A non-fungible token — or NFT — is a unique digital asset verified by blockchain, the underlying record-keeping technology used to authenticate its originality and ownership. Blockchain was initially invented for the exchange of Bitcoin, the first cryptocurrency.

The market is growing fast

NFTs are credited with helping artists, musicians, and digital media companies to monetize and control the use of their creations. The market took off in 2021 when a flurry of digital collectibles — including images, videos, music, trading cards, sports highlights and memorabilia, virtual property in gaming worlds, tweets, gifs, and even viral memes — were minted as NFTs and traded by collectors. In March 2021, a digital image by a graphic artist known as Beeple was sold as an NFT for $69.3 million. This was the first sale in history by a major auction house of a purely digital work of art that doesn’t exist in physical form.1 Altogether, NFT sales skyrocketed to about $25 billion in 2021 from just $95 million the previous year.2

Currently, most NFTs are traded on the Ethereum blockchain platform, using its native currency Ether (the second-largest cryptocurrency by market value after Bitcoin), although some marketplaces accept other forms of payment.3 After an NFT is purchased, it’s kept in the owner’s digital wallet.

Traders could lose money or owe taxes

Avid fans may be happy to support artists whose work they admire, or the teams/athletes they follow, by purchasing NFTs. However, collectors should be aware that these are highly speculative investments. Just like some physical collectibles, NFTs may have little intrinsic value and can be sold only if there are willing buyers. Prices can be extremely volatile, and there is a high risk of loss as pop-culture trends shift. Many NFTs could eventually become worthless.

Profits on the sale of appreciated NFTs are typically subject to capital gains tax, and some NFTs are defined as collectibles under the tax code. This means that single filers with taxable incomes over $459,750 and married joint filers with taxable incomes over $517,200 (in 2022) who sell collectibles held longer than one year would be taxed at a maximum rate of 28% instead of the regular long-term capital gains rate of 20%, and they may also be subject to the 3.8% net investment income tax. Short-term capital gains on collectibles held less than one year are taxed as ordinary income, as they are with other investments.

Blockchain plays a key role

A blockchain is a digital ledger shared among a network of computers that can either be public (open) or private (closed). All network participants have simultaneous access to a single body of strongly encrypted data. When new information is added, it is time-stamped and linked to the prior record, forming a series of blocks in an unalterable digital chain. A blockchain can also be coded to execute or enforce smart contracts automatically when certain conditions are met. Because no third-party intermediary (or central authority) is needed, transactions can be completed instantaneously and at a lower cost. As a result, the opportunities for blockchain-based innovation extend far beyond cryptocurrency and NFTs.

All investing involves risk, including the possible loss of principal, but new technology ventures are especially risky. It’s important to be skeptical when evaluating a claim made by a company about its entry into this arena. Rising interest in blockchain and crypto technology is also being exploited by scammers, so steer clear of unsolicited investment offers — and never wire money to pay for an offer or service.

1) Reuters, March 11, 2021

2) Reuters, January 11, 2021

3) Money.com, April 4, 2022