Non-fungible tokens have become a hot topic – and a very hot commodity. The skeptics have dismissed them as absurd, while enthusiasts call them the wave of the digital future. Fine arts specialist Queenie Mo and financial expert Malcolm Wright explore how NFTs are growing fast at the nexus of technology, finance and culture.
Non-fungible tokens: Perceptions are shifting from dismissing NFTs as a passing fad for the young and tech savvy to growing acceptance of a digital product that is being adopted by an expanding mainstream audience (Credit: munidssima / Shutterstock.com)
Non-fungible tokens, or NFTs, have achieved astounding market growth, reaching over US$40 billion in sales in 2021 alone. NFTs appear to be everywhere, so much so that “NFT” was named Collins Dictionary’s Word of the Year 2021.
What are NFTs, and how are they disrupting global finance, society and culture?
NFTs are built and backed on a blockchain – a decentralized and immutable store of information where the NFTs are scarce, rare and unique. A single NFT represents unique ownership of a physical or digital asset. NFTs appeared as early as 2012, evolving from digital art to “phygital” assets – physical assets that are linked with digital tokens. In the world of art, collectibles, fashion, events, music, real estate, golf courses, virtual land, in-game assets and beyond, NFTs represent ownership.
While the exponential growth and popularity of NFTs has been global, Central and Southern Asia and North America drive much of the demand. As society becomes increasingly digitalized, particularly in an era of lockdowns and self-isolation, people have become more dependent on technology and the internet.
The NFT craze started in 2017, when CryptoKitties, an online game where players can adopt and trade virtual kittens, rose in popularity. The game raised US$12 million, with some reputable kitties selling for over US$100,000 each, epitomizing the cryotocurrency mania. Fast-forward to 2021 when Beeple’s "Everydays" digital artwork sold for US$68 million in March and CryptoPunks, a set of 10,000 unique digital characters, gained notice in the crypto-community as the most stable popular NFT collection. Following in CryptoPunks’ footsteps: Bored Ape Yacht Club, Art Blocks, CyberKongs and CryptoToadz, which, though more volatile, remain some of the most popular NFT collections.
Driven by crypto whales – entities that hold a significant number of tokens of a cryptocurrency – the resurgence of CryptoPunks, auction houses Christie’s and Sotheby’s, Visa, Time Magazine, Adidas Originals, Pepsi, McDonald’s, the department store group Macy’s and other organizations, the NFT trend exploded in August 2021. As global brands have entered the space, popular perceptions have shifted from dismissing NFTs as a passing fad among the young and tech savvy to growing acceptance of a digital product that is being adopted by an expanding mainstream audience.
The creator economy
Yat Siu, founder of venture capital company Animoca Brands, once said “Bitcoin is a store of value, NFTs is a store of culture”. Together, they form a “valued culture”. NFTs are changing cultural value creation: Owners of NFTs are like club members with VIP access to loyalty programs, both online and off. Simultaneously, NFTs have enabled new revenue models, such as royalty contracts, which gives original curators and artists shares of transactions from the sale of NFTs.
Depending on what they represent, NFTs are sold, branded and marketed on different platforms. TopHolder, a platform dedicated to NFT art, recently auctioned the NFT version of Chinese painter Qi Baishi’s Shrimp painting in the Shanghai Jiahe Auction. The most popular and largest platform, OpenSea, allows artists to freely upload and mint, or create, NFTs to sell on the peer-to-peer marketplace. Other platforms, such as Foundation.app, are by invitation only: Artists will need to be invited to the platform to mint and sell their NFTs. When choosing their platforms, artists compare terms, platform fees and transaction fees, which range from 2.5 to 15 percent, and features and perks. Binance’s NFT Marketplace, which aims to be a “home to a vibrant crypto community with community-driven approaches to development”, has a record low one percent platform fee.
Virtual land and property have also gained significant popularity, driven in part by top celebrities like American rapper Snoop Dogg, who purchased an NFT house. An NFT collector later bought a plot of virtual land in “Snoopverse”. According to DappRadar, virtual land sales in Sandbox, Decentraland, CryptoVoxels and Somnium Space, exceeded US$1 million within one week in November 2021.
Social media plays an important role in driving NFT adoption, with platforms such as Twitter, Discord, Instagram, Telegram, WhatsApp and Clubhouse helping companies grow followers organically by sharing links and promoting NFT groups or channels in posts and discussion boards. The purpose? To bring targeted communities to life. By collaborating with influencers, creating websites and metaverses, and livestreaming, companies can engage directly with followers and facilitate interaction among followers and between followers and NFT projects.
Offline events can also drive the adoption of NFT culture. In Hong Kong, gatherings have taken place at major events and venues including Digital Art Fair (DAFA), K11 Musea, K11 Art Mall, Fine Art Asia and the new M+ museum of visual culture. There have been numerous NFT pop-up galleries even during the pandemic. On the international stage, more and more platforms are turning the spotlight on NFTs including Miami NFT Week, Art Basel Miami, NFT NYC, the Non-Fungible Conference in Lisbon in April 2022, and Blockworks PERMISSIONLESS in Palm Beach, Florida, a month later.
Risks and policy considerations
As with traditional finance and all emerging technologies, NFTs carry with them risks, some of which can be addressed through existing government policies, while others may need new ways of thinking to tackle. NFTs also require responsible innovation from market participants – only then can buyers feel secure and NFTs can thrive.
1. Ownership, intellectual property rights and trademarks
When a buyer purchases an NFT, they often acquire ownership and other rights, but rarely full ownership of the intellectual property (IP). For example, someone who owns an NFT of a Jackson Pollock painting owns Pollock’s IP rights, too. The NFT issuer will need a license from the Pollock-Krasner Foundation, which will come with reproduction limitations. Unlicensed reproductions are not just an issue with NFTs; for years, such unauthorized reproductions have been available both on and offline.
NFTs, however, offer new avenues where IP rights need careful consideration and management. Sports and streetwear brand Nike and luxury fashion house Hermès have filed lawsuits against shopping platform StockX and artist Mason Rothschild, respectively, for creating NFTs of their products and branding.
Crypto exchanges have become increasingly susceptible to hacking. Data from the Chainalysis Crypto Crime Report 2021 highlighted attacks totaling US$531 million in 2020, and evidence suggests that the figures are higher for 2021. There have also been reports of hackers stealing from crypto wallets.
Many of these issues are driven by the nascency of the crypto ecosystem. Crypto exchanges responded to past security breaches with substantial improvements to security systems and customer information safeguards, driving high demand for specialists in these areas. Responsible innovators will need to consider appropriate controls and the necessary education to inform buyers of potential cyber risks.
3. Illicit activities
Although illicit activities are less common in the NFT world than the traditional financial sector, one can expect to see old crimes occur in this new world, such as “rug pulls” in NFT sales, where instead of delivering NFTs after payment, an NFT issuer disappears with the funds, and “man-in-the-middle” attacks where funds are diverted to the bad actor instead of the NFT issuer. Illicit funds can even be used to purchase NFTs that are then resold in exchange for clean funds.
Regulators are also beginning to consider the link between NFTs and sanctions evasion. In the US, although regulators have yet to produce clear guidance on NFTs, the Office of Foreign Assets Control (OFAC) has made it clear that US persons and entities dealing with virtual assets remain subject to OFAC controls.
4. Securities and taxation
NFTs can be purchased as a whole piece or as a fractionalized part. One could take a whole item, such as a Leonardo da Vinci painting, and sell it in smaller parts. However, fractionalization may fall under existing securities legislation and NFT issuers and promoters may also come under scrutiny.
In addition, the NFT ecosystem has several potential implications for tax policy, including income tax from NFT creators, capital gains on a buyer’s profits, and corporation tax on NFT platforms.
5. Cyber literacy and financial inclusion
Purchasing NFTs requires a certain level of technological knowledge, and buyers often have to purchase primary crypto tokens, such as Ethereum, before they can make their NFT purchases. They might also have to “whitelist” crypto addresses to receive early access to benefits or discounted pricing. Policy makers will need to look at how to make crypto and NFTs as accessible as possible, whilst encouraging NFT innovators to build knowledge platforms and streamline processes for buying, owning and selling NFTs.
6. Energy usage
Ethereum, the most commonly used cryptocurrency for NFTs, uses anywhere from 48 kWH per transaction – roughly the same energy expenditure of the average US household for 1.5 days, or 2-3 days for an Australian household – to 238.22 kWH, which equates to 100,000 Visa transactions. Policymakers might have to consider how best to balance the environmental impact of NFTs with sustainability initiatives.
The NFT sector will continue to accelerate and mature. Jurisdictions, particularly hubs such as Hong Kong that bring together financial acumen, technology, a strong legal and regulatory ecosystem, and a thriving arts-and-culture sector, can succeed by considering how crypto could offer access to the transformational ecosystem of NFTs, how the skills and employment opportunities for the next generation will be born from this emerging world, and how society can benefit.
Ali, Muddasar; and Bagui, Sikha. (2021) “Introduction to NFTs: The Future of Digital Collectibles”, International Journal of Advanced Computer Science and Applications, vol. 12, no. 10, pp 50-56, The Science and Information Organization, CleckHeaton, West Yorkshire, UK.
Demertzis, Maria. (January 25, 2022) “Non-fungible tokens (NFTs): the next chapter in crypto”, Bruegel, Saint-Josse-ten-Noode, Belgium.
Kaczynski, Steve; and Kominers, Scott Duke. (November 10, 2021) “How NFTs Create Value”, Harvard Business Review, Harvard Business Publishing, Harvard University, Brighton, MA, USA.
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