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Top 5 Myths & Misconceptions About NFTs

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April 18, 2022
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    Non-fungible tokens, or NFTs, have become tremendously popular over the past couple of years. For example, the Bored Ape Yacht Club – a limited collection of NFT art depicting apes that doubles as membership to an exclusive online club –  has had nearly $3 billion in total transaction volume. As NFTs move beyond digital art and into the metaverse and finance, these figures could grow into the tens or hundreds of billions per year.

    In this article, we'll debunk five common myths and misconceptions surrounding NFTs.

    There are a lot of common myths and misconceptions about NFTs—here's what you need to know about them.

    What Are NFTs?

    Non-fungible tokens, or NFTs, are unique pieces of data stored on the blockchain that anyone can buy, sell, or trade. The data stored in NFTs may include photos, videos, audio, or coded information representing a real-world asset. In most cases, NFTs are minted on the Ethereum blockchain in various marketplaces, given the blockchain’s support for smart contracts.

    Importantly, NFTs do not inherently grant any intellectual property rights to a digital asset that it represents. So, for example, a digital artist may sell an NFT representing their work. However, the buyer doesn't necessarily own the copyright, so the artist could theoretically create more NFTs of the same piece.

    NFTs can also encode unique terms for buyers and sellers. For instance, a digital artist may sell NFTs that pay them a percentage of future sales. That way, they can grant a copyright to the work without necessarily giving up all of the value if their art becomes famous.

    #1. NFTs Are a Currency

    Fungibility is an item's ability to replace or be replaced by another identical item. In other words, it ensures items are mutually interchangeable. These properties are essential for currencies and other mediums of exchange. After all, one dollar must be worth exactly as much as another dollar to serve as a medium of exchange.

    Non-fungible tokens (NFTs) are not fungible, meaning they're not suitable for use as a currency. Instead, each NFT is unique and has its own value, making it more like a piece of fine art or real estate. So while it's possible to trade NFTs and exchange them for currencies, they cannot effectively serve as a currency on their own.

    #2. NFTs Are Worthless

    NFT critics argue that they're little more than digital receipts or certificates of authenticity. If anyone can copy the underlying item (e.g., a Bored Ape JPEG), they argue that the certificate of authenticity has no value. In their eyes, the only valuable NFTs are those that prove ownership of physical assets that can be bought and sold.

    The five most popular NFT projects in April 2022 - Source: Nonfungible.com

    Of course, it's possible to counterfeit any artwork or collectibles. The only thing that differentiates a valuable piece of art and a perfect counterfeit is the knowledge of its authenticity. Therefore, it's hard to argue that NFTs are worthless when they represent the same kind of knowledge. And unlike paper certificates, NFTs are impossible to counterfeit.

    #3. NFTs Are a Scam

    The crypto industry has seen its share of scams thanks to its lack of regulation and pseudo-anonymous nature. For example, Bitconnect's multi-level marketing-led Ponzi scheme scammed investors out of about $4 billion before shutting down. And the Plexcoin ICO promised returns of 1,354% before the SEC shut it down and ordered it to repay $20 million.

    Of course, NFTs aren't immune from fraudulent activity. When OpenSea made it free to mint NFTs, malicious users flooded the market with plagiarized works, fake collections, and spam. Many real-world artists saw their works put up for sale as NFTs without their knowledge or permission, with unknowing buyers bidding for digital ownership.

    #4. NFTs Hurt the Environment

    Most NFTs leverage the Ethereum blockchain, which uses a proof-of-work mechanism. As a result, minting, selling, and transferring NFTs may generate significant carbon emissions. Computational artist Memo Akten estimates that minting an NFT generates 83 kilograms of CO2, and selling it causes another 51 kilograms to hit the atmosphere.

    Ethereum’s energy consumption trends. Source: Digiconomist

    The good news is that environmentally-friendly proof-of-stake algorithms are becoming the norm. While Ethereum is still transitioning to PoS, many Layer 2 blockchains already use them. For example, Bubblehouse built an NFT platform atop the Polygon blockchain—a Layer 2 solution with a 99.99% lower carbon footprint than the Ethereum mainnet.

    #5. NFTs Don't Trigger Taxes

    Most people know that cryptocurrency transactions generate a tax liability thanks to the new question atop Form 1040 and warning letters sent to crypto users over the past couple of years. However, many people don't realize that NFT transactions also trigger potential tax liabilities, and a failure to pay these taxes could have serious consequences.

    There are a couple of ways that NFTs can trigger taxes. First, purchasing NFTs requires selling a cryptocurrency, generating a potential capital gains tax. And second, selling the NFT may trigger another capital gains tax if it appreciates. And, of course, NFT artists must pay ordinary income tax on the sale of their digital artwork.

    The Future of NFTs

    Today's NFTs are mainly digital art that serves as a status symbol and provides access to exclusive social groups. For example, Bored Apes have become celebrity memes with their own culture. Axie Infinity and other crypto games also employ NFTs to power in-game items and economies, adding a new dimension to the gaming experience.

    However, the future of NFTs most likely lies in finance and commerce. For example, they could become indispensable tools to track the fractional ownership of assets, such as real estate. NFTs could also play a vital role in providing supply chain visibility—a digital receipt that follows a product from raw materials to the final retail product.

    Drops and other platforms are also looking to bridge the worlds of decentralized finance, or DeFi, and NFTs. The idea is that NFTs—including those backed by real-world assets—could be collateral for loans or generate interest income. And income-generating NFTs could ultimately make them a compelling financial asset for investors.

    The Bottom Line

    Non-fungible tokens have become tremendously popular over the past couple of years, with digital artwork selling for millions of dollars. However, despite the industry's growth, several common misunderstandings influence the public's perception of these assets. Understanding the truths can help avoid any problems.

    If you trade cryptocurrencies or NFTs, ZenLedger can help you organize your taxes. Our platform aggregates transactions across wallets and exchanges, computes your capital gains and losses, and auto-populates IRS tax forms to ensure you're paying just the right amount. You can even identify opportunities to save through tax-loss harvesting.

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    Simplifying DeFi, NFT, and Crypto Taxes for Investors and Tax Professionals

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