The rise and applications of NFTs
In early 2021, the artist Beeple sold a non-fungible token (NFT) collection at Christie's for a record-setting $69 million. The rise of NFTs is changing how collectibles are bought and sold. But what exactly is an NFT, and how is it used beyond art collections? What are the implications for creators, owners, sellers, and investors? How are NFTs used in a business context?
What is a Non-Fungible Token (NFT)?
The term "fungible goods" is used by economists to describe interchangeable goods (e.g., a bushel of wheat.) A non-fungible asset, like a piece of artwork, can't be traded or exchanged at equivalency like you could with currencies or cryptocurrencies, which are a medium for commercial transactions.
A non-fungible asset can be either digital or physical. An NFT is a cryptographic record of ownership for an item encoded into a blockchain with unique identification codes and metadata. The token enables the transfer and tracking of ownership of these assets among holders.
How are NFTs used?
Currently, most NFTs are based on the Ethereum blockchain. The tokenised assets can be bought, sold, and traded globally without the risk of fraud and forgery. NFTs can also be used to present individual identities, property rights, and more.
Although NFTs can be applied to any assets (eg, real estate,) their current market focuses on collectibles, such as digital artwork and sports cards. People are also trading highlights of sports or other events (e.g., NBA) as digital cards and video clips on NFTs. Meanwhile, Twitter founder and former CEO Jack Dorsey tokenised the first tweet ever written and sold it for $2.9 million.
The application of NFTs will become much wider as more people and organisations realise its many advantages. For example, it can remove intermediaries in a transaction and facilitate identity management. It can also connect buyers and sellers to create new markets that don't yet exist.
What do NFTs mean to buyers, sellers, owners, investors, and businesses?
By enabling digital representation of physical assets and combining it with a tamper-resistant blockchain of smart contracts, NFTs are introducing significant changes in how assets are traded.
NFTs essentially convert a physical asset into a digital one, which helps remove intermediaries in transactions. For example, artists can connect directly with collectors instead of working through an agent. NFTs can also improve business processes, for instance, by allowing different parties in a supply chain to verify the provenance, production, and sale of a product to ensure its authenticity.
By converting physical identification documents (e.g., passports) into NFTs, entities can verify their identities without physically presenting a piece of documentation. This can help facilitate cross-border transactions and streamline business processes while reducing the risks of identity theft and fraud that can cost companies reputational and monetary losses.
The digitalisation of physical assets makes fractional ownership and the democratisation of investment feasible. The ability to verify and track ownership can open up more investment opportunities in many asset types while the ease of investing and trading can increase the worth and revenue of an asset.
By simplifying business processes and transactions, NFTs can facilitate the creation of new markets or investment vehicles. For example, a seller can tokenise a piece of land. Each parcel will have its unique characteristics and be priced differently using relevant metadata. This bypasses traditional complex and bureaucratic trading processes and enables more investors to participate in the market.
Understanding the taxation implication of NFTs
As NFTs become more widely used, we need to consider how taxation and financial reporting work for these assets. Governments are still grappling with this new form of investment, and investors must understand their local tax laws when buying and selling NFTs.
In the US NFTs are classified as capital assets unless the seller is in the trade or business of buying and selling NFTs. While artists and creators may not be taxed for creating an NFT, the sale can be taxed as ordinary income subject to self-employment tax.
In Canada, NFT ownership is treated as an asset. The disposal of an NFT is calculated and taxed as a gain or loss. In the UK, an NFT is often considered as a capital asset held for investment purposes. The sales, which generate a capital gain or loss, are subject to Capital Gains Tax (CGT).
Navigating the new world of NFTs
NFTs offer many benefits to creators, buyers, investors, and businesses as an investment vehicle or a method to facilitate transactions. As a fast-evolving field, there are still many questions about how NFTs fit into the current financial infrastructure and how individuals and businesses should account for an NFT's value. Therefore, it's important to work with qualified financial and accounting professionals who understand the global implication of NFT transactions as the rules and regulations evolve.