Unless you’ve been living under a rock for the past year or so, you’ve heard about NFTs. If you’ve been lucky, you have a disinterested monkey. If you’ve been unlucky, you’ve been subjected to a crypto bro trying to explain how they work on Twitter.
Either way, it’s hard to ignore that NFTs are becoming mainstream in the financial world.
What is an NFT?
This section assumes some familiarity with the concepts underlying crypto.
The basic principle behind non-fungible tokens (“NFTs”) is pretty simple, and it revolves around the concept of fungibility. A good service, or currency is fungible if it can be exchanged for more-or-less equivalent substitutes. A fungible token is one that can be equally divided and is non-unique.
Dollars, for instance, are fungible. If I offered to give you my $10 USD bill in exchange for your $10 USD bill, you’d look at me a little strange, because we all know that both $10 USD bills are equal. They can be used to buy exactly the same things, and although your bill might be a little older, or wrinkled around the edges, it’s still a functional equivalent of every other non-counterfeit $10 USD bill in existence.
Many cryptocurrencies are also fungible: any given unit of most cryptos (for example, bitcoin or one ether) is the functional equivalent of any other unit. It would be weird for me to trade my one bitcoin for your one bitcoin, for the same reason it would be weird to exchange $10 bills.
The Mona Lisa, on the other hand, is not fungible. Only one Mona Lisa exists in the world, so it’s impossible to trade it for an identical substitute.
A non-fungible token, such as The Mona Lisa, is unique and non-divisible. You cannot divide The Mona Lisa into multiple pieces like you could divide a $10 USD bill into two $5 bills or ten $1 bills. In addition, one non-fungible token may be worth much more than another non-fungible token of the same type.
In the crypto universe, non-fungibility occurs when a certain key is embedded in the designs of certain cryptos through a cryptographic procedure. In other words, embedding a given token with specific information makes that token unique.
It’s a little bit like drawing a treasure map on the back of a $10 USD bill. Once you’ve added unique information to the bill (the token), there is no other token in the world identical to it, and therefore it is non-fungible.
NFTs work pretty much the same way: an NFT is exactly like any other ether, except for the unique information associated with that particular ether on the blockchain.
What are NFTs used for?
NFTs have become popular because most NFTs are associated with digital objects. They are a certificate of ownership of a given digital asset. NFTs have been tied to art, music, items in video games, and even a drawing of a goat wearing sunglasses.
Anyone who uses the associated cryptocurrency accesses a permanent, public record of the wallet that owns the token, the certification, and the asset.
Some NFTs are associated with “smart contracts,” which execute automatically (typically by transferring assets from one wallet to another) when certain conditions are met.
Because of these advantages, some creators have “tokenized” their work, creating NFTs associated with particular assets and then selling the NFTs to investors. In some cases, these NFTs have attained astronomical valuations, making them a potentially lucrative but potentially risky investment.
The Problem with NFTs
The NFT concept comes with an important caveat that’s easy to overlook: the NFT is not the same as the asset to which it is tied.
A certificate saying ‘the holder of this certificate owns X’ is not X itself.
Digital assets are easily replicated — sometimes it’s as easy as copy and paste.
See? Not that hard. And we won’t go to jail for printing that, either.
Creating a certificate is easy, but enforcing the rights associated with it might not be. NFT holders don’t have a problem demonstrating that they own the NFT, but because the NFT and the asset aren’t the same thing, they only gain a property right in the asset by purchasing the NFT if
- The transaction included both the NFT and the asset itself, or
- The law considers NFTs to be valid sources of rights in their associated assets (i.e., the copyright comes with the token).
This is because the courts enforce copyright law. Unless a court is willing to declare that you do, in fact, own a certain copyright, and award you damages from parties who infringe on that copyright, waving a certificate that says otherwise isn’t going to get you very far.
What rights are courts willing to award to the owners of NFTs? It’s too soon to tell.
For investors, this could be a giant red flag. If courts are not willing to enforce ownership claims predicated exclusively on NFTs, then it’s hard to see what NFTs are good for.
What does this mean for real estate?
The law is uncertain for now, but NFTs are still relatively young technology. The law catching up to the technology is probably not a question of ‘if’, but of ‘when’.
In the long term, it’s possible that the law will eventually be willing to enforce property rights conferred via NFT transactions, and accept NFTs as evidence of ownership.
If this turns out to be the case, the possibilities are virtually limitless. NFTs have already been associated with a breathtaking variety of digital assets, but for real estate investors, the more exciting possibility is tokenizing physical assets.
These technologies could transform the way real estate is bought and sold.
Our best guess is that it might be similar to the current state of the equity crowdfunding space. On the other hand, if the law is not willing to enforce property rights via NFTs, the future looks bleaker.
In the short term, it’s far less likely that NFTs will seriously impact the state of real estate investment.
First, real estate is protected from the effects of disruption in the NFT space simply because the assets are in very different markets.
Second, NFTs are still primarily associated with digital assets. Traditional real estate investors (i.e. investors who invest in physical real estate) just don’t have a current use for NFTs.
Cryptocurrency and NFTs are still new technologies in a traditional industry. If cryptocurrencies fail to make their mark on mainstream finance, it’s hard to imagine them revolutionizing real estate. There’s still no guarantee that crypto will turn out to be more than a short-lived historical phenomena.
Similar to our expectations for cryptocurrency, NFTs will impact real estate if they succeed in becoming truly mainstream financial options. Lots of uncertainties and questions still exist.
The emerging possibilities are exciting, but it’s just too soon to say what impact they’ll have on real estate years from now.