Animated flying cat with a Pop-Tart body

The Blockchain Investor’s Guide to NFTs

Animated flying cat with a Pop-Tart body

Quick Summary: As blockchain investors, we look for underlying value. Most NFTs today have zero underlying value. But NFTs as a concept have a ton of potential value, especially if they are linked to things that really do have value (like earning future royalties on a pop song NFT, for example).

The illustration above is an animated flying cat with a Pop-Tart body. It recently sold to a collector for over half a million dollars.

If you’re new to this world of digital collectibles, also known as non-fungible tokens (NFTs), this will require some explaining.

This animated GIF is Nyan Cat, one of the first Internet memes. The original YouTube video, with 185 million+ views, was a mashup of a Japanese pop song and a flying pastry kitten leaving a trail of rainbows and sparkles. It has all the makings of a meme: it’s catchy, it’s weird, and it involves cats.

…But is it art?

Meme creators don’t usually get paid for the joy they bring to the world, but Chris Torres, the digital artist who animated Nyan Cat, put up the one-of-a-kind “original” for auction as an NFT, digitally signed on the blockchain (just as you would sign over proof of ownership on an expensive piece of art).

I repeat: it sold for half a million dollars.

The original meme puts the “cat” in “catchy.”

Two things are driving this mania:

1) People are trying to “flip” NFTs: buying low and selling high, hopefully in a short period of time (just as people tried to flip Beanie Babies).

2) Money doesn’t feel real: The flood of Covid-19 stimulus money makes it feel like “Monopoly money,” combined with the flood of crypto tokens, which makes it feel like you’re gambling with casino chips.

Money feels divorced from real value, so people are running up the price buying all kinds of ridiculous things. This has all the makings of a bubble, which is why I am currently staying out of the NFT market altogether.

It is not good for the blockchain industry for so many people to get burned—that brings in regulators and their lawyers.

To that end, we need some principles for investing in NFTs. In this column I’ll briefly explain whether and why NFTs are worth anything, and how we might think about them as blockchain value investors.

CryptoKitties: The NFT Origin Story

The first NFTs were a project called CryptoKitties, and we literally wrote the book on it. In short, these were digital cats that you could buy, sell, and breed with each other, with proof of ownership stored on the Ethereum blockchain. (Watch the one-minute video above.)

When they were introduced in 2017, CryptoKitties were such a phenomenon that they brought down the entire Ethereum network. I remember going to Meetups where blockchain geeks were livid that these silly cartoon cats were disrupting their Very Important Business.

Great art is disruptive. We forget that the masters – from van Gogh to Picasso, from Wagner to Kanye West – redefined what art “should be.” Great artists break the molds.

…But is this art?

Now millions of people are “investing” in these NFTs, just as quickly as creators can churn them out. It’s not limited to cat memes: you can buy all kinds of digital art, pop music, sports memorabilia, and even virtual real estate.

Even if you understand all this, the NFT craze may be a bit of a head-scratcher. If you buy traditional art – say, a Warhol print – you’re the only one who owns that Warhol print. The $580,000 Nyan Cat, in contrast, is still available for anyone to go watch on YouTube for free.

Which brings us to the basic question for blockchain investors: What are you really buying?

The jester
The “Jester” NFT, based on yours truly, is part of the Blockchain Heroes pack, currently listed on Cryptoslam for $1,000. (I don’t get any royalties, but I’m honored.)

Why Are NFTs Worth Anything?

NFTs are just a digital form of collectibles, which have been around for as long as humans have been collecting stuff. Traditional collectibles include not just fine art, but luxury items like wines and classic cars—as well as more common collectibles like coins and comic books.

Investing in collectibles relies on one central idea: that someone will pay more in the future for them.

That’s it. That’s the whole ball of WAX.

The hard part is knowing which collectibles will be worth more in the future. It’s easy to see the mint-edition Superman comic is valuable now ($3.2 million), but it wasn’t easy to see then, or more people would have saved them. The scarcity, by definition, drives the price.

The argument for NFTs is that they are scarce by definition: if you’re buying Jack Dorsey’s first tweet, well, there’s only one of them. You become the owner, with the digital record verified on a public blockchain.

…But is this true?

Does anyone really own Jack Dorsey’s first tweet? We understand that seeing a photo of the Mona Lisa is not the same as seeing the actual Mona Lisa, but seeing a link to Dorsey’s first tweet is exactly the same as seeing the “original.” Why on earth would someone pay $2.5 million for that?

The New York Times art critic Jason Farago recently dismissed the $69 million sale of a work by the digital artist Beeple, along with the concept of NFTs in general. I want to be careful about writing off the entire movement — because again, great art is disruptive. (I suspect Farago’s NFT column will age like a banana duct-taped to a wall.)

There’s a huge difference between enjoying or appreciating art, and investing in art. When you buy an NFT, you are entering the world of investing—why else would you buy it? A perfect digital replica is already available, for free. (Nyan Cat has been viewed 185 million+ times.) When you pay half a million dollars for the “official” Nyan Cat, what are you really buying?

Buying NFTs is buying bragging rights. If you think the bragging rights will be worth more in the future, then invest in them. But realize that collectibles are a highly risky and highly illiquid investment, and NFTs even more so. Here’s why.

The Two Principles of Great Art

One of the best art exhibitions I’ve seen was a collection of the actor Steve Martin, at the Bellagio Hotel in Las Vegas. Steve Martin, you may know, is a sophisticated art collector—and the Bellagio actually has a world-class art gallery.

The exhibition had an audio tour, narrated by Martin himself, along with art curator James Mann. Martin offered two principles for evaluating great art, especially the tricky subject of modern art, which does not offer us the perspective of time. These two principles struck me as so important that I still have them committed them to memory, twenty years later.

The two principles for evaluating great art are:

1)     A sense of imprint: Does the image sear itself on your mind? When you close your eyes, can you see it vividly: every line, every brushstroke, every hue and color?

2)     A sense of incompletion: At the same time, does the image seem to be unfinished? Does it raise more questions than it answers? Does it leave you wanting more, a mystery always on the verge of being solved?

These two contrasting elements—imprint and incompletion (my words)—are the tests of great art.

They are, of course, highly subjective. And they also require expertise: you have to evaluate a lot of art before you can really feel confident in your assessment. You don’t just go to OpenSea and sort by “Greatness.”

On the other hand, art is not like other investments: it is a thing of beauty, an object to be enjoyed. So if you are buying a collectible like art for the enjoyment of the thing, who cares whether an art critic likes it? If it brings enjoyment to you, that’s valuable.

If modern art is tricky to value, NFTs are even trickier—especially given that art is only one of the NFT categories. So if you’re thinking about NFTs as an investment, here are some guidelines.

Principles for NFT Investing

Think of NFTs as collectibles. Traditional financial advisors recommend no more than 5% of your portfolio be invested in collectibles, if you’re rich. If you’re just starting out, less than 1%. Make it a tiny slice, and be willing to lose it all.

Rarity = value. When the market is flooded with artists monetizing everything they’ve ever made, it’s difficult to spot what will be considered “rare.” Many NFTs — like CryptoKitties — can be endlessly manufactured using computer algorithms. (Just because it’s sold on Rarible doesn’t mean it’s rare.)

It’s not easy money. According to The Telegraph, the average return on “investment-grade” art held between five and 10 years is around 4 percent. That’s for the mature and established art market; NFTs are just becoming a thing.

IRS will tax your capital gains. If you buy and sell an NFT for a quick profit, know that governments will still view it as a digital investment, meaning you pay tax on the profit. If you’re trading NFTs on a regular basis, keep track: every transaction is taxable.

Buy an NFT because you enjoy it. Don’t try to time the market or “flip” for a profit. If you are a super-Superman fan and want to own rare issues because you love the story, great. But don’t buy comic books expecting to make money. With NFTs, as with all collectibles, buy it because you love it.

The Future of NFTs: The Bruno Bond

While I think individual NFTs are a waste of your hard-earned money, I think that NFTs as an asset class are potentially a revolutionary technology that will allow us to invest directly in artists we admire. I want to paint a vision for what I think NFTs can become, which is incredibly exciting.

In my book Blockchain for Everyone, I tell the story of the Bowie Bond, which was a financial instrument launched by David Bowie in 1997 with the help of banker David Pullman. They offered a bond that earned income based on the future royalties of David Bowie’s music.

In other words, if you were a Bowie fan and looking for a reliable income stream, you could buy one of these bonds, which would pay you a percentage of Bowie’s ongoing royalties. In return for giving up these future royalties, Bowie got a bigger payday up front, which he used to invest in Internet businesses during the dot-com boom. (The full story is fascinating.)

Imagine there was a way to pull a “Bowie Bond” using blockchain-based NFTs. Here’s how it would work.

1) An artist releases a new work: let’s say Bruno Mars releases a hot new single with Anderson .Paak.

2) A blockchain investor (and Bruno Mars fan) buys an NFT tied to the single.

3) As the single earns royalties from streaming and radio plays, a percentage of those royalties are now paid back to the owner of the NFT in Ethereum.

This “Bruno Bond” is an investment I’d consider, because now we can a) be confident of a future income stream and b) have some idea of what Bruno Mars singles are likely to earn, based on his past record(s).

Also, that single is incredible.

Potentially, artists and writers will also be able to earn royalties more directly, rather than through networks of streaming services, publishers, agents, and managers. (I suspect these networks of middlemen will still stick around, though, because they do provide value by allowing artists to focus on their art.)

We don’t technically need NFTs to realize this vision – it could all be managed in a standard blockchain smart contract – but here I think NFTs give an added psychological value. Record companies have long relied on “limited edition” singles; movies are reissued as “Director’s Cut” editions; even the traditional art market has “signed and numbered” prints. Again, these things imply rarity, and rarity drives up value.

As blockchain investors, though, we look for underlying value. Most NFTs today have zero underlying value. But NFTs as a concept have a ton of potential value, especially if they are linked to things that really do have value (like earning future royalties on a pop song NFT, for example).

For me, NFTs are currently a giant bubble made up of a million smaller bubbles. I’m not going anywhere near them. But I believe that bubbles are usually the “startup capital” needed to fund some great next stage of innovation. That next great wave of NFTs, I believe, may actually be quite nifty.

…And that just may be art.

John Hargrave is the author of Blockchain for Everyone: How I Learned the Secrets of the New Millionaire Class, which tells the full story of the Bowie Bond.

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