Non-Fungible Tokens (NFTs) - Buyer Beware in the Digital Era

Although they've been around since 2014, interest in Non-Fungible Tokens (NFTs) has exploded this year. Although the digital file that is an NFT includes details about what it represents, the old adage of "caveat emptor" (buyer beware) still applies.


What is an NFT?


Although it's an oversimplification, an NFT is a digital file (created through a process called "minting") that:

  1. Represents a tangible or intangible item; and

  2. Exists on a blockchain - a digital ledger that records every transaction related to that item to demonstrate true ownership.

Practically speaking, an NFT is a digital certificate of ownership. Because NFTs are digital, they can also contain anything digital - images, GIFs, video games, or even tweets.


The digital NFT file can also be programmed to include elements additional to those captured in traditional registers, such as royalties (so that the original creator can collect a percentage of future sales) or the signature of the original creator (to demonstrate authenticity).


Why Should I Beware?


There are a number of reasons why buyers, collectors, and investors should beware when purchasing NFTS.


First, not all NFT marketplaces require verification of NFT listings. OpenSea and Rarible, for example, do not require owner verifications for NFT listings. This allows sellers to sell NFTs for content they do not own. If an NFT is sold without the permission of the owner of the original work, the buyer may receive no rights in the work.


Second, the value of most NFTs is speculative. Their price is based entirely on what someone else is willing to pay for it - which means price is driven by demand (unlike stocks, which trade based on fundamental, technical, and economic indicators).


Third, verified NFTs may not contain all rights associated with the original work. Much like how an artist can continue to sell copies of their work even after selling an original, an NFT can be sold without passing the intellectual property rights (namely copyright) to the original work. Although the relationship between copyrights and NFTs is yet to be tested by the courts, an NFT that does not embody intellectual property rights may just be sold as a digital copy of the work. Thus, the owner of the copyrights may continue to produce copies (including other NFTs) of the work, diminishing the value of the NFT sold.


Bottom Line


Despite being backed by immutable blockchain ledgers, NFTs and their marketplaces still carry certain risks. Do your homework and exercise caution before buying.


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