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The collectibles industry used to be defined by classic keepsakes such as stamps, coins, and trading cards. Today, a new kind of collectible called non-fungible tokens (“NFTs”) has exploded in popularity. From music to digital game pieces, NFTs are digital assets that sometimes sell for millions of dollars. Twitter co-founder Jack Dorsey sold his first-ever Tweet as an NFT for $2.9 million!

But is there any substance behind the hype? And what does it mean for you?

Understanding NFTs

NFTs offer a blockchain-created certificate of authenticity for any digital asset. This asset can be a piece of music, a token for a popular game, or a piece of digital art. To understand an NFT, consider its components:

• Non-Fungible…Where cryptocurrency like a Bitcoin is designed to be readily tradable (fungible), non-fungible is just the opposite. There is one and only one of it.
• Token…In this case the non-fungible identification is attached to a specific digital asset or token.

Therefore, each NFT is unique and can readily solve the problem of users creating multiple copies of a digital asset. In effect, Jack Dorsey’s original tweet cannot be copied or duplicated because of NFT technology!

Why are NFTs popular?

Traditional artists rely on auction houses and galleries to sell their work. These galleries and auction houses authenticate the work as original. Now artists can sell digital works at the same prices as rare works of art by using NFTs to do the authentication work for them. It is so popular now that even companies are getting in on the action. For example, a Charmin digital brand was auctioned off to raise funds for charity.

Why are some NFTs so expensive?

Just like physical collectibles, there’s a market for NFTs. Current NFT buyers tend to be tech workers and entrepreneurs who understand the intricacies of purchasing digital goods. Artists are also dipping their toe into the NFT waters. For instance, superstar artists like King of Leon and Steve Aoki have sold NFTs for millions of dollars. Just imagine if your favorite musician decided to record an exclusive piece of music and then only sell 100 copies of the song. How much would you pay?

What You Need to Know

Here’s what you need to know about getting involved with NFTs:

• Large cash outlay is not necessary to invest. There are multiple NFT marketplaces where you can get involved as a buyer without getting into 5- and 6-figure bidding battles. Some of the more popular marketplaces are Opensea, Rarible, SuperRare and Nifty Gateway.
• Beware of fees to create NFTs. If you want to create your own NFT, you’ll likely spend hundreds of dollars in various fees to make your own tokens. If you end up selling your tokens, you may be able to cover the cost of these initial fees. If you struggle to sell your tokens, however, you’ll end up eating the cost of creating the tokens.
• Do your research. Since NFTs are so new, there isn’t a lot of history to judge its performance. As with any investment, you could either make a fortune, lose everything you invested, or end up somewhere in between. And these digital assets are treated just like other property, so you would pay capital gains taxes if you sold an NFT at a profit.
• NFTs require power. NFTs use blockchain technology. Blockchain technology requires power. Lots of it. There is growing concern on the energy usage for this new digital marketplace and whether it is sustainable.

Because NFTs are becoming so popular, so fast, many experts are leery of what the world of NFTs will look like in the future. Regulation is currently lacking, and legal precedence is unclear. While blockchain technology can verify your purchase, does owning the NFT of something really mean you own the asset? Will NFTs stand up in court? These are some of the questions being asked without concrete answers.

As always, should you have any questions or concerns regarding your tax situation please feel free to call.