You might have heard some hype about NFTs in the news recently. But what’s an NFT?

In this post, I’ll talk about exactly what an NFT is, what the psychology behind it is, and how it could make you very rich (or very broke).

NFT Definition

NFT stands for non-fungible token. An NFT represents a digital item where it’s 100% unique and not interchangeable (i.e. definition of non-fungible).

Psychology Behind What An NFT Is, And Why They’re Useful

If you buy an NFT, all you’ll literally get is to attach a jpeg to your username. In other words, if you buy an NFT, you mostly get to flex on your friends.

“But why’s this useful then? There’s no fundamental utility. You’re just buying a jpeg that can be infinitely replicated. That seems stupid.”

True, but most of the human race is stupid. If everyone is rational, then no one would touch NFTs. However, human are irrational, and value things like social currency and flexing on social media. When you think about how many influencers go into severe debt because they need to rent and buy expensive stuff to “maintain” an image, you’re getting warmer to the appeal of NFTs.

To create a concrete example, consider the following:

• You bought some apparel for a trivial amount of money, say $1.
• All your friends, family, and strangers compliment you when they see you sporting that piece of apparel.
• If you knew about this wave of admiration ahead of time, would you have paid more for it? Let’s say you would pay more for it, and you’re willing to pay $5 for the product instead of $1. Then the social currency would be worth $5-$1 = $4 to you.
• Thus, the ‘flex’ and social currency has nonzero monetary value in this example. This is essentially the backbone of what an NFT is.

What’s An NFT, Actually Though? You Can’t Tell Me People Are Just Buying Things That Have No Functional Value For Millions!

But people have been buying things with no functional value since forever. Think about art.

An NFT is digital art. You own the art. It’s not the artwork that makes it expensive, it’s the ownership that makes it expensive.

“What’s an NFT but a jpeg that’s infinitely reproducible? Where’s the value if the supply is literally infinite with right-click > save as?”

• Yes, the jpegs are reproducible, but your ownership of the original isn’t.
• Analogy: Owning the original NFT is like owning original artwork. The original Mona Lisa is worth a lot, but exact duplicates of it isn’t because it’s fake.
• To say jpeg duplication will drive NFTs’ values down would be to say the original Mona Lisa would be worth nothing as everyone else can make pixel-perfect duplicates of the original painting.
• So the fact that it’s “just a jpeg = no value” hypothesis seems empirically untrue. As a counterexample: all art can be duplicated in a pixel perfect manner. But art trading has been around for a long time and art in general has always kept value. It’s also traditionally made a lot of people a lot of money.

Luxury Goods Example

One of the riches people in the world is Bernard Arnault. He owns a group called LVMH, and it owns Hennessy, Moet, and Louis Vuitton.

• People buy luxury goods to flex and to belong to a certain clique of people. People don’t just buy LV for their high-quality Italian leather. If that were the case, there are plenty of cheaper and higher-quality options than LV.
• Just because you’re responsible with your money and avoid luxury goods as a consumer, doesn’t mean the market does.
• The market ultimately decides, and the market has decided to make Bernard Arnault one of the richest people in the world. Empirically, the market has uniformly decided that flexing and being in the “in-group” is financially valuable.

As such, you should still avoid luxury goods as a consumer, but you should consider buying luxury goods as an investor. Investing in NFTs is pretty much the same exact business model me trying to sell collectibles on EBay for a profit. On steroids.

NFTs Can Make You Very Rich, Or Very Poor

NFTs can make you homeless, very fast. Here’s some reasons:

• The crypto space is full of scams and you can get rugged. Example: you can ‘mint’ NFTs and the creators could just never give you a product in exchange for your ETH.
• The market is in a bubble and may crash at any time.
• NFTs are highly speculative and is based on market conditions, sentiment, and hype. These things change hour-by-hour. Extreme volatility could mean you lose a lot of money.

NFTs can also “lambo” you.

• One tailwind going for NFTs is the “endowment effect.” This is a cognitive bias where people think their items are worth more because they own it.
  • Unlike stocks where the share ownership doesn’t feel personal, NFT ownership feels “personal.” Thus, people are less likely to sell at a loss.
  • Ergo, people are more willing to HODL until prices are favorable.
  • This makes it so that it skews price upwards.
• Another tailwind is the property of a “value-hold.” Like art, you can hold the asset for a super long time before you sell it. It’ll still hold value. Art has no PNL to dictate its price. Art is a decorative piece whose value will hold just because people like the art.
  • The jpeg itself mostly no value hold (read the next point to say why I say mostly). It’s not functional and not intrinsically valuable like real estate.
  • The vast majority of an NFTs value is the ownership and the bragging rights. This’ll never go away because at the end of the day, we’re all monkeys looking to show off our social status so we can advertise to strangers for sexy-time.
• Secondary income generation.
  • Most projects’ jpegs are worthless. But some projects’ jpegs, like the very popular Bored Ape Yacht Club (BAYC) collection, are actually financially useful.
  • How it works: Owners of the NFTs own the IP for their specific ape .jpeg.
    • NFT owners can sue if someone uses their NFT without their permission.
    • Since BAYC is so hype and viral, companies can buy an NFT as their own IP for marketing schemes.
      • Most notably Arizona Iced Tea has bought a BAYC NFT to be able to print an ape on their iced tea bottles. This marketing tactic could ride on the virality of BAYC and increase their bottom line.
    • Likewise, NFT owners can ‘lease’ their NFTs to companies so they can use the IP and ride the virality without having to explicitly own the NFT.
    • If you want to participate in e-commerce as an NFT owner, you can even start a Shopify store to sell your own NFT printed on a shirt.
    • TL;DR: for certain projects the .jpegs in itself is a big enough of an IP it can throw off passive income your way.

While the list of upsides is longer than the list of downsides, it’s important to contemplate the downside seriously when you invest in NFTs. The list of upsides are made longer because there’s a lot of non-obvious things to explain.

The list of downsides are short because they’re obvious. But the severity of the downside is extremely serious, so don’t let the shorter list fool you.

As always, never invest what you can’t lose. I’d rather delay my lambo than wake up homeless.