NFTs are now a $3 billion industry, and as Bloomberg puts it, there’s a small group out there reaping most of the profits.
Profits, you say?
So, where are these NFT profits? What are NFTs, for that matter, and are the risks worth the potential reward?
What Are NFTs, Again?
An NFT, or non-fungible token, is like a “certificate of ownership” for a piece of digital art.
In literal terms, an NFT is several lines of computer code that contain (among other things):
- The name of an artwork
- The name of the artist
- The name of the current owner
NFTs live (mostly) on the Ethereum blockchain, which is like a giant Google Doc that the whole world shares.
So yes, in essence, an NFT is just a jumble of code in the cloud that says “Chris Butsch owns Dissolving Freedom by Beeple.”
Why Do People Buy NFTs?
When I explain NFTs in under 30 seconds to people — and confirm that yes, these are what people are paying thousands, sometimes millions of dollars for — I typically get this face:
That face is justified.
In my experience, folks buy NFTs for some combination of the following reasons:
- For the joy of collecting art
- To support an indie artist
- To be part of a cool new trend
- To score the extras that are sometimes included with NFT purchases, such as tickets or a chance to meet the artist
- As an investment
Chances are that if you’re reading this, you’re primarily considering buying an NFT as an investment — a quick win for easy cash.
But before discussing whether an NFT investment would be profitable, let’s cover the basics of how to buy NFTs in the first place. Because to be honest, both of these topics are loaded like a Wendy’s baked potato — and may influence your decision to invest in NFTs in the first place.
How Do You Buy NFTs?
If you’re considering an investment in NFTs, you should know that buying NFTs is a clunky, tedious, fee-ridden process.
Granted, buying NFTs gets easier once you’ve done the initial ~20-minute setup of accounts, wallets and such — but sadly, the gauntlet of fees never goes away. Here’s the CliffsNotes version of the NFT purchase process.
- Create a Coinbase account.
- Link your bank account.
- Create a “hot wallet” using MetaMask.
- Create an OpenSea account.
- Link your MetaMask wallet to your OpenSea account.
- Browse OpenSea for an NFT you’d like to bid on or purchase.
- Go back to Coinbase and purchase enough Ethereum to cover the cost of the NFT on OpenSea, plus 10% contingency to cover fees.
- Send the Ethereum to your MetaMask wallet.
- Purchase the NFT and pay transaction and gas fees.
- Optionally store your NFT in an offline “cold wallet”
I really wish that buying NFTs was as simple as buying stock on a modern brokerage app like J.P. Morgan Self-Directed Investing. That process involves:
- Creating an account.
- Linking your bank account.
- Buying stocks.
And zero fees.
But if you’re not deterred by the tedious buying process, let’s dive into the next essential FYI: the controversy.
Why Are NFTs Controversial?
There’s been some backlash against NFTs that prospective investors should be aware of — similar to how you’d probably want to know about a company’s dirty laundry before buying its stock.
The two biggest controversies surrounding NFTs are definitely:
1. They’re not so great for the environment.
When you buy an NFT, a bank of computers somewhere (a “crypto mine”) has to safely transfer your Ethereum and “mint” (aka process) the NFT.
Sounds simple enough, but the process is actually so complex that a single NFT transaction consumes more electricity than the average American household consumes in a week. And since crypto mines are heavily based in coal-dependent countries like Iran and Kosovo, each NFT purchase will release more C02 than driving an SUV for 300 miles.
2. They’re not so great for artists, either.
Per OpenSea’s tutorial, selling an NFT is as easy as uploading a .gif or a .jpg and setting a price. There’s no upfront verification process to ensure you’re the original owner of the artwork.
As a result, the IRS is concerned that NFTs are conducive to fraud. People other than the original artist can create NFTs and sell work that isn’t theirs. One artist discovered that someone listed 87,000 unauthorized NFTs of their work. In another scam, an investor paid $336,000 for a fake Banksy NFT.
To avoid buying a fake, only purchase from listings linked out from the artist’s webpage or social accounts — and make sure they haven’t been hacked!
Are NFTs a Good Investment?
Well, let’s start by defining what makes a “good” investment.
A good investment is one that provides, or is projected to provide, good risk-adjusted returns. This means that your expected profits from the investment are worth the risk.
The lottery may have high potential returns, but your chances of winning are extremely low.
High reward + even higher risk of losing money = low risk-adjusted returns = bad investment. (Check out: Why You Should Never Play the Lottery).
S&P 500 index funds may have modest expected returns (~11% APY), but the risk of losing money over the long term is extremely low.
Ok returns + extremely low risk = good risk-adjusted returns = good investment. (Check out: Why Index Funds Cost Less, Reduce Risk, and Make You a Better Investor).
Now, let’s examine NFTs through the lens of risk-adjusted returns.
The potential profit from flipping NFTs is high. Beeple’s Crossroad originally sold for $66,666 in October 2020. The buyer flipped it four months later for a cool $6.6 million.
The risk of losing your money, however, is extremely high. Pretty much astronomical.
99% of NFTs will go to $0, according to Motley Fool, and it’s nigh impossible to ID the 1% that won’t. Even skilled NFT “flippers” only profit 20.8% of the time, according to Chainalysis.
Now, you might think that popular, “Blue Chip” NFTs like Jack Dorsey’s first Tweet or Snoop Dogg’s Journey with the Dogg collection would at least hold their value. But no; bids on the secondary market are 1% or lower than the NFTs’ initial sale price.
The problem with treating NFTs as investments is that they’re non-fungible. There’s only one of each, so in order to profit from your investment, you have to find someone in the future who:
- Wants your specific NFT, and
- Is willing to pay more than you paid for it
Do those people exist? Well, the secondary market was down 92% by May 2022, so it’s not looking great. As a net result of sellers outnumbering buyers, most NFT resales end in a loss of more than 50%.
According to Chainalysis, “if you’re not on the whitelist, it’s significantly harder to turn a profit after buying a newly-minted NFT.”
What About Getting Whitelisted?
“Getting whitelisted” is the new craze among NFT investors. You might’ve seen it propped up as an easy way to generate 10x, even 100x profits.
Here’s whitelisting 101:
- Get super involved in an NFT project (join the Discord, promote it, etc.).
- The creator notices your engagement and promotes you to their VIP “whitelist.”
- Whitelisters get early access to new NFTs.
- Flip your exclusive new NFTs on the secondary market for profit.
In the end, whitelisted supporters who flipped their NFTs earned a profit 75.7% of the time — nearly four times the rate of non-whitelisted investors according to Chainalysis.
But now that the secret’s out, getting whitelisted can be a competitive, labor-intensive process. Some creators will truly test their supporters by requiring multiple daily posts to social media in support of the project, sending in custom artwork, and more. It could be a months-long effort getting whitelisted, and in the end, the 25% chance of still losing money just isn’t worth it.
Pros and Cons of Investing in NFTs
- Unique assets. NFTs aren’t going anywhere, and being “first in” brings its own form of pride.
- Supporting artists. Over 90% of the purchase price of an NFT goes directly to the artist to support their livelihood.
- Adding art to your portfolio. Historically, artworks have been out of reach to most investors. NFTs level the playing field.
- Whitelisting your way to success. Chances of generating a profit more than triple if you get whitelisted and flip your early-access NFT.
- Very high risk. With supply vastly outstripping demand and a flatlining secondary market, the vast majority of NFTs will lose some or all of their value.
- Tedious, expensive buying process. The buying and storing process is clunky, complicated, and riddled with fees.
- No passive income. Unlike with stocks or even proof-of-stake crypto, there’s no turnkey solution to generating passive income with NFTs.
- Rife with scams. Investors face a high risk of inadvertently buying a fraudulent NFT.
- Environmental concerns. ESG investors may be turned off by NFTs’ voracious appetite for electricity — and resulting C02 emissions.
Who Should Invest in NFTs?
I think the best candidate for an NFT “investor” is someone who would like to make a profit, but would shrug if they didn’t.
My friends Bob and John fill their house with art that brings them joy. They have a few pieces that they hope will appreciate in value, but if they don’t, oh well! They’ll just keep it.
I think that is the right mindset for an NFT investor to have. Because statistically, your NFT investment will likely lose more than half its value after you buy it. So if you’re cool with those odds — and would be happy just keeping your NFT — an “investment” might make sense.
Who Shouldn’t Invest in NFTs?
Anyone looking to reliably profit from investing should stay away from NFTs. The risk-adjusted returns are just too low.
I mean sure; you can improve your odds through rigorous research and attempts at getting whitelisted. But to be honest, you’re better off making a 10-minute investment in index funds and spending your saved time on other online income-generating activities.
You don’t need NFTs to get rich. In fact, more than half of independently wealthy Americans got that way by putting their money in “boring” risk-adjusted investments and just letting it sit.