NFTs: Making sense of the meteoric rise of the crypto art market

In a much-viewed Saturday Night Live skit earlier this year, the cast parodies Eminem’s song “Without Me” with the alternative title, “What the **** is an NFT?” The tutorial rap has students explaining non-fungible tokens (NFTs) as their classmates, professor and the U.S. Treasury Secretary (played by Kate McKinnon) listen. The tune is catchy and playfully mocks crypto art’s complexity—making it an instant hit. Contextualizing NFTs within the art market, however, requires a slower pace and a more nuanced conversation. We offer just that: a primer on NFTs and the art market.

An understanding of asset types

To understand Non-Fungible Tokens (NFTs), it’s helpful to contextualize them among other asset types. Fungible means “mutually interchangeable,” and this concept is useful, as it is the opposite of “unique.”

Breaking down different asset categories helps us understand how NFTs fit into the mix.

1. A dollar bill is fungible and tangible: This means it is physical and interchangeable. If I had 50 one dollars bills, you would likely accept any one of them, as each has equal value.

2. Cryptocurrency is fungible and non-tangible: Cryptocurrencies—such as bitcoin and ether—are digital and therefore non-tangible. However, like a dollar, each piece of cryptocurrency is interchangeable, meaning the individual piece is not unique. 1 bitcoin = 1 bitcoin.

3. Fine Art is non-fungible and tangible: An Impressionist painting by Monet is a unique (non-fungible) physical object. The same is true of other tangible collectibles like a classic car or a Barbara Hepworth sculpture.

4. An NFT is non-fungible and non-tangible: A non-fungible token is a digital asset with a unique code. NFTs represent unique digital data and function as a digital certificate of ownership registered and sold on the blockchain. The blockchain is like a digital ledger, so an NFT certifies that a digital asset is unique and not interchangeable. NFTs can be created for music, text, images and more, and exist in digital forms such as GIFs or JPGs. They can be sold as one-offs, limited editions or in open editions where anyone can buy one for a limited period of time.

Crypto art and digital art, explained

Crypto art is a term currently being used to describe digital art that is turned into an NFT. Although crypto art catapulted into the world’s consciousness this year, the technology has been around for a few years. In 2017, two developers at Larva Labs created computer software to generate 10,000 unique pixel portraits, each sized 24 x 24 pixels. They named them CryptoPunks, inspired by the London punk-scene, with perhaps a humorous reference to the designers’ rebellious streak as well.

Most of these images were offered for free, and the developers kept 1,000 for themselves. Nine of them sold for $16.9 million at Christies on May 13th. The lot description from the Christie’s website explains what NFT ownership confers, “There’s a composite image of all 10,000 CryptoPunks on Larva Labs’ website. Anyone can save a copy of the image file to their memory stick or hard drive. Each Punk also has its own page, detailing its special features and complete transaction history…But only one person can officially own a CryptoPunk.”¹

This description contextualizes some of the art world’s questions around digital art minted as NFTs. In the traditional world of collectibles, owning a Stradivarius, vintage Ferrari or Rembrandt painting confers the privilege of ownership and experience. Driving a Ferrari, playing a Stradivarius or basking in the aura of a Rembrandt is, for most, the end goal of ownership.

Many people in the art world wonder: if anyone can access and download the digital image, how is ownership “unique”? How is there long-term financial value in an object easily accessed by anyone? It is the opposite value paradigm of owning a collector car, a rare musical instrument or an Old Masters painting.

The crypto community has a different view. Tyler Winkelvoss, a co-owner of Nifty Gateway, an NFT platform, was quoted in a recent Esquire magazine article as saying, “Physicality is a bug, not a feature…There was no scarcity in ones and zeroes until you enter with the blockchain.”² While the traditional collector values the physical, Winkelvoss and others value the beauty of creating digital rarity in code.

Digital art often looks like graphic design or commercial illustration and digital artists often use AR (augmented reality) software and AI (artificial intelligence) technology. Mike Winkelmann is a digital artist better known as Beeple. His work Everydays: the First 5,000 Days, set a record for an NFT at auction for $69 million at Christie’s this past March.³

New artists, new buyers for NFTs

Beeple is a well-known artist within in his community, but not the art world, so it’s not surprising that the top bidders of Beeple’s NFT were from the tech and crypto community. The buyer of Beeple’s work was Vignesh Sundaresan, also known as MetaKovan. He is the founder of a cryptocurrency company based in Singapore.⁴ The underbidder was the 31-year-old founder of the TRON blockchain company.⁵

These bidders are part of a new generation. Christie’s reported that 353 bids had been placed on the Beeple NFT by 33 bidders. Almost 60% of those bidders were Millennials (those born between 1981-1996), with Gen X (1965-1980) making up another 33%. What’s more, 91% of the bidders were new clients to the auction house.⁶

Digital artists were naturally the first to seize the new technology options for monetizing their creativity. But some “traditional” artists are also interested in joining the NFT marketplace. A few examples:

• Swiss artist Urs Fischer recently sold his first NFT through the auction app Fair Warning for $97,700. Subsequent NFTs from his CHAOS series will be sold though PACE gallery and the NFT platform MakersPlace.⁷
• British artist Damian Hirst recently announced an NFT project with Palm, an alternative NFT platform that is touted as more environmentally-friendly.⁸

Even non-artists are minting their inventions, correspondence and other memorabilia as NFTs. Tim Berners-Lee, inventor of the world-wide-web, recently sold an NFT containing the web’s original source code for $5.43 million at Sotheby’s.⁹ In March, New York Times journalist Kevin Roose decided to “enter the freewheeling world of nonfungible tokens,” with a news column that was turned into an NFT and sold for over $500,000.¹⁰

These audiences represent what appears to be the emergence of a three-pronged marketplace:

• NFTs created by digital artists/graphic designers/tech community and sold at traditional auction houses
• NFTs created by artists with established galleries and marketplaces
• NFT platforms on which anyone can create and sell an NFT—not just creatives or artists

NFT creation, sale and ownership

Understanding the landscape for NFTs and their place in the art market also involves a basic understanding of how these tokens are created, purchased and stored. NFTs can be minted through companies with the digital infrastructure to create them. Some prominent names are MakersPlace, Nifty Gateway, OpenSea and Rarible.

To create and/or purchase NFTs through these online platforms, you first set up a digital wallet and add cryptocurrency—for example, ether (ETH) is the preferred cryptocurrency used on Ethereum networks. If you purchase an NFT, it is also sent to your digital wallet, where the image resides—so you can only display your NFT in a device that stores your wallet. (This is the case currently, but the technology could evolve).

Crypto art considerations: understanding regulation, copyright, loss and damage

While NFTs are hotly publicized today, there is also a lack of clarity around regulatory, copyright and legal issues associated with this new technology. We break down three of these considerations, including (of interest to those of us in the risk management space) some cautions for would-be buyers looking to help avoid loss and damage.

1. Cryptocurrency and NFT regulation

Cryptocurrency tokens such as bitcoin and ether are decentralized and not currently recognized, issued or regulated as legal tender by the United States Federal Reserve, but this may eventually change. As recently reported in the Wall Street Journal and Financial Times, some of the risks of unregulated assets can include value fluctuations, money laundering and the potential for tax avoidance on the profits from crypto-currency speculation.¹¹ In a recent paper describing NFTs as a digital gold rush, Withers law firm outlined how the SEC (Securities and Exchange Commission), FinCEN (Financial Crimes Enforcement Network) and the IRS are exploring regulation around this emerging but unregulated financial asset.¹²

2. Considerations with copyright

Another issue worth mentioning in a discussion of NFTs is copyright. Beeple and Urs Fischer created and sold their own digital art, but this is not the case for all NFTs. Tokenization is the term used when a physical asset—like a drawing by an artist—is “registered” on the Blockchain through an NFT. The NFT acts as a digital proof of ownership. Yet ownership of an artwork—physical or digital—does not automatically include reproduction and IP (intellectual property) rights.

A recent example highlights some of the potential risks. Recently, someone tried to sell an NFT of a Jean-Michel Basquiat drawing and claimed that “reproduction and IP rights would be sold to the highest bidder in perpetuity.”¹³ A representative of the artist’s estate told the The Art Newspaper, “The estate of Jean-Michel Basquiat owns the copyright in the artwork referenced. No license or rights were conveyed to the seller and the NFT has subsequently been removed from sale.”¹³ Since there is currently no regulation over what gets converted into an NFT, intellectual property lawsuits could occur as some people seek to profit from others’ creativity.¹⁴

3. Risks in a digital environment

Tangible fine art and collectibles can suffer physical loss or damage. NFTs are digital assets, not tangible physical assets. So, the next question is, how might NFTs be vulnerable to loss and damage, since they exist digitally rather than physically? We know the term cybertheft, which is the theft of personal or financial information from a computer. There appear to be similar cyber risks related to NFTs and digital wallets.

Journalist Tim Schneider wrote a recent article on ARTNET.com in about a form of cyber-counterfeiting referred to as “sleepminting.” NFT enthusiasts often highlight the verifiable chain of custody written in the Blockchain as providing inherent security, explaining that thanks to this digital provenance, potential buyers should be able to trust non-fungible tokens. However, Schneider explains how sleepminting could enable a sophisticated hacker to, “mint NFTs for, and to, the crypto wallets of other artists, then transfer ownership back to [him or herself] without their consent or knowing participation.”¹⁵

What’s next for a changing market?

For many in the art world, a more immediate concern is whether crypto art will stand the test of time and still be desired in the marketplace 5 or 10 years from now. Today’s hot market price may not be relevant tomorrow. Impressionist paintings and Greek antiquities, for example, are valuable today because they are recognized as historical objects that provide insight into political, cultural and aesthetic issues in the evolution of humanity. Do NFTs offer that in a unique way? And will new parameters for aesthetic valuation be created?

It remains to be seen, but one thing is certain: it will be fascinating to see how the market for art and collectibles—both digital and physical—continues to unfold.

Berkley One is a Berkley Company.