A New Frontier in Cryptocurrencies: What are NFTs?

Non-fungible tokens — a player in the shadowy cryptocurrency world — have increasingly been making their mark. But what are they, and how do they work? Why were they used to buy the artist Beeple’s work Everydays: The First 5000 Days at a recent Christie’s auction for $69,346,250?

The answer is both simple and complicated.

NFTs are unique digital tokens that use Ethereum to digitally record transactions. Ethereum is a cryptocurrency, similar to Bitcoin, and operates in blockchain technology. However, NFTs are not exactly the same as Ethereum or any other cryptocurrency.

Here’s why: One Ethereum can be exchanged for another Ethereum in much the same way one nickel can be exchanged for another nickel. They are exchangeable and they have a set value. Ethereum and other cryptocurrencies are digital assets that are recorded in a digital ledger and can be bought and sold.

NFTs also are digital assets that are recorded in a digital ledger and can be bought and sold. NFTs offer a blockchain-created certificate of authenticity. Most NFTs exist on the Ethereum blockchain and are stored in digital wallets.

They are different from cryptocurrency because they are not fungible; they are tied to a defined digital asset. For example, Beeple’s work is not the same as any other artwork ever created, and consequently it is not exchangeable for another artwork. It has its own unique sequence on the blockchain.

Here’s where it gets even more complicated. The owners of the digital token for Beeple’s work have a record and a hash code showing ownership, but that does not mean they are the only ones who can use it. Anyone who wishes to download and use its image can do so. However, they do not own the image, so they cannot sell it. Only the owner of the unique token has the right to sell it.

However, even if the owners decide to sell the NFT, the artist retains the right to the underlying intellectual property.

The Unknowns

NFTs have been around only since 2015. They have some practical uses, such as verifying the authenticity and tracking the sales history of fine art, but for the most part use of the technology is still evolving. In addition to artwork, NFTs can be used to sell music, video highlights, a meme, or even a tweet.

Businesses are exploring how NFTs can be used for other digital assets. An NFT can represent ownership of timeshares, tickets to concerts and sporting events, or items in video games.

The tax and legal implications of unique tokens is a developing area. There is a lot of ambiguity in the various concepts surrounding unique tokens, and it might turn out that the courts have a different view of how they should be treated.

Caution Is Key

As with any speculative investment, caution is key. Understand the potential risks and benefits before investing and do not invest more than you can afford to lose. Contact us at (805) 963-7811 if you have any questions.