NFT stands for non-fungible token. Non-fungible is an economic term that means that it can’t be interchanged due to its unique properties. A Rs 20 note can be interchanged with another Rs. 20 or two Rs.10 notes.
NFTs are digital representations of real-world objects like art, music, in-game items and other collectibles tied to a blockchain. NFTs are generally purchased with cryptocurrencies such as Ethereum or in dollars. The blockchain technology keeps a record of transactions. NFTs allow people to prove ownership of digital assets and give them, a kind of, digital bragging rights.
Example: In March 2021, Twitter CEO Jack Dorsey sold his first-ever tweet as an NFT for $2.5 million.
NFTs are traded on specialized platforms like in the case of cryptocurrencies. There are many popular platforms for trading NFTs in India.
Anyone on the internet can mint i.e. create an NFT out of anything. This means there are a lot of worthless or even copied versions of original NFT tokens out there for trade. It takes an experienced eye to weed out what’s worth collecting or investing in. Further, there exist risks of people minting an NFT out of a file that doesn’t belong to them; And they pass it off as their own to unsuspecting buyers.
Various types of manipulation and malpractices that are prevalent in other markets also take place in the NFT marketplaces. For instance, there have been many cases of Wash trading. That is, someone simultaneously sells and buys the same NFT to create misleading, artificial activity in the marketplace. The motive is to artificially pump the price. An experienced NFT collector/ trader might be able to sniff it out, but might be tough for newcomers to identify.
The NFT market is highly volatile. This is because the market is at its nascent stage and is yet to evolve. Also, there aren’t any proper mechanisms in place to help people price the assets. Lack of awareness about NFT among people doesn’t help.
How easily an asset can be exchanged for cash- of NFTs depends upon the popularity of the NFT. This is because, in the NFT marketplace, every seller needs to find a buyer who’s willing to pay a certain price for that particular, unique NFT. More popular the NFT, the larger the number of potential buyers it has. However, since NFTs are not widely understood, the number of potential buyers and sellers is small. This leads to NFTs being very difficult to trade, especially during periods of distress.
Unlike interest-bearing bonds, dividend-paying stocks and rent-generating real estate, NFTs do not offer their owners any income potential. The returns associated with NFT investments are based wholly on price appreciation.
Currently, most marketplaces use the Ethereum network to power their transactions. So, a buyer will need Ethereum’s native token Ether (cryptocurrency) to purchase an NFT. If a buyer does not have Ether tokens, he/she can open an account with a cryptocurrency exchange to purchase the tokens from there.
A buyer also needs to set up a crypto wallet compatible with Ethereum. A crypto wallet is a digital address where you can store cryptocurrencies that you’ve purchased. A buyer can choose among platforms and register to open a wallet with them. After opening the wallet, one will need to send the ether bought from the exchange to the wallet’s address.
The next step is to choose the marketplace for the buyer to purchase NFTs. A buyer will then need to register an account at the preferred marketplace.
Next, the buyer has to connect the wallet to the marketplace. Most marketplaces have a simple ‘Connect wallet’ option on the platform.
After all the above steps have been taken, a buyer can now start browsing the marketplace and choose an NFT which he/she wishes to buy. Most marketplaces have an auction system set up for purchasing NFTs. Hence the buyer will need to bid for the NFT he/she wants.
After a successful bid, the buyer will complete the transaction and the necessary amount will be debited from his/her wallet. Along with the price of the NFT, certain other transaction fees such as gas fees will also be charged.