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What Advisors Should Know About NFT Investing

Every day seemingly brings a new scam in the world of crypto, and yet the growth of the industry is in no way slowing.

The popularity of non-fungible tokens (NFTs), at least for now, continues to overshadow news of scams such as “rug pulls,” where NFT creators hype up the value of a new digital asset then cash out once people buy into it. Consider the recent Frosties rug pull, where more than 2,000 people bought $1.3 million in cartoon ice cream digital collectibles before the anonymous creators shut down their social media pages and disappeared. The collection of 8,888 NFTs still remains, but digital assets are only as strong as their leaders; with nobody to head up the Frosties community, all those pieces of art are nothing more than cute cartoons.

This article originally appeared in Crypto for Advisors, CoinDesk’s weekly newsletter defining crypto, digital assets and the future of finance. Sign up here to receive it every Thursday.

DYOR

The general guideline among the crypto community is DYOR – “do your own research” – when buying into an NFT project of any size. But in a sector that’s evolving so fast the federal government can’t keep up and hackers are getting away with billions, what constitutes “research” can feel more like Google searches, Twitter Spaces chats and shaky ground.

NFT collectors suggest making friends with others in the space before investing any money in new projects or communities. An easy way with a low barrier to entry is to start by joining free Twitter Spaces chats and Discord communities, where you’ll learn about the added benefits that NFT projects offer buyers (known as utility), industry news and more.

From a financial planning perspective, NFTs are likened to rare collectibles like comic books, authentic artwork, doll collections, sneakers and other alternative investments: Enjoy them, but don’t expect them to fund your whole retirement. (NFTs also involve special tax considerations.)

Except, in some cases, NFTs can change someone’s financial situation dramatically – or at least they have. Consider the World of Women NFT collection, which dropped in July 2021 and had an early average price of .1 ETH (somewhere around $300 USD). The collection now ranks on OpenSea, where each NFT is valued at 7 to 8 ETH on average (between $21,000 and $24,000 at the time of writing). Or the sold out Women Rise NFT collection, which reached 1,900 ETH in trading volume (approximately $5.9 million at the time of writing) in just a few months.

Buying an NFT creates an indelible record of digital ownership on the blockchain, so the tokens can therefore serve as a membership ticket of sorts. It’s not every community’s recipe for success, but many NFT creators added value to their projects through utility to NFT purchases, awarding investors with exclusive access to online clubs, gaming communities, Discord chat rooms and interactive experiences – all in addition to the art itself.

The risks and rewards of NFTs

All this fast money has the NFT world divided. On one hand, the potential of NFTs is undeniable, but on the other, the risks and rewards are a bit head-spinning.

“This NFT thing is like when a dog gets a new toy and they just keep ripping the toy out. And then now they don’t have a toy,” said Nelson Merchan Jr., co-founder and CEO of blockchain public relations firm Light Node Media. “ It’s kind of like we’re almost doing the same thing, and we’re realizing, ‘OK, maybe we shouldn’t do it this way.’”

A crypto investor since 2017, Merchan has owned NFTs from the popular Pudgy Penguins collection since shortly after it dropped in June 2021. The Pudgy Penguin founders were recently ousted by frustrated collectors who were tired of waiting for the project to deliver on its grandiose promises. But Merchan, surprisingly, isn’t terribly concerned about the state of his Pudgy Penguin NFTs, noting the promise inherent in what the situation demonstrates.

“It was definitely not a rug pull,” said Merchan, noting that rug pulls happen with speed and anonymity. During the alleged Bored Bunny rug pull on Jan. 5, for instance, scammers seemingly made off with 2,000 ETH in just a few hours before silencing their social media accounts.

The Pudgy Penguins project stands a chance, Merchan argues, because the process of replacing the leaders was community-driven, public and more or less democratic.

“Some of these projects that have been failures are actually really good,” he said. “The community, through the failure, is having to figure out how to build something from this really cool NFT and say, ‘Let’s make it work.’ Those are the NFT projects that I think have significant potential to grow because it’s the community saying we’re going to do something about it. At the end of the day, with NFTs and really crypto in general, it’s all about the community. If the community is strong, the project is going to be strong.”

When it comes to long-lasting value, investors should think into the future about ways that NFTs can integrate with existing infrastructure, argues Merchan. Through smart contracts and QR codes, NFTs have the potential to unlock greater value in both the metaverse and the “real” world through ticketing, VIP memberships and sales.

Consider the club scene. “People go to the club party, they order bottles, the promoters are there,” Merchan said. “The club is always looking for ways to keep people coming back and excited about their brand. This is where NFTs are going to be perfect. Say you attend the club a few times in that month; you’re getting a specific amount of NFTs each time you go. Maybe the level of the NFT increases in rarity if you go, let’s say, three or four times in that month.”

Rare NFTs will theoretically determine whether a person gets rare perks. And all these transactions will exist on blockchain, a sort of digital ticket stub that definitely beats the shoebox most of us kept collectibles in as kids.

Decentralized value investing

It’s almost as if investing in an NFT community could be considered a form of decentralized value investing.

“I’m really investing in the community, or at least the potential of the community to come out of these NFTs,” Merchan told CoinDesk. “If you look at it from the outside, they’ve been failures – almost all of them. But the energy is actually really strong.”

The trick is to not buy the hype, no matter how enticing. “It’s just a very crazy industry. You have to keep more of a long-term perspective. If you’re buying an NFT to flip it, well, that’s just trading. There’s a lot of risk involved,” said Merchan.

“But if you’re buying it because you truly like the community, or because something about it intuitively makes you feel like it is going to go somewhere, that I think is a lot more appealing,” he noted.

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