Whether it’s Gary Vee’s VeeFriends, Beeple’s $69 million sale, or Andy Milanokis bragging on Twitter, NFTs have been all over the news in the past 18 months. Artists, content creators, brands, and even leagues like the NBA have tokenized their work. News networks have been reporting about digital NFT releases and auctions, accelerating the adoption of these collectibles into the mainstream.
But before we figure out where NFTs are going, let’s figure out what they are.
What are Non-Fungible Tokens (NFTs)?
Non-Fungible Tokens (NFTs) are digital items on a blockchain that are unique and cannot be replicated.
Let’s start by defining a token. A token is anything that is well-defined. Currency, the flag of your country, your car lease, those are all tokens because they can be defined. But in the world of blockchains, a token usually defines a cryptocurrency. And like other forms of currency, crypto is fungible. If you send 1 BTC to your friend and he sends you 1 BTC back, you have the same value of BTC as when you started.
If something is fungible, the units of that item are considered mutually interchangeable. The $10 bill in your pocket is fungible. Your $10 bill might be older than mine, but when we pay for something, both of our money is still worth $10. But what if a former president signed my $10 bill?
All of a sudden, my $10 isn’t so interchangeable. The bill I have is one of a kind. And while the value of that bill depends on who is valuing it, it’s surely worth more than just $10. So now, that bill has turned from one that is fungible to one that is non-fungible.
Something is non-fungible if it’s unique and non-exchangeable. It has to be something that is one of a kind. Gems are considered non-fungible because each one is unique. If you have a diamond, it would be very unlikely that it would retain the same value if you exchanged it for a random diamond since each diamond varies by size, cut, purity, etc.
NFTs are similar to gems in that way. The smart contracts create unique IDs and metadata for each NFT, making them un-interchangeable, even though the base files themselves may be reproducible.
Each NFT has record data on the blockchain that represents information about the NFT and to whom that data belongs. Having that data on the blockchain isn’t important, but having your name next to that data is important. Think of this like the verification checkmark on social media. While there may be thousands of fake Post Malone accounts out there, the checkmark separates the original from all copies. As the owner of the NFT, your name is now attached to that NFT until you decide to sell it.
Here is an example of the first NFT created by @mccoyspace, then purchased by @sillytuna for $1.4 million. @sillytuna will have their name next to that data forever, or until they decide to sell it.
Although anyone can download an image file of Dak Prescott’s interactive NFTs made by Ethernity, each NFT set can have one contract address, and each specific NFT has a unique ID. So even if two people exchanged VeeFriends tokens whose files were visually identical, they wouldn’t have the same assets as before because the data behind each NFT is different. It’s the ultimate proof of ownership for collectors. It brings power to the artists because it allows the original owner of the NFT to be attached to that forever, no matter how many times it’s sold in a secondary market. And most artists are paid a royalty percentage every time a token is resold.
Because NFTs are based on blockchains, NFTs can also be used to remove intermediaries and connect artists with audiences, simplify transactions, and create new markets while allowing the owner to retain copyright ownership of their work.
Remember Beeple, the guy from South Carolina that was mentioned earlier. He’s the guy who sold 5,000 images in March 2021, depicting figures from pop culture in chronological order. The bidding started at $100. The buyer of those images, who paid $69 million in total, is prohibited from selling individual images in the piece. However, because he retained the copyright to his work, Beeple was able to raise $6 million for the non-profit Open Earth Foundation by selling an individual image as a separate NFT.
What’s the use of an NFT?
Just like any other collectible, the use depends on who has the NFT. If you gave your $10 autographed bill to a kid, they might use it to buy candy. But if a collector gets that $10 bill, they might keep it forever and pass it on to their children and grandchildren. Beauty is in the eyes of the beholder, but the value lies in the eyes of the holder.
The primary function that NFTs serve for most people right now is bragging rights. Remember, the mainstream that this is hitting is the kids who grew up online. These “digital natives,” as they are sometimes referred to, have grown up with iPads in their hands. So what you and I used to think was a flex purchase, a car, a watch, a house, has now turned into digital flexing. Why pay $75,000 for a vehicle to show your neighbors and family when you could spend the same amount of money on an NFT and reach your tens of thousands of Twitter or TikTok Followers, and never have to take it for an oil change?
Like everything else, certain NFTs are more trendy, worth more, high demand, low supply, so people pay a ton of money for them to use them as their Twitter profile picture. The easiest way to gauge what it’s worth is by how much you can brag about it. And the internet makes that a lot easier and more fun to do.
But beyond bragging, we’re starting to see some really exciting uses beyond just a JPG file. I mentioned Dak Prescott’s NFT. A company called Ethernity Chain created an interactive NFT, that has three settings that change during the 2021 football season according to Dak’s gameplay. So based on how well or poorly the Dallas Cowboys quarterback plays that week, the NFT will change from futuristic blue and silver, to a fiery red, to storm, based on his quarterback rating.
Imagine your autographed baseball changing colors in your room, based on whether or not the team won the game that day. Or the jersey hanging on your wall changing colors based on the jersey the team is wearing that day. It would have been game-changing to me as a kid if my Pokemon cards changed based on various factors.
Earlier I also mentioned Gary V’s VeeFriends. These are interesting because not only are they digital NFTs, but they also have additional utility. There are 10,255 total VeeFriends tokens organized into three categories – access, gift, admission. Access tokens are redeemable to unlock unique experiences with Gary, like playing tennis, having dinner, coaching, etc. Gifting tokens allow the holder of the token to receive a certain number of physical gifts in the mail per year. And Admission tokens allow for admission to a Gary V convention named “VeeCon.” So not only are you purchasing something digitally that you can hang on to forever, you’re buying real-world experiences as well, with your favorite marketing guru. Think about how other coaches and industries can adopt a concept like this.
Think about how this can apply to music; the Kings of Leon already released their March 2021 album as an NFT, making it an instant collector’s item. We are just getting to the tip of the iceberg with the potential for this technology.
Think about how this can be utilized in your business someday. It might seem farfetched now, but I’m sure there’s a way. After all, those NFT holders will likely be our customers someday, so stay ahead of them always and give them what they want.
What are NFTs selling for?
The biggest marketplace for NFTs is OpenSea; it’s a place to Create and Sell your NFTs and purchase them. And once you purchase them, you can list them right for sale again on OpenSea. The prices are all over the place; they range from $5 to hundreds of thousands. But of course, on the news, we only hear about the ones that cost millions and millions.
Over the past six quarters, the quarterly sales have increased from $7.24 million per quarter to $1.24 billion in Q2 2021. But OpeaSea, the marketplace mentioned above, saw sales of more than $3 billion in August 2021.
How are NFTs taxed?
That’s what piqued my interest in NFTs. Creating an NFT is not a taxable event. However, purchasing, trading, and disposing of an NFT is a taxable event. Notice how I accidentally kept referring to NFTs as collector’s items? Well, that’s because that’s how they’re treated for tax purposes.
When you purchase an NFT with crypto (usually ETH), you’re creating a taxable event since you’re disposing of that ETH. So you’ll pay tax on the gain (or loss) of that ETH that you disposed of. So if you bought the CryptoPunk for 2 ETH (worth $5,000 at the time), and that 2 ETH was purchased two years ago for $1,000 total, you’ll owe tax on the $4,000 gain. Luckily, it’s a long-term gain, so it’s taxed at a lower rate.
When trading or disposing of an NFT, some considerations have to be made. The IRS has yet to issue definitive guidance on the issue, but when collectibles, like art, rugs, gems, metals, coins, are sold more than a year after they’re held, they don’t get the benefit of a lower capital gains rate, the capital gains rate on collectibles held long-term is 28%. Most NFTs that are available now probably fall under this collectible category, being digital art. So if you purchased an NFT for $5,000, held it for a year two months, and either sold it for $10,000 worth of ETH or traded it for another NFT worth $10,000, you’d have to pay tax on a $5,000 long-term capital gain, as collectible, which would be subject to 28%. That‘s right, even if you don’t receive ETH that you can convert to cash and pay your tax bill with, even if you just traded it for another NFT valued at more money, you still owe the capital gains tax on that increase in asset value.
Have fun with the NFT space, research them online, check out OpenSea, check out what other brands, leagues, and companies are doing with them. There is a ton of potential there and a way to really, really easily expand your customer base worldwide instead of being limited to just where we live or where our office is. But most important, keep accurate records and data about any crypto dealings, whether it’s cryptocurrency purchases, NFTS, staking, mining. Whatever you’re doing, there are tax implications, so ensure that you’re compliant.