What Alternative Investors Need to Know About NFTs

October 8, 2021

We’re sorry to tell you, but Grimes’ suite of art sold out for $5.8 million in 20 minutes, all offered in the form of NFTs.

Even if you’re not a fan of Grimes, art world aficionados are already familiar with NFTs, the latest blockchain craze that’s shaking up the art world. And for alternative investors who love art as a passion investment but don’t know about NFTs, it’s time to get familiar.

Here’s a look at what alternative investors need to know about NFTs—and how you can expect NFTs to shake up the digital art landscape.

What are NFTs?

Non-fungible tokens, or NFTs, are cryptographic assets on blockchain, each with a unique identifying code and metadata that makes the asset verifiable. These are not to be confused with cryptocurrencies or other blockchain assets—unlike any other type of blockchain asset, they cannot be substituted or exchanged for similar items.

Picture a Bitcoin. One unit of Bitcoin can function like a penny insofar as it has the same value if you swap it for another single unit of Bitcoin, or an equivalent sum in some other cryptocurrency.

NFTs don’t work like that. Every individual NFT is completely unique, which means it cannot be substituted for another NFT. That would be like trying to swap a Van Gogh for a Warhol—technically, they’re both paintings, but you’ll never win an argument saying that they’re interchangeable items. The same goes for NFTs.

Because of the unique construction of each NFT, they have several potential (and exciting) applications—including in the art world. Digital artists like Grimes are using NFTs for digital artwork.

How Do They Work?

Granted, that doesn’t quite explain why some NFTs (like Grimes’ digital artwork) can fetch millions of dollars, especially because these artworks are not physical items. In fact, they have no tangible form on their own, though the NFT can be bought and sold as property and doubles as a certificate of ownership.

To understand why, we have to dig a little deeper into how NFTs derive value.

Well, technically, we have to take a quick side-trip to a concept economists call a subjective theory of value, or STV, which says a good or service is valuable in proportion to its importance to the consumer, not because of its inherent value. A Van Gogh costs more than a painting made by your local artist in part because consumers view it as more valuable.

In other words, value is based on perception with a dose of supply and demand economics. This is how NFTs derive value. Grimes’ digital paintings might be worthless to some but worth millions to others, and those in the latter category drive value for the NFT. Plus, because each NFT is completely unique, it has a supply of one, which hurtles the supply-demand curve in one direction.

That doesn’t mean every NFT is worth millions, or even thousands, but it helps explain why Grimes could earn $5.8 million on a collection of digital artwork: people wanted it, therefore it was more valuable.

NFT Assurance

At this point, clever investors are slamming the brakes. After all, you can’t reproduce a Matisse, but you can reproduce thousands of digital replicas of a Matisse. What’s to stop a digital artist from doing the same?

That’s the area that held many digital artists back from being able to earn money on their work in the past—and why NFTs completely change the game.

Remember, NFTs are based in blockchain technology, which is a decentralized, immutable digital ledger for recording transactions. It’s all but unhackable (at least with our current computing power) since every block entered in the chain gets a hash and a timestamp linking it to the blocks before and after it—which means that to hack it, you would have to hack every hash in the chain, and the chain is constantly updated from nodes across the world.

Oh, and by the way, most blockchains are open-access, which means that anyone can view the transaction history and it’s relatively easy to spot shady deals.

Basically, blockchain is a list. An impressively secured list, but a list. NFTs, with their unique codes and metadata, are recorded in the chain just like cryptocurrencies, which means that once the transaction happens, the record of it cannot be erased.

This means that digital art encoded as NFTs are now as verifiable as historical artworks. They have a verifiable purchase history, an easily verifiable provenance from artist to owner, they travel securely between owners, and they have unique characteristics that distinguish them from forgeries.

NFTs and the Art World

Whether NFTs are art assets depends on who’s asking. Plenty of art world experts turn their nose up at paying thousands for a digital file that could be viewed online for free, and insurers still consider NFTs to be digital assets that cannot be covered under a fine art insurance policy (which only covers physical damage).

But for digital artists, it’s a brave new world for art. They leapt on the opportunity to earn money from artwork that previously got plenty of shares and no income to speak of. For these artists, NFTs envision a different future for digital art, one that transforms the creative process and how the world values digital art. Meanwhile, technologists point to NFTs as another step in the long-promised blockchain revolution that could upend consumer capitalism…when it finally arrives.

Are NFTs a fad? Maybe. Are they changing the art world? Absolutely.

Masterworks is a fintech company democratizing the art market. Our investors are able to fractionally invest in $1mn+ works of art by some of the world's most famous and sought-after artists.