for physical artists, there is uncertainty as to how such rights may be protected for digital artists.
Authenticity and Safeguarding:
Blockchain technology means that each NFT will carry its unique chain of title, but there is no cast iron guarantee that the original entry is not false, or an error made. This has a direct impact on validating authenticity and undermines certainty and security. On the flip side, those considering acquiring NFTs should expect to be subject to authenticity checks themselves, as transactions conducted through cryptocurrency or token exchange can raise compliance issues under anti-money laundering regulations.
Another complicating factor is that no matter how secure and robust Blockchain platforms may appear, all digital assets are potentially vulnerable to cyberattack. Alongside due diligence, insuring against these risks is an essential part of the acquisition process.
What may be harder to guard against is the obsolescence effect of technological development. With Blockchain under fire for its huge energy consumption, it's likely that new technologies will be developed, and the compatibility and maintenance of older assets is impossible to foresee.