Top Lessons for Investing in NFTs
Over the past couple years, I have fallen into the bottomless crypto rabbithole. As the crypto natives would say, I’m going “full degen” (pronounced dee-jen). More recently, I began researching NFTs and throwing some money in as a speculative investment. While I believe that 99 percent of NFTs will go to zero in the next 1-2 years, the asymmetric upside of hitting the 1 percent is very tempting. It feels like buying lottery tickets where your odds of winning are much higher. Throughout my experience investing in NFTs over the past couple months, I learned some extremely valuable lessons and wish to pass them on. But first, let’s go over some crypto-native terminology for the “normies”.
Crypto Terminology
- Blue chip NFTs- the NFT collections that have consistently been in the top valuations (e.g. crypto punks, bored ape yacht club, art blocks, etc.)
- DAOs- decentralized autonomous organization; a group with no central authority and power distributed to the masses
- Degenerate (or degen)- Going deep into the most innovative and risky ventures occuring in the world of crypto. Not referring to Bitcoin, but the newest cryptocurrency or protocol that shows an ounce of promise.
- Digital/software wallet- an electronic device, online service, or software program that allows one party to make electronic transactions with another party bartering digital currency units for goods and services (i.e. hot storage)
- Floor pricing- This is the lowest price that a specific collection of NFTs has sold for, typically priced in Ethereum/ETH
- Hardware wallet- a cryptocurrency wallet which stores a users’ private keys in a secure hardware device (i.e. stored offline in something akin to a flash drive; cold storage)
- Minting- the process of turning a digital file into a crypto collectible or digital asset on a blockchain
- NFTs- non-fungible tokens, they authenticate the owner of an image/video;
- For a quick introduction, go to this brief NFT FAQ by Lucky Trader
- For a longer introduction, check out this NY Mag article
- NFT Collection- while some NFTs are one of one (i.e. only one exists), there are many that are part of a collection of a finite supply (e.g. 10,000 slightly different versions of an image will exist)
- Normie- the opposite of a degen; not involved in crypto at all
- OpenSea- the most popular marketplace for buying/selling NFTs
- Rugged- losing all of your crypto or NFTs in your wallet due to malicious actors/scams
Lesson #1: Investing in Crypto is INSANELY Volatile
Investing in crypto and NFTs is not for the faint of heart. If you can’t handle 500 percent increases or decreases over night, then stick to the boring world of stocks where a 10 percent annual return is applauded. Speaking from personal experience, I have lost thousands overnight from sinking floors in my NFT valuations, as well as, made 1000 percent gains in a speculative investment in the metaverse currency, SAND, in a matter of weeks. When you invest in a speculative asset that dives to zero, it’s not too hard to follow your instinct and dump it. But when an asset shoots to the moon overnight, how do you know when to sell?
Lesson #2: Investing in NFTs is the Wild West
When you enter the world of NFTs, you will soon be introduced to the chaotic world of DAOs. Most DAOs are currently being run on Discord, which is basically Slack on steroids. There are dozens of channels in each community, software bots automating messages, people hyping up their own shitcoins and NFTs, and anything else you can imagine. While DAOs on Discord can be fun and interesting, there should be a giant CAUTION sign when you sign up to any DAO Discord community. Discord is filled with hackers sending malicious links in your DMs or in channels with the aim to retrieve your secret passphrase from your digital wallet (e.g. Metamask). Michael Batnick, cohost of the Animal Spirits podcast, was kind enough to share his experience of getting rugged in crypto in a recent episode. DO NOT ENTER YOUR SEED PHRASE AFTER CLICKING ANY LINKS IN DISCORD.
Lesson #3: Purchasing NFTs Requires Technical Knowledge
Here is the minimum level of knowledge required to purchase an NFT:
- Sign up for an account at a crypto brokerage firm (e.g. Coinbase, Gemini, FTX)
- Purchase Ethereum/ETH at the crypto brokerage firm
- Sign up for a digital wallet (e.g. Metamask, Coinbase wallet, etc.)
- If you chose Metamask, install the Google Chrome plug-in
- Save your Metamask seed phrase and password in an off-line, safe location
- Note your digital wallet Ethereum account address, a string of 64 characters
- Connect your digital wallet to an NFT marketplace (e.g. OpenSea)
- Convert your ETH to WETH
- Purchase your NFT
Easy, right? Unless you are a celebrity who can afford the high fees to use a concierge service to purchase NFTs, it is incredibly complicated to purchase an NFT. Only a small percentage of people could figure out that process. Even if you are one of the few who can purchase an NFT, it is likely that you are doing it in an expensive or insecure manner.
Lesson #4: Transaction Costs are HIGH
While low fee trading exists in trading cryptocurrencies, it has not transitioned to NFTs yet. Buying, selling, minting, or moving NFTs can yield incredibly high transaction costs. Transaction costs (i.e. gas fees) on the Ethereum blockchain are variable in nature, but will often be over 100 dollars. The variable pricing is determined by supply and demand and the design of the blockchain. If you want lower fees, try looking into one of the following solutions:
- Transactions on layer 2 protocols (e.g. Polygon)
- Swapping currencies on decentralized exchanges (e.g. SushiSwap, Uniswap)
- Buying/selling NFTs on a blockchain with lower transaction fees (e.g. Solana)
- Using a blockchain on a day with low demand (e.g. Thanksgiving)
Note: Here is a good article on reducing gas fees.
Lesson #5: Being a Self-Custodian is Dangerous
So you watched some youtube videos or tiktoks and figured out how to buy an NFT. Congratulations! You passed the first major hurdle, but you aren’t out of the woods just yet. Owning an NFT or any cryptocurrency means you are now a target for hackers. Any asset in hot storage (i.e. stored online) is susceptible to being hacked via malicious actors. Anytime you are about to enter your seed phrase or password to log into Metamask, you should do a LONG pause. You are about to connect your digital wallet to another entity online. Each time you make this connection, there is an inherent risk. Before making any significant investments into crypto or NFTs, I highly recommend you read up on security. Here is a great thread on securing your NFTs from Punk6529, an early crypto adopter who frequently shares words of wisdom on Twitter. I recently purchased a hardware wallet and plan on moving some assets over by end of year.
Note: Receive 20 percent off your Ledger hardware wallet by using my referral link.
Lesson #6: Your NFT is Likely NOT on the Blockchain
NFTs consist of two parts, data and media (i.e. image or video). The data includes metadata that describes the NFT, such as the pointer to communicate where the media is stored. Some data is almost always on the blockchain, but the media is often not on the blockchain. Media is often stored on IPFS, which is safer than a single server or cloud computing environment (e.g. AWS), but not as safe as the blockchain. The more information stored on the blockchain, the more secure your NFT will be. If the media is stored on a random server, there is a huge 3rd party risk that the media could disappear. This degree of how “on-chain” your NFT is can be thought of as an on-chain spectrum. Verifying where an NFT is on the on-chain spectrum requires some technical knowledge, but is a necessity before purchasing one.
Lesson #7: Finding Good NFT Investments is Hard
If you believe as I do that 99 percent of NFTs will go to zero, then finding worthy investments is challenging. After joining a handful of DAOs, constantly surveying crypto Twitter, and frequently listening to crypto podcasts, I still have yet to find a good strategy for investing in NFTs. The field is too nascent to have fundamentals or a more data-driven strategy. Here is a breakdown of research and advice I have encountered over the past month and my reaction:
| Research/Advice | My Reaction |
|---|---|
| Buy what you like | Digital art has infinite supply. Not a strategy likely to yield a good return. |
| Buy NFTs that held up during bear markets | A small sample size of 1-2 mini bear markets is not data-driven evidence |
| Analyzing NFT collection rankings | Most rankings are extremely subjective with random data-driven insights that are low correlations at best |
| Buy the floor price of an NFT collection you like | Is there any data-driven evidence that floor pricing yields better returns? |
| Look for undervalued rarities in an NFT collection | The entire rarity culture in the NFT world might not last once it goes mainstream |
| Invest in NFTs with active engagement in Discord | Exploring each individual DAO can take hours – too time intensive |
| Buy the blue chips | This ignores macro events and innovation in the NFT space. Maybe it will work in a bear market. |
| Invest in creators you believe in | Similar to venture capital strategies |
| Invest in innovating concepts | This could work for short term investing, assuming macro events hold stable. Will this work for in the long term? |
Personally, I find that investing in creators that you believe in and investing in innovating concepts to be the best strategies. Both will likely mean buying NFT collections early on in their journey, which means lower price points. This will lower the downside, increase the upside, and make it easier to diversify. With so much luck involved in choosing the right NFT, diversification is a must. Unfortunately, diversification is not simple nor cheap until this asset class becomes more liquid and the transaction fees are dramatically reduced. NFTs will remain an extremely small percentage of my portfolio until those two challenges are addressed.
PS: The first company to simplify the NFT purchasing process will likely be rewarded handsomely. Will it be OpenSea, Coinbase, NFT Gateway, or someone else?
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Note: To learn more about investing in Bitcoin, see my previous post.