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Q&A: What Advisors Should Know About Investing in NFTs

US News & World Report - Money 12/8/2021 Coryanne Hicks

TOKYO, JAPAN - 2021/06/25: Digital artwork form different artists is seen on a wall one day before the opening of CrypTOKYO Blockchain Art Exhibition 2021 in UltraSuperNew Gallery in Shibuya City. It is the first NFT (non-fungible token) exhibition in Japan and will give Japans art lovers, tech heads, and investors a one-of-a-kind chance to learn the history of NFTs, experience the technology, and meet its future stars

© (Stanislav Kogiku/SOPA Images/LightRocket via Getty Images) TOKYO, JAPAN - 2021/06/25: Digital artwork form different artists is seen on a wall one day before the opening of CrypTOKYO Blockchain Art Exhibition 2021 in UltraSuperNew Gallery in Shibuya City. It is the first NFT (non-fungible token) exhibition in Japan and will give Japans art lovers, tech heads, and investors a one-of-a-kind chance to learn the history of NFTs, experience the technology, and meet its future stars

Summer 2021 marked an upheaval in cryptocurrency investing with interest in nonfungible tokens, or NFTs, taking off. NFTs are tokens that represent ownership of unique digital or physical assets, such as art, music, an autographed tweet or even a part from a video game.

In fact, interest soared by more than 700% from the previous quarter, according to DappRadar, a source for managing NFT and decentralized finance portfolios. Instead of buying primarily Bitcoin and other cryptocurrencies on centralized exchanges, investors started snatching up NFTs to the tune of almost $10.7 billion in trading volume in the third quarter of 2021.

The key feature of an NFT is that the underlying asset is one-of-a-kind. This is what "nonfungible" means: While each individual Bitcoin is interchangeable, each NFT is unique. The fact that NFTs are original and may be based on collectibles that have historically appreciated in value make them interesting investment opportunities, especially for clients looking to diversify their traditional stock-and-bond portfolio.

To learn more about the investment case for NFTs and how financial advisors can use them in client portfolios, we spoke with Eliézer Ndinga, head of research at 21Shares, one of the largest issuers of cryptocurrency exchange-traded products in the world. Here are edited excerpts from that interview.

How are NFTs changing the investment landscape?

The NFT marketplace is experiencing enormous month-over-month growth in trading volume. NFTs went up by more than 900% in trading volume from $300 million in July to an all-time high of $3 billion in August this year. In fact, one NFT-gaming project similar to Pokemon, called Axie Infinity, generated over $800 million in revenue between August and November this year.

NFTs redefine the business models of various industries such as art, gaming, music and sports. These new use cases give the opportunity to retail and institutional investors to explore this space with a new angle. That said, NFTs should be approached just like any other investment: Conduct research, understand the associated risks and proceed with a healthy dose of caution.

How does investing in NFTs compare to investing in cryptocurrency directly?

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There are several differences when comparing investing in NFTs to investing in cryptocurrency directly. Like other forms of art, an NFT's value is based entirely on what someone else is willing to pay for it. As a result, demand dictates the sale price rather than fundamental, technical or economic indicators.

While NFTs are subject to capital gains taxes, just like when you sell stocks at a profit because they're considered collectibles, they may not receive the preferential long-term capital gains rates stocks do and may even be taxed at a higher collectibles tax rate. However, the IRS has not yet ruled on how to consider NFTs for tax purposes.

Additionally, it is worth noting that the cryptocurrencies used to purchase the NFT, and as such sell them, may also be taxed if they've increased in value, thus highlighting the importance of checking in with a tax professional when considering adding NFTs to a portfolio.

What is the greatest challenge for cryptocurrency ETFs?

The greatest challenge for crypto exchange-traded funds and decentralized finance more broadly is education. This is a fast-moving industry that is still very new to many investors, regulators, governments and financial institutions. We are in the early stages of crypto being adopted by mainstream investors.

At 21Shares, we see our products as a companion and, to some extent, disruption to equities, fixed income and other traditional market headwinds. For example, inflation, central bank influence (and) money printing. In comparison to other "pandemic-proof" investments, crypto provides the most superior risk-adjusted returns for investors.

Ideally, we can work with our corporate and governmental partners to empower more investors to participate in the new digital and decentralized economic system.

What role could NFTs play in a client's portfolio?

Our view is that NFTs provide yet another important use case for how investors can continue to diversify their exposure to crypto assets, akin to art collection.

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