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Are NFTs a Good Investment?

Investors are pouring millions of dollars into non-fungible tokens (NFTs). But there are some huge risks associated with them that they might not know about.

The fever and frenzy over non-fungible tokens (NFTs) is rapidly catching investors’ attention. Last month, Beeple’s NFT collage Everydays: The First 5000 Days sold for an eye-popping $69.3 million, while Twitter founder Jack Dorsey’s NFT of the first-ever tweet was auctioned for a cool $2.9 million.

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Overall, however, NFTs can be a high-risk investment.

“The marketplaces that create and transfer NFTs are relatively new and they have not made credible promises that they will still exist 20 or 50 years from now,” William Entriken, the main author of the ERC-721 NFT standard, told TheStreet. ERC-721 is the first open standard used to build NFTs on the Ethereum blockchain and remains one of the two main standards used today.

NFT marketplaces, like the stock market, provide a means for buyers and sellers to transact business -- without them, selling or reselling an NFT may prove difficult. OpenSea and SuperRare have emerged as NFT marketplaces in the past several years and only last month scored their first venture-backed funding rounds.

“Many (art) collectors love the hunt but don’t take time to think about how they will unwind their collection when they downsize, change interests, or simply need some extra cash,” cautioned Lark Mason, president of the Appraiser’s Association of America. “The unknown is what NFT is likely to still exist in a month, year, or ten years. How will advances in technology change the market and what regulatory issues may arise? There are many unknowns in this market.”

Technical Challenges

But perhaps an even bigger concern with NFTs is losing the entire investment -- literally.

A stock can drop in value and wipe out all your gains but you can still hold onto the security and hope for better days. With NFTs, an investor can literally see their digital asset disappear into cyberspace if it isn’t stored properly, or they can lose access to their multi-million dollar digital image.

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An NFT, via the blockchain, permanently records who created the digital image, the buyer and any subsequent buyers. It serves as a certificate of ownership and can store a smattering of information on the token. It typically costs too much to store the digital image on the token itself, so data on the token will point to where the digital image, or file, is stored. But the NFT itself serves as a permanent certificate of ownership and the image cannot be changed or copied, making it one-of-a-kind.

The NFT may contain the URL that directs the buyer to a website where the image is stored or hosted, or, more typically, it contains a link to a file on the InterPlanetary File System (IPFS). The IPFS is a peer-to-peer network for sharing and storing files on a distributed file system.

Trouble arises when the URL breaks or the company hosting the website and digital image goes belly up. As a result, the investor won’t be able to access their beloved -- and expensive -- digital work.

IPFS, however, is considered a more reliable system than relying on just one website server and URL, since IPFS files are shared and stored across numerous servers. But IPFS, too, can be flawed.

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“IPFS only serves files as long as a node in the IPFS network - intentionally - keeps hosting it. Which means when the startup who sold you the NFT goes bust, the files will probably vanish from IPFS too,” warned IT professional Jonty Wareing in a Twitter thread.

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What NFT Investors Can Do

Entriken, the author of the ERC-721 NFT standard, offered a workaround.

“When you buy a digital product, NFT or otherwise, you should download it. If you didn’t download it and other people stopped hosting it for you, then it is understandable that the thing is lost. I think platforms should do a better job of communicating this to customers,” Entriken said.

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Apparently, most people who buy NFT artwork are not downloading them, Entriken noted.

Entriken added he created a project to demonstrate how an NFT should be created. His project, cited in the ERC-721 standard, for example, references the need to commit to keeping the website online when creating an NFT and discusses considerations that need to be made should government officials threaten to take a website down under a Digital Millennium Copyright Act (DMCA) claim.

“These are things buyers should learn about before they buy, rather than after something bad happens,” Entriken said.

He added, however, that “these issues do not make NFTs investments questionable. If you buy a fine wine, you should expect to store it properly. If you buy an NFT, you should download your media. And any reputable dealer should educate you on these things before you buy.”

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One of the advantages of investing in an NFT, assuming the digital asset creator acts ethically, is the buyer is assured of the authenticity of what they are buying and the limited quantity available, Entriken said.

However, scammers have latched onto NFTs, creating bogus digital images that they claim were created by famous artists and then selling them to unsuspecting buyers.

An NFT Bubble?

Meanwhile, the froth surrounding NFTs has been compared to the internet bubble. And not just by market pundits.

Count Mike Winkelmann, aka Beeple, among them.

“I do think there is a bubble,” Beeple said in a CoinDesk TV interview last month following the record-breaking, $69.3-million sale of his work last month. “And if it’s not a bubble now, I do believe it will probably be a bubble at some point because there are just so many people rushing into the space.”

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Beeple compared the current hype and frenzy surrounding NFTs to the internet bubble of the late 90s.

“Everyone was super, super hyped about it, but it didn’t kill the internet when the bubble popped. It just wiped out all of the crap,” Beeple said. “I honestly think that’s what’s going to happen with this. It will take all the things that are hype and not real [NFT] projects and those will go to zero. But it’s not going to kill this technology.”