Non-Fungible Tokens (NFTs)

A Non-Fungible Token (NFT) is a unique, one-of-a-kind digital identifier recorded on a Blockchain that is used to prove ownership of an asset, most commonly a piece of digital art, a video clip, or a virtual item. The “non-fungible” part is key. Think of something fungible, like a dollar bill or a share of Apple stock; each unit is identical and interchangeable with another. In contrast, something non-fungible is unique and cannot be replaced with another, like the original Mona Lisa painting. An NFT acts as a digital deed or certificate of authenticity for its associated item. This certificate is secured by the same cryptographic technology that underpins Cryptocurrency like Bitcoin or Ethereum, making its record of ownership supposedly immutable and publicly verifiable. While proponents tout NFTs as the future of ownership in a digital world, they represent one of the most speculative crazes in modern financial history.

This is the million-dollar question, and the answer often surprises people. When you buy an NFT, you are typically not buying the digital artwork itself (e.g., the JPG or GIF file). Instead, you are buying a token that exists as a snippet of code on a blockchain. This token, governed by a Smart Contract, contains metadata, which usually includes a link that points to where the actual digital file is stored on a server somewhere on the internet. Think of it this way: you are not buying a house, but rather a deed that has the address of the house written on it. This distinction is critical because if the server hosting the artwork goes offline, your NFT becomes a “deed” that points to an empty lot. The ownership record on the blockchain remains, but the asset it represents is gone. You own a provably unique link to a broken image.

For a value investor, the analysis of any potential Asset begins and ends with a simple question: does it have Intrinsic Value? That is, can it generate cash for its owners over its lifetime? This is where the entire concept of NFTs as an “investment” collapses.

A stock has intrinsic value because it represents a fractional ownership of a business that produces goods or services and, one hopes, generates profits. A bond has value because it contractually promises to pay interest. A rental property generates cash through rent. An NFT, in almost all cases, generates nothing. It does not produce cash flow, pay a dividend, or create any economic output. Its price is determined by one thing and one thing only: what the next person is willing to pay for it. This is not an investment thesis; it is a textbook definition of the Greater Fool Theory, where the only path to profit is finding a “greater fool” to buy the asset from you at a higher price.

The father of value investing, Benjamin Graham, defined an investment as an operation that, “upon thorough analysis, promises safety of principal and an adequate return.” Anything that does not meet this standard is, by definition, Speculation. Trading NFTs is pure speculation. It is a bet on market sentiment and mass psychology, not on the fundamental, cash-generating capacity of an underlying asset. While fortunes can be made in speculative frenzies, they can be, and more often are, lost just as quickly when the narrative changes and the crowd moves on.

The NFT craze of 2021-2022 rhymes perfectly with some of history's most infamous speculative bubbles. In the 1630s, the Netherlands was gripped by Tulip Mania, where the prices for rare tulip bulbs reached astronomical levels before collapsing to almost nothing. The tulips, like today's digital images of bored apes, had no intrinsic value. Their prices were driven by a social frenzy and the fear of missing out, a potent but fleeting combination.

Beyond the philosophical objections, NFTs carry a host of very real and potent risks.

• Extreme Volatility: The prices of NFTs are hyper-volatile. An NFT purchased for thousands or even millions of dollars can see its market value evaporate to zero in a matter of weeks or days once the hype fades.
• Crushing Illiquidity: If you own a stock, you can almost always sell it instantly at the prevailing market price. With a unique NFT, you must find a specific buyer willing to purchase your specific token. If demand dries up, you can be left holding a completely illiquid asset, unable to sell it at any price.
• Technical Fragility: As mentioned, the underlying digital file can disappear. Furthermore, the platforms and blockchains they are built on are new technologies with their own sets of risks, including bugs, hacks, and network failures.
• Rampant Fraud: The largely unregulated NFT market is a minefield of scams, from “rug pulls” (where developers abandon a project and run off with investors' funds) to phishing schemes and outright theft.

NFTs are a fascinating cultural and technological phenomenon. They may well have future applications in areas like ticketing, gaming, and digital identity. However, as an asset class for the ordinary investor looking to build long-term wealth, they fail every fundamental test. Treat them like you would any other collectible, be it Beanie Babies, stamps, or baseball cards. They are items for hobbyists with disposable income who enjoy the thrill of collecting and are fully prepared to lose their entire principal. For the serious investor, capital is a precious resource. It should be allocated to productive businesses that build real-world value, not to digital tokens whose only value lies in the ever-fickle mind of the crowd.