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What Are NFTs? | The Motley Fool

Has the world gone mad or are these actually investment opportunities? Sit back, relax, and tune in. We’ve got Motley Fool analyst Aaron Bush here to walk you through the burgeoning world of NFTs.

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Jan. 12, 2022.

David Gardner: Own any cryptocurrencies? I don’t, but depending on which one we’re talking about, I have really missed out. Had I just bought Ethereum when this week’s guest, my long time Motley Fool Rule Breakers sidekick Aaron Bush, first mentioned Ethereum on this podcast, well, maybe you did buy some of it. If so, you’ve made well more than five times your money since that fall of 2017 appearance. Well, Aaron is back again this week this time not talking Bitcoin, but instead NFTs, Non-Fungible Tokens. Some of us know exactly what those are, but many more of us would, I think have a hard time explaining them to the proverbial stranger on a train. Though I once heard a stranger on an Amtrak train do just that. Well in my experience people into cryptos and NFTs, well, some of them anywhere are really, really into them. But for the rest of us, the intention of this week’s conversation is to inform and to acquaint. No salesmen here, not Aaron or I. Though we are here, as usual, to make you smarter on the topic because NFT crypto or no, regardless of your investment choices, you will come away this week a lot smarter about what’s happening today into the future. Only on this week’s Rule Breaker Investing.

Yes, the familiar sound, the sound of rules being broken. Welcome back to Rule Breaker Investing, a delight to have you with us this week. I say us because my longtime compatriot here at The Motley Fool, Aaron Bush, who in fact grew up with the Motley Fool from the age of 12, learning investing from one of his parents. Motley Fool services, Aaron, he’s still only in his twenties, for many years now has been a Motley Fool employee, and one of my favorites, somebody who is great at thinking about the future, living backwards from the future, helping us invest today and where maybe things are headed today. Aaron does yeoman’s work across the Motley Fool, Motley Fool Rule Breakers included. Well, we’re going to be talking about non-fungible tokens, as I said at the top. Before I welcome him in and we get started, I guess I just want to say one thing. 

Not everybody is into the whole crypto thing. As an investor, I’m not invested. I’ve always been pretty plain Jane with by investing, I love investing in common stocks. I’ve never even bought or sold an option. I certainly haven’t gone the crypto route, but I respect it. I always have an open mind about where the future is headed. Sure enough, maybe one day I’ll be a big investor in some of the things we’re going to talk about this week. But for a lot of us, the phrase non-fungible token is pretty opaque and my hope is that our conversation will elucidate what non-fungible tokens are, what they aren’t, the investment possibilities here or not, where the future is headed, and more than anything, I’m pretty sure Aaron and I are going to talk about games at some points because the overlap between NFTs and the video gaming and gaming world and the metaverse can’t be mistaken and that’s of interest as well. This will be a wide-ranging conversation. My hope is it makes you smarter, happier, and richer. I can at least promise smarter this week. Without further ado, let me welcome him back. Aaron Bush, welcome back to Rule Breaker Investing.

Aaron Bush: Thanks for having me, David.

David Gardner: A delight to have you back. It feels like anytime we’re going to talk about something exploratory, anytime we’re talking about, well, not just possibilities because there is some kinetic energy, there’s definitely action already happening. But you and I were speaking before coming on the air and I was saying it’s not really possible to sound authoritative or definitive about anything we’re going to talk about this week. But for a lot of us, I think it makes sense to start with defining our terms. In fact, let me just give the brief outline of our conversation so people know where we think we’re headed and we give ourselves permission to go off the rails in a good way at any point. But I think we’re headed to four sections. Section 1, what are NFTs? Section 2, why have they become so popular last year and what kinds of projects led the way? Section 3, we’ll go to, well the future. Where else could NFTs go from here? Finally, number 4, how should Foolish investors view NFTs? That’s Foolish with a capital F of course. For those just listening to this exploratory conversation, that’s how I think it’s organized. Let’s start with number one. Aaron, right from the top. What are non-fungible tokens?

Aaron Bush: I think the best definition of an NFT actually comes from Wikipedia. They define an NFT as a unique and non-interchangeable unit of data stored on a blockchain. Of course, that definition doesn’t lend itself to being intuitively understood, but I think it covers the basis pretty well. Let’s break that down just a little bit more. First, an NFT is unique and non-interchangeable. That basically means it’s scarce and one-of-a-kind, unlike something like the dollar or Bitcoin where each unit or piece of paper is completely interchangeable. If we each have $1 bill in our pockets, we could use them the exact same way in the economy, that’s fungibility. NFT is unique, it’s non-fungible. The second part to unpack is unit of data, in short, a unit of data can be text, an image, a video, it can be a digital item playable on a game, or many other things, for sure we can dig into later. 

But in short, an NFT is a unique and non-interchangeable piece of data, really, piece of code which can represent a bunch of things. Most popular right now are images and art, you’ve probably seen a lot of talk about people buying JPEGs, NFTs of JPEGs. It can’t be more than that. Again, we can dig into much more of that in the future section. Then the third and final part is stored on a blockchain. Blockchains are used when you want that data, whatever it is, to be completely and utterly decentralized, that means that whoever owns that NFT truly owns it and it is there to trade, to collateralize, and commercially use as they see fit. The other unique thing about the blockchain is that it is a type of database that enables and enforces digital scarcity in a decentralized and financialized way. It makes that unique data. Again, whatever it is tradable, the data becomes tokenized, so to speak. Hence, being a non-fungible token. We can dig into more nuances or whatever questions else around that as we get going. But I’ll just pause there to ask if what I said makes sense.

David Gardner: It does. Let’s go a little bit deeper. I was thinking about this, I was thinking about World of Warcraft. I was thinking about a very popular game that’s been running more than a decade, Activision Blizzard. I was just thinking about gold farming, which I won’t even explain for the moment. But I was thinking about having an account on World of Warcraft where you have a unique character who is your character. You’ve leveled them up to level 57. He has an epic sword that is rare and a bunch of other digital assets. In effect, is that an NFT? Do I have a unique digital asset that could be traded or given to somebody else for value?

Aaron Bush: Yes, in that situation, that unique sword would be an NFT. Just to further the point and differentiate between fungible and non-fungible within World of Warcraft, gold, which is the currency, that would be the fungible token of that economy. While the unique digital items: the swords, the armor, the character. Those would be the non-fungible, unique tokens.

David Gardner: Yeah, and I remember fungibility from my econ classes in undergrad. I was not an econ major, I did go to college, assuming I would be an econ major and then I decided to go the English direction. But I do remember that fungibility basically means replaceability. As you were saying, Bitcoin is fungible in the sense that if you own a Bitcoin and I own a Bitcoin, they are identical to each other. They could be exchanged. But if I have an epic unique sword in some of these online game, I’m the only one who owns that. Another way I have thought about this is sports. Now I think about baseball cards and now I’m thinking about physical baseball cards. The world that I grew up in, one you did too, they were more popular perhaps decades ago versus today. I can’t speak to that. I know there’s always going to be a market around the Honus Wagner card of the early 1920s when even though he didn’t like tobacco, it was sold in a tobacco packet. 

Today, that Honus Wagner card is worth millions of dollars. There are a distinct number of cards that are printed by tops, let’s say. We know, especially with the historical cards that it’s down to X number left. There’s an idea of scarcity and presumably generally transparent scarcity. Baseball cards up, football cards, etc. Now those things are digital increasingly, and NFTs early on came to my attention when a friend said, hey, have you seen NBA Top Shots? I said, what’s that? This is about a year ago. I clicked in and anybody can do this today. You can see that what’s happening at NBA Top Shots is like basketball cards, except that they’re digital, not physical, and they’re actually video clips, not still images, at least the ones I’m thinking of. I think that the NBA has partnered to sell unique copies of five-second clips of somebody hitting a three-pointer to win a game, and those are being actively traded today on the NBA Top Shot’s site. Those are NFTS as well. Am I right, Aaron?

Aaron Bush: You’re right.

David Gardner: We’re talking about an epic sword in a digital online game. We’re talking about a real-world NBA happening that’s been turned, of course, thanks to TV, into a television clip that is now a unique digital asset tokenized at NBA Top Shot. Then of course you mentioned earlier, art. There’s certainly seemingly a very vibrant amount of art being NFT-ized, probably the wrong phrase, and sold today, and I’m sure some of it is legit, and I’m pretty sure some of it is illegitimate. One thing before we move to the Section 2, why did this all become so popular last year? One thing, because Wikipedia is also my friend. I was reading that there is some question about the difference between proof-of ownership, which is what you can get. 

You can say, hey, that epic sword is mine because it has this unique coating that means that’s the only one in the world and I own it, and if I sell it to you, you get to own it too. But there’s some question about proof-of ownership separate from copyright. I think the reason this could matter isn’t so much for World of Warcraft, but if I were to sell you my painting that I’ve just taken a picture of and digitized, and you buy it from me, you do own it. The blockchain will prove that you own that, but you may not have the copyright from me. I might not be telling you, but I could be selling 37 other copies of that to friends because I own the copyright. It feels as if there’s some extra-legal, lots of questions that still need to be ironed out in terms of what is the real value here and who actually owns what?

Aaron Bush: Yes, I think that is extremely important. Right now we’re in an interesting phase of the cycle where there are just so many open legal questions where we need the SEC [laughs], we need different government organizations in the US and around the world to come up with the right rules and standards for how these things should work. It definitely applies to NFTs. For example. You mentioned NBA Top Shot, that’s an official partnership with the NBA. Any of us could record clips and then turn them into NFTs and sell them online. But that probably shouldn’t be allowed. There should be rules around that. In many cases, the market sorts that out for itself by knowing what is legit and not. But there are many things to sort out there. I can give an example later where we’re seeing some like a new use case around commercial ownership appear. But this is an important question for how digital assets should work, how different types of cryptocurrencies should work, how brokerages should work. Just like basically pick your topic in crypto, and it’s their open legal questions that are trying to get sorted out right now.

David Gardner: Well said, and we’re gliding along blockchain. We’re using the phrase, we’re not really defining it. We’re assuming some knowledge or at least interest on the part of our listener. We’re not going to define every phrase this week. We’re one click down from blockchain here talking about NFTs. But blockchain at its heart, it’s a digital ledger. It basically, at its best, it provides clear awareness of anything that’s happened that you’re documenting through the code of the digital asset we’re talking about. You can see exactly who made that deal on that date with the timestamp you and I both agreed, and we made a bet, let’s say online, and you took your Texas Longhorns and I took my North Carolina Tar Heels, and you won, and so if we were using blockchain to determine that, you would automatically have put into your bank account that $5 that I may have lost you in a battle between our respective alma mater. That’s an example of blockchain, but at its best, blockchain gives the world transparency around a lot of the assets and transactions and things we’re hoping to do in the coming metaverse and the universe that we live in today. These are really big weighty topics, and we’re still so early on. Aaron, if we’re baseball still top of the first inning for all of this?

Aaron Bush: Maybe the second inning at this point. I think the first inning, probably it’s played out over the past decade, but still pretty early.

David Gardner: Well, I feel like we’ve done a decent job, well, you’ve done a good job defining our terms. We’ve knocked out the definitions early. Let’s move on now to Section number 2. Why did this all blow up, and I mean in a popular blow up way in 2021?

Aaron Bush: Twenty-twenty-one was the year that NFT trading volume skyrocketed the leading NFT marketplace OpenSea. They just raised money at a $13 billion valuation. This is big business and the genie is out of the bottle now. That said, NFTs aren’t new, and I think it helps to understand what’s going on or what happened 4-5 years ago to better understand what exact changes led to what was possible in 2021. I think just for a brief aside of history, the first NFT was maybe made in 2015-ish. The very first wave of NFTs hit in 2017. About the time at the Motley Fool, we started paying attention to crypto and started Crypto Society and start putting a lot of thought into this. Crypto punks, one project which they’re essentially a pixelated collection of profile picture-looking images. Those released in mid-2017. Those are as a collection, I think the first or second most valuable art NFT collection today, although it wasn’t until again 2021 that those took off. 

Also, David, I don’t know if you remember CryptoKitties, but those were the NFTs that took off the most in that 2017/2018 era. They were unique digital cats that you could own and breed and there was a little game around it. The other thing that was interesting there is that, and this is broader than this, but NFTs are also composable sometimes, meaning that anyone can build on top of them. There was also like a small market of Crypto Kitty hat NFTs, for examples, that owners would buy for the cats. [laughs] It was all ridiculous, but in a fun experimental way. The problem though, at that time was that everything was built and running on Ethereum, but Ethereum was not very scalable. CryptoKitties at the time basically jammed the entire Ethereum network and pushed transaction fees way up to the point where no one could really use that network. The game behind CryptoKitties wasn’t sustainable too. But it was a glimpse of what would be possible a few years down the line. Zoom forward to today, what changed? A few things. One, more scalability and the underlying blockchain networks has occurred. Higher demands for compute, for making all of these types of transactions can now be met with a higher supply of compute. We don’t need to dig into all the weeds, but in short, Ethereum has scaled quite a bit. There are other layer twos built on Ethereum, such as Polygon, Flow, Ronin, and many more that basically take new technology and build on top of Ethereum to make transactions faster and cheaper. 

Then there are also new blockchains like Solana, that are competing with Ethereum by offering their own advantages. A lot has happened, but in short, the technology today allows for far more activity than it did five years ago. There’s just been tremendous infrastructural progress that has been made. Second, there are just a lot more people involved in crypto today in whatever capacity than in the past. We’re still very much in the early adopter phase, but there are more people willing to spend money, get involved in communities, and play around with digital assets. Because scalability is improving and there’s demand for just experimentation and playing around. There are many, many more builders and creators tackling the space with new ideas too. Lots of artists are getting involved. Lots of creators with communities are using NFTs as a way to grow their income and involve fans. Video game studios are starting to think about how endgame assets can become NFTs and much more. Really, the infrastructure improvements were laid over the past few years that set the stage for a breakout moment, and 2021 really became that breakout for experimentation. I have maybe like two or three examples to share, but I just want to pause David and see if you want to add anything there.

David Gardner: Sure. You mentioned Ethereum and when you came on this podcast years ago, you were already talking about Ethereum back then. I certainly remember Bitcoin when we first started talking about somewhere around 2017 as a company, we started a service, helping people think through or advising them around where and where not to invest within this whole new world we’re talking about. But Ethereum in particular, Aaron at that time jumped out as something that was different from Bitcoin. It was a little bit more interesting. It wasn’t merely a store value, it had functionality. I do notice that Ethereum, over the last two years has gone from about $500 a unit to about $3200. It’s a six bagger here in the last couple of years, do you think that’s justified?

Aaron Bush: Absolutely. I think that we’ve seen an explosion of activity and just entrepreneurship around the platform. There’s been a tremendous inflow of talent and capital that are building so many types of projects using Ethereum as its foundation. It’s hard to say exactly what the value of some of these networks should be. You can’t as easily do so-called discounted cash flow model [laughs] on crypto networks as you can companies. But I do think it’s justified just because there’s been a tremendous explosion of adoption.

David Gardner: Ethereum in particular, and again, I’m going to guess about one in five of our listeners already knows this, and I’m guessing four and five couldn’t, if you asked them point blank, identify what makes Ethereum special. But as I recall, it was partly this contractual nature of Ethereum. It was like that bet that I made up that we had with each other and for some reason, I let Texas beat North Carolina for that example. But…

Read More: What Are NFTs? | The Motley Fool

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