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What are NFTs? Decoding non-fungible tokens

A new digital innovation made a splashy arrival this spring, disrupting the contemporary art world.

 


NFTs—unique, digital assets created and exchanged on the internet—catapulted to attention this March with Christie’s record-setting $69.3 million sale of an NFT digital collage by Beeple (the artist Mike Winkelmann, who was transformed overnight into a household name).

NFTs have rapidly become a mainstream popular culture phenomenon, garnering front-page news coverage and a skit on Saturday Night Live. Sotheby’s also announced a collaboration with the anonymous artist Pak on an auction held in partnership with Nifty Gateway, a digital marketplace.

Like cryptocurrencies, NFTs belong to a borderless, decentralized, virtual global ecosystem—crypto marketplaces in which they are created, proffered and acquired. NFTs’ authenticity, provenance and ownership are verified using blockchain technology, a decentralized, immutable ledger of transactions.

NFTs have been “minted” and promoted by celebrities in sports, entertainment, art, tech and by big consumer brands. While artists have been working in other digital media for over 50 years, NFTs are a new horizon for the fine art sector. NFTs encompass a broad universe, from tweets, GIFs and images to songs and videos. Here, we focus on their implications for the contemporary art market and for collectors.

Disrupting the contemporary art market

We’re in the early days of a commercial, technological and aesthetic experiment. In 2020, the pandemic accelerated the traditional art market’s pivot to digital sales. NFTs present new, perhaps speculative, opportunities for auction houses, galleries, art fairs, even museums and nonprofits, and the collectors and donors with whom they transact.

We are witnessing tectonic shifts in real time. NFTs’ native crypto marketplaces aim explicitly to circumvent and disrupt institutional gatekeepers, yet NFTs are increasingly being offered by many major art institutions. Auction houses and galleries are capitalizing on and coopting NFTs, with the featured artists’ cooperation. We will likely see more established commercial and nonprofit art institutions embrace NFTs; meanwhile, new products and services are cropping up to meet demand from NFT creators and consumers.

NFTs have indisputably entered the fine art space, and are generating heated debate due to both skepticism and enthusiasm from all sides. For centuries, “establishment” aesthetic gatekeepers have questioned the validity of avant-garde art forms and movements. Many now-iconic, vanguard artists of past eras never enjoyed financial success during their lifetimes. NFTs’ steep, sudden rise is unprecedented.

Are NFTs considered art assets?

Whether NFTs are considered art assets depends on who is making the assessment and why. While NFT creators and consumers may regard them as art works, thus far, traditional insurers consider NFTs to be digital assets. Practically speaking, that means insurance policies covering fine art only encompass physical loss or damage, and because NFTs and other digital assets aren’t physical, they aren’t covered. Even so, NFTs are asserting their value in the marketplace, and some resale opportunities may be attractive to both creators and collectors. 

The NFT is a digital, inalterable certificate of authenticity and proof of ownership. NFT creators retain intellectual property rights, unless they sell or license the copyright for the specific NFT. For artists, NFTs represent a liberation from middlemen and brokers, as royalties can be built in at the creation of the NFT—traditionally, artists have not benefited from secondary sales. A caveat, however, is that royalties may not be recognized from one sales platform to another. Some NFT artists build in incentives for buyers to hold them long-term (e.g., offering the current owner a higher share of the resale price to discourage flipping).

The traditional art world presents more barriers to reselling, generally (despite various proprietary digital sales platforms) because the venerable auction houses and galleries are brands with investments in their expertise. Some NFT platforms are exclusive, too, allowing artists by invitation only. But unlike the traditional art market, they’re open globally 24/7 to any buyer with a cryptocurrency wallet (some also take credit cards).

How can we then determine value and, accordingly, risk and reward? Art is worth what it sells for on a given day, whether it is analog or digital. Markets can be irrational and unpredictable; the modern art market, dating to the 19th century, has seen booms and busts. NFTs have already experienced volatility parallel to that of cryptocurrencies. NFTs do not have long track records of sales histories, making them difficult to appraise. 

It’s too early to say if NFTs will hold long-term value. Avant-garde artworks of past eras, such as Impressionist, Cubist, Abstract Expressionist, Pop and Street Art, have achieved blue-chip asset status and art historical significance over time. At present, NFTs are proliferating, but their long-term impact is yet to be determined. Artists innovate and markets respond to new opportunities. What appears more certain is that the blockchain technology underlying NFTs is here to stay.  

Interested in exploring your options?

We suggest collectors continue to focus on their strategies, motivations and objectives. We also recommend you:

  • Consider the risks and rewards of acquiring NFTs, while focusing on goals and conducting due diligence.
  • Stay informed. It’s a rapidly evolving environment. Best practices relating to NFTs are still being developed.
  • Take the long view. While the term “NFT” is new, art, commerce and technology have intersected for millennia.

If you’re interested in learning more, contact your J.P. Morgan team. We have a depth and breadth of financial and subject matter expertise to help you identify trends and make more informed decisions. Speak with us for information and practical tips on:

  • Decoding NFT, blockchain and cryptocurrency terminology
  • Addressing the current challenges of valuing NFTs and crypto assets
  • Risk management of NFTs and crypto assets
  • The tax implications of cryptocurrency transactions and tax compliance best practices
  • How NFT transactions should be reported
  • Estate planning opportunities and considerations
  • Practicing good cybersecurity hygiene
  • Intellectual property rights issues
  • Assessing NFTs’ environmental impact

 

 

 

 

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