Should You (or Anyone) Buy NFTs?

Before you buy an NFT, make sure you understand the risks.

NFTs, or non-fungible tokens, are another facet of the recent crypto boom. Over $250 million worth of NFTs was traded in 2020, according to NonFungible. That's an increase of 299% on the year before. And it's just one of the reasons people are wondering if they should buy NFTs.

But what exactly are they? NFTs are tokens that contain an item's ownership and copyright information. You can buy NFTs in art, music, sports trading cards, virtual land, and in-game collectibles. You can even buy NFTs for real-life collectibles, but they are less common.

If something's fungible, it's interchangeable with another item of the same type. For example, a $10 bill could be swapped for another $10 bill -- or two $5 bills. In contrast, an original piece of art or a signed first edition of a book is non-fungible. They are unique.

The information recorded in an NFT essentially lets a creator digitally "autograph" their art. So even if an image or piece of music has been shared hundreds of times, if you buy the NFT, you're buying something unique. Each token is recorded in an immutable ledger, using the same blockchain technology that's behind various cryptocurrencies.

Considerations when buying NFTs

The biggest risk when buying NFTs is the volatile and unpredictable nature of this new market. People are also worried about the high levels of energy consumption involved. Here are a few other factors to bear in mind:

1. It's a very new market

We don't yet know how the NFT market will develop in the coming years or decades. Take Beeple's digital art that recently sold at Christie's for over $69 million. That piece may appreciate considerably, or it could completely lose its value. We just don't know.

For all the experts who say that NFTs are here to stay, there are many who question the market's longevity and see it as a bubble.

Everything crypto is hot right now. The price of Bitcoin -- the first and most popular digital currency -- has increased around 180% so far this year alone. The difficulty in markets where people are willing to spend crazy money on crypto-anything -- regardless of whether there's substance to it -- is how to find the good long-term investments. If you're not involved in the art world, that will be extremely challenging.

2. Fraud and theft

One of the big selling points of NFTs is that they allow digital artists to claim ownership of their work. Previously it was difficult to earn anything from files that people could download and share for free (often without the artist's permission). However, this does not mean NFTs are immune to fraud.

Unfortunately, there are already cases of artists complaining their work has been tokenized without their knowledge. As yet, it isn't clear how artists can reclaim ownership of their work once it's been wrongly entered onto the blockchain in someone else's name.

Just as you would with a cryptocurrency exchange, check out the NFT exchange you plan to buy from. Make sure it carries out a high degree of artist verification and has good security credentials.

Another issue that hasn't yet fully unfolded is NFT theft. Like cryptocurrencies, your NFT could be stolen. If you keep your NFT on the exchange where you bought it, make sure you have good password security and enable two-factor authentication. If you've purchased a high-value NFT, you might consider storing it offline in a secure location that's difficult to hack.

3. Copyright

Know that when you buy an NFT, you probably won't own the copyright to that art. In many cases, the artist retains the copyright and can claim royalties when the item is sold. Some NFT buyers haven't understood this, and buy in the belief they'll be able to do as they please.

Look at it this way. If you bought an autographed copy of a book, you wouldn't assume you owned the copyright to that book. It's the same with NFTs. Each token contains something called a smart contract, which sets out what rights the NFT owner has. For example, the NBA Top Shot collectibles contain limited permissions for the owner to share and display their NFT for noncommercial use.

Make sure you understand what terms are involved before you buy.

4. Storage

We touched on the possibility that your token could be stolen. But what about the original file? You can't store the individual assets in the blockchain ledger -- the ledger stores the token, not the item itself. Your NFT contains something like a URL link to the item you've bought.

So, your digital art will be stored elsewhere. What happens if that file type stops working, or the data gets corrupted? Or the domain goes bankrupt and ceases to exist?

As a buyer, you'll need to find out where your asset will be stored and take steps to ensure the company hosting your asset will maintain it.

Should I buy an NFT?

The issues above are all solvable problems. But the industry is at such an early stage, it's not yet clear what the solutions will be -- and whether they'll protect early NFT adopters.

Buying an NFT right now is incredibly risky. NFTs are a volatile part of the already volatile cryptocurrency market. Moreover, even traditional art and collectibles are hard to value and difficult to invest in if you don't understand the market.

It isn't a great idea to invest in NFTs because you're scared of missing out on an opportunity. Indeed, it likely only makes sense to invest in NFTs if you can check any of these boxes:

• You understand the traditional art market
• You are already a collector -- of sports trading cards, art, or anything else
• You aren't trying to make a quick buck, and you see long-term value in the investment

Finally, you should only invest in NFTs if your emergency fund is fully funded and you are on top of your retirement contributions. There's a chance the NFT market will grow and your NFTs will appreciate in value. But before you buy, ask yourself if you want to bet cash you actively need on the chance your investment will fail.