The art NFT scene exploded into mainstream consciousness in February 2021 when Beeple sold an NFT artwork for $69 M. For months afterward, people new to NFTs and blockchain Googled “what is an NFT?” and tried to understand how digital art that can be copied and sent with the click of a button, could have any value, let alone be “worth” millions of dollars.
At the same time, thousands of new NFT artists flooded the exchanges with new collections. Even though the bubble eventually burst in April 2022, the NFT art space didn’t completely implode. In fact, it’s showing signs of resiliency and growth.
In the meantime, the traditional art world is taking note and taking action. Let’s take a closer look.
Challenges in the Traditional Art Market
The traditional art industry grew via centralized intermediaries like galleries, dealers, and auction houses. While these parties play an essential role in curating and promoting art, they can also increase costs, create barriers to entry, and limit opportunities for artists and collectors.
Furthermore, the traditional art market suffers from a lack of transparency. Fraud is a risk for collectors. Blockchain is emerging as a solution for what ails the art industry.
Blockchain, NFTs, and Digital Art
Blockchain, the underlying technology behind cryptocurrencies like Bitcoin, is a decentralized digital ledger that records transactions across multiple computers. Each computer, or node, stores and updates an identical copy of the ledger, which means it’s “immutable,” or very hard to edit without the consent of the entire network.
Blockchain’s innate transparency, security, and immutability make it a natural fit in the art world, where establishing ownership and provenance is a fundamental step in art valuation and reducing fraud.
Digital artists may create an NFT (non-fungible token) for each unique artwork. Art NFTs are code snippets containing information about the artwork, such as the artist, creation date, and a description of the artwork’s unique characteristics.
Artists can create scarcity by designating one copy of their artwork as the original. They can also create multiple versions of the same different NFT with different “rarity” characteristics. NFTs may also include smart contracts that enable artists to set rules and conditions for the ownership and distribution of their work.
The Distinction Between the NFT and the Artwork
In the context of art and NFTs, people often use the term NFT to refer to the artwork itself. It is important to note that the NFT is not the digital art itself; it’s the code on the blockchain (token) associated with the artwork. In fact, the artwork file is usually not stored on the blockchain due to space considerations.
Secondly, an NFT can represent an almost infinite variety of digital and real-world items, not just artwork.
Traditional Art and NFTs
In the realm of traditional art, blockchain’s promise lies in providing a transparent and tamper-proof record of provenance for tangible art. For example, when an artist creates an NFT for a real-world painting, she establishes a record of the painting as her work on the blockchain. When she sells the painting, she transfers the NFT to the new owner along with the painting.
As mentioned above, it is difficult, if not impossible, to secretly tamper with the NFT’s information. Anytime the painting changes hands via a sale to a new owner, the new owner receives the NFT via a blockchain transaction, thus creating a clear ownership path over time. Anyone can look up an artwork’s provenance on a public blockchain without contacting a dealer, gallery, auction house, or other specialist.
In addition, if the smart contract includes a royalty clause, the artist may receive a commission on each sale into perpetuity. Let’s look at some more advantages for artists and collectors.
New Possibilities for Artists and Collectors
Integrating blockchain technology and NFTs in art presents exciting possibilities for artists and collectors alike, below are a few examples:
- Fractional NFTs: These tools allow collectors and investors to own a portion of a high-value artwork. The fractional ownership model lowers the barrier to entry for collectors who may not have the means to purchase an artwork outright. For investors who want to pool their funds, fractional NFTs simplify the transaction, reduce fees and reduce the need for intermediaries.
- Ability to earn commission on repeat sales: One exciting development for artists is the possibility of earning royalties or a commission every time a new buyer purchases the artwork. NFTs can include smart contracts that stipulate resale royalties for artists, ensuring the artist, and not just the collector, benefits from the artwork’s appreciation as the artwork changes hands over time.
- Direct engagement with audiences and fans: Artists can establish direct connections with their audiences, bypassing intermediaries and gaining more control over their artistic careers. Through online platforms and social media, artists can showcase their work, engage with fans, and sell their art directly.
- Empowering emerging artists and global accessibility: The decentralized nature of blockchain technology and NFTs offers greater visibility and opportunities for emerging artists. Artists worldwide can gain exposure to a global audience, leveling the playing field and reducing the influence of geographic barriers.
Challenges with Art and NFTs
As with any emerging innovation, Web3 brings advantages to the art world while also presenting challenges.
- When NFTs took off in 2021, most of the minting activity occurred on the Ethereum blockchain. At that time, Ethereum still used the energy intensive proof of work consensus algorithms. Industry watchers raised legitimate concerns about the environmental implications of building a full-fledged industry on a POW blockchain. In September 2022, Ethereum completed a long-awaited shift from proof of work to proof of stake. Overnight, the environmental impact of NFTs diminished to negligible levels. At the same time, some creators offer carbon offsets as part of their business model.
- Legal considerations: Integrating blockchain and NFTs raises legal questions regarding copyright and intellectual property. On the regulatory front, the legal and tax status of cryptocurrencies and digital tokens as assets or collectibles is still evolving, meaning artists and collectors alike need to pay close attention to emerging regulation.
- Questions around the value and authenticity of digital art: A high profile NFT purchased at the peak of the bubble for $2.9 million later sold for only $280. The collector expected to sell it for about $48 M. The scale of that discrepancy illustrates some of the questions that remain about these digital assets’ long-term value and authenticity. As with any market, there is the potential for speculative bubbles and market volatility that may impact artists and collectors.
Blockchain, NFTs and smart contracts are revolutionizing the art world for tangible and digital artists and collectors. Do you create or trade art NFTs? If so, you already know that the recordkeeping and tax time is the not-so-glamorous side of the art world.
ZenLedger can help you organize everything for tax time. The platform automatically aggregates transactions, computes your capital gain or loss, and generates the tax paperwork to file your taxes accurately and on time.
The above is for general info purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.