By now, you’ve seen the three letters, N-F-T, as they have taken the worlds of art, finance and sports by storm. Patrick Mahomes and Mark Cuban are both in; your friends or even your children likely are too, spending time—if not millions of dollars—on new sites from Dapper Labs and OpenSea.
NFT evangelists believe the technology will redefine ownership in a digital world. Skeptics question why suckers are paying millions for images and video clips that are easily viewable online. Meanwhile, plenty of others are simply asking, OK, but what is it, exactly?
NFTs, or non-fungible tokens, share some similarities with cryptocurrencies like Bitcoin. But whereas a bitcoin is like a dollar bill—insofar as each one is worth as much as every other (making them fungible)—NFTs are individually unique. Even if an artist uploaded the same image as an NFT twice, the two would be distinct entities on the blockchain, which is, of course, the decentralized (and therefore unalterable) online ledger that tracks and verifies transactions in the cryptocurrency world. So one of those identical-looking NFTs could be worth more than the other by virtue of, say, the order in which they were produced, for example.
Largely built on the Ethereum blockchain, NFTs often serve as digital certificates of ownership, though they can also have digital assets, like images or music, attached. For now, the most popular applications of the tech have come in the world of digital art and collectibles. Sometimes the online tokens also unlock real-world tangible products, like custom basketballs or concert tickets. Theoretically, an NFT could even represent a land deed or any singular item.
Based on the digital contract language, some NFTs convey more rights than others. “Owners” of highlights on NBA Top Shot, for instance, don’t have the legal right to reproduce or profit off of the clips in the collection. They only own the specific Top Shot collectible, referred to as a “moment.” Each moment comes with a unique serial number, and the blockchain it’s built on (or “minted,” in cryptospeak) ensures its authenticity.
NFTs’ limitations haven’t stopped the market from exploding of late, though. Pieces of digital art that used to sell for $1 can now go for as much as $150,000. NFT marketplace OpenSea has seen its sales volume balloon from $8 million in January to more than $80 million in February.
Yes, it’s all a bit crazy. But it also could only be a taste of what’s to come. With so much novelty and so much volatility, it’s reasonable to have questions. Here, we provide some answers.
How does one enjoy an NFT?
The files are digital and can be viewed on a computer, but there are ways to show them off in more traditional ways. RareRooms creates virtual, 3D rooms where collectors can show off their purchases. Even more tangible, Infinite Objects lets you frame digital art, even short clips, to put on your wall. There has also been talk about the real-world experiences NFTs could unlock, like a Q&A only available to certain NFT holders, though that remains more theoretical.
Still, the limits of digital goods often mean owners can do less with their possessions for either technical or legal reasons. They also rely on the product’s creator to keep supply limited. Many of the items also still require a digital currency like Ether to purchase, meaning their value is in some ways tied to another volatile asset. As long as skepticism remains in traditional collecting communities, some will see that as a knock against the space, while others see room to grow.
What does it mean for leagues and athletes?
It’s another marketing opportunity. In the same way leagues sell licensed apparel, video games, barbecue grills and memorabilia, NFTs are just another class of e-commerce (albeit one with many more potential applications). Top Shot is a good representation of an early NFT from a league itself, while Rob Gronkowski’s own digital cards show a player-driven version.
The short-term innovation will likely be driven by athletes, who are increasingly becoming their own media platforms. Players’ unions large and small have taken great steps in the past few years to help stars monetize themselves apart from their teams. The NBPA, for example, took back group licensing in the last round of labor talks; the NFLPA and MLBPA recently helped launch OneTeam Partners, a marketing venture that also works with unions representing MLS, WNBA and USWNT athletes.
Can media companies get involved?
Yes, and they already have. Anyone who owns popular IP can mint and sell NFTs. WarnerMedia’s Bleacher Report, for example, just sold a limited run of digital basketballs in connection to a celebrity 2×2 event it held over NBA All-Star Weekend.
How do the economics break out?
There’s a lot that makes NFTs attractive from a unit economics standpoint. Designs are digital, there’s no supply chain, and delivery to customers can be instantaneous. In the Bleacher Report example, the company chose to also create and deliver actual basketballs to the people who purchased their “Gold Edition” NFTs. The digital art cost less to produce and was delivered on March 6, right as the auctions ended; the actual basketballs need to be manufactured and shipped across the Pacific Ocean.
It took Bleacher Report just 10 days from idea to market for those NFTs, which banked more than $810,000 in sales. That money will be shared across B/R (it was created by an in-house designer), the rappers who participated in the event, the company that helped mint the NFT (GigLabs) and the marketplace where they were sold (OpenSea).
If these are such a big business, what about the tax implications?
While collectibles, including NFTs, are increasingly thought of as investments, they often come with unenviable tax burdens. Top-line returns may be eye-popping, but you’re going to have a higher hurdle to leap in order to realize a net profit after you render unto Caesar. The long-term tax rate on collectibles—those held one year or more—is 28%, not the lower rates enjoyed by stocks, bonds, real estate or other traditional assets, according to The Tax Adviser, a CPA-focused publication. Those old-school investments are taxed at long-term rates of 20%, 15% or nothing at all (depending on your income tier).
Another reason for finding a good accountant: It’s not clear if the Internal Revenue Service would always consider an NFT an investment or a collectible held for personal enjoyment. That has implications for whether you can offset NFT sale gains on your taxes or even if you can deduct any future loss of value. There are further complexities if the collectible is held in a business partnership or a trust, which could trigger capital gains if one’s stake in the partnership is sold, even if the NFT it possesses isn’t. And if the NFT also comes with some sort of right to a physical object, taxation will be complicated once again, according to ZenLedger, a cryptocurrency tax software provider. Don’t get us started on the implications of an NFT being sold as part of a fundraiser, like Mahomes’ were.
The complexities don’t stop there. Popular NFT platforms, like Rarible, conduct transactions in cryptocurrency only. Unless you convert a fiat currency (like a dollar) to crypto and then are able to buy an NFT without the value of your crypto shifting much, you’re OK. But if when you buy the NFT, your crypto is worth more than you paid for it, you’ve created a taxable event. That is, you’ve recognized a gain on your cryptocurrency by trading it for an NFT, according to Shehan Chandrasekera, the head of tax strategy at Cointracker, a crypto site.
And what about for the people offering the NFTs?
Businesses creating and selling NFTs—or holding them for whatever reason—aren’t addressed specifically by accounting rules (in the U.S. at least), and so they need to be reconciled with existing regulations, according to Deloitte. That means crypto for a business—whether a currency or an NFT—doesn’t count as cash, a financial instrument or even inventory. “It is not possible for the company’s accounting function to reflect the economics of how it may value its digital assets,” the accounting firm noted. For a business involved in NFTs, generally speaking, transactions will be considered barter. Like normal sales for cash, barter transactions need to be reported to the IRS and will affect everything from total tax liability to employment taxes.
Lastly, because NFTs are unique, it’s easier for the IRS to track sales and identify tax cheats using the same methods they deploy today for cryptocurrencies.
Ok, so should I invest in NFTs?