What are NFTs and what should you consider when investing in them?

Cryptoassets have become increasingly popular amongst many investors and particularly with the younger generation, with the current trendiest of cryptoasset being Non-Fungible Tokens (NFTs). 2021 saw the total trading volume NFTs reach £16.9 billion, a significant jump from the previous year when approximately £73.9 million worth of NFTs were traded. So, what are NFTs and what should people be considering when incorporating them into investment portfolios?

What is a Non-Fungible Token (NFT)?

NFTs are a unique type of cryptoasset that is recorded on a blockchain. Each NFT has a unique identification code which distinguishes them from each other. Non-fungible means that they cannot be traded or exchanged at equivalency, this differs from fungible tokens like Bitcoin which are identical to each other and therefore could be used as a medium for commercial transactions. For example, one ‘Bitcoin’ is always equal in value to another ‘Bitcoin’.

NFTs could be considered to be in its infancy in terms of an investment asset. However, NFTs are already being considered for use in a number of ways. These include:

  • Art and collectibles: NFTs have allowed artists to reach a wider audience by allowing people to purchase unique digital versions of their work. Effectively removing the need for intermediaries (physical art galleries) which in turn makes the transaction more efficient. The most notable example of this has been digital artist Beeple selling a group of NFTs titled ‘Everydays: The First 5000 Days’ for over £50.9 million.
  • Identity Management: By linking a physical asset to an NFT, it would be easier to ensure its legitimacy. This has been used in some of the world’s biggest fashion brands such and Fendi and Dior who became the first companies to used NFTs as a means of ensuring an item’s authenticity. The blockchain system allows consumers to track the origins of their purchases instead of having to store physical receipts which can easily be lost or damaged. Expanding this idea, consider your passports being NFTs. By converting individual passports into NFTs, each with its own unique identifying characteristics, it is possible to streamline the entry and exit processes for jurisdictions.
  • Fractionalising real world assets: Where typically there can only by one single owner of a piece of art. NFTs can allow the digital equivalent of the art to have multiple owners with each owner being responsible for a fraction of the painting. This could be extended to real estate where you can fractionalise a property, with each owner of a portion of the property benefitting fractionally from its sale.

What to consider before investing in NFTs

NFTs are very new for the majority of investors and as such are highly volatile. The UK Regulator (FCA) consider cryptoassets to be ‘very high risk, speculative investments.’ NFTs are currently not regulated and you are unlikely to be protected by the Financial Service Compensation Scheme or Financial Ombudsman Service if something goes wrong, unlike more traditional investments. Equally financial advisers are not regulated to provide advice on the subject matter. Nevertheless, we can use FCA’s guidance around high risk investments to aid individuals who wish to incorporate NFTs into their portfolio:

  • Am I comfortable with the level of risk?

Typically, the higher the potential return the higher the risk. Seeing an NFT project named Bored Ape Yacht Club returning 58,118%, you have to ask yourself, what are the underlying risks and can you afford to lose all the money you invest should those risks not pay off. The FCA states ‘consider limiting yourself to not investing more than 10% of your net wealth in investments where there is a real risk of losing a significant part, or all, of your investment’.

  • Do I fully understand the investment being offered?

Make sure you fully understand what you are investing in. Ask questions such as how liquid is the investment? Is it easy to sell the investment? Would people be willing to buy the investment from you?

  • Am I protected if things go wrong? Are my investments regulated?

NFTs are a vastly unregulated space, with most tokens being classed by the FCA as unregulated. This means that your investment into NFTs will not be protected should something go awry.

To summarise, NFTs are seen to be a very interesting and exciting investment space with many different forms of potential utility. However, as they are not regulated and with their future being uncertain, they must be regarded as very high risk for the purpose of investment and as such an investor must be willing to lose the total value of their investment.

NFTs are not regulated by the Financial Conduct Authority

If you would like to discuss investment planning and tax planning more generally, please feel free to contact us on 01903 534587.

* The value of investments can increase or decrease so you may get back less than you invested