The Ultimate Guide to Valuing NFTs -Crypto Ex
What do characters from Axie Infinity, Bored Apes, and a piece of Decentraland land have in common? Each of these is an illustration of a non-fungible token (NFT) that denotes ownership of a digital asset.
According to Chainalysis, the NFT industry will top $40 billion in 2021 and is not expected to slow growth in 2022. Christie's and Sotheby's have also sold NFTs worth millions of dollars, including the $69 million sale of Beeple's Everydays: The First 5000 Days in March 2021, in addition to iconic collections like Bored Apes and CryptoPunks.
Unfortunately, there are various obstacles for investors who desire to dabble in the NFT market. Technically speaking, buying and keeping NFTs might be difficult for some, but more significantly, the majority of consumers have no idea how to value the emerging digital assets. After all, there are no tangible objects like traditional collectibles or ongoing payments like bonds.
Let's examine how NFTs operate, why you could invest in them, and the methods of valuation you might use to make wise choices.
In 2021, NFTs grew to a $41 billion asset class, yet many investors are unsure about how to appraise digital artefacts.
A Brief NFT Primer
NFTs, or non-fungible tokens, are exclusive tokens on a blockchain that demonstrate ownership of a unique digital property. However, contrary to popular belief, NFTs do not include any real artwork or digital materials. In its place, they refer to a digital asset, such as a link to a piece of digital artwork stored on the Interplanetary File System (IPFS).
NFTs are essentially agreements or contracts between an artist and a collector. Each of these agreements has a unique set of provisions. As with actual art collections, an artist could keep copyright and reproduction rights. Or, in other circumstances, NFTs might only provide owners non-commercial, personal rights to the artwork.
NFT markets are where most NFTs are acquired and traded. OpenSea, which has over two million collections with over 80 million NFTs and over $20 billion in transaction volume, is the most well-known NFT marketplace. Of course, non-artistic NFTs often have their own unique platforms, like the characters from Axie Infinity or the LAND plots from Decentraland.
By setting up a wallet like MetaMask and linking it to an NFT market, anyone can buy an NFT. For instance, you could add ETH to a wallet, link the wallet to OpenSea, then use ETH to buy an NFT. The NFT will show up in your wallet, where you can save it as a collectible and use it to authenticate (such as the BAYC).
Why Invest in NFTs?
Similar to investing in any other collectible, you might buy NFTs. Nobody can prevent someone from forging a work of exquisite art or a valuable baseball card, but anyone can replicate a Bored Ape picture. More than the actual media, the concept of ownership provides the value. Simply said, NFTs are digital-only collectibles.
Compared to physical storage, NFTs offer several advantages:
Liquidity - NFTs are much easier to swap than physical pieces of art or other collectibles. You don't need to worry about sending items through the mail and insuring them for damage or loss.
Extensibility - NFTs are smart contracts with tremendous flexibility. For example, an artist may include code that entitles them to a certain percentage of secondary sales.
Variety - NFTs can represent any type of art or collectible. For example, they may describe a plot of real estate, a piece of fine art, or even a personal avatar.
Of course, there are also many drawbacks. Consider:
Security - NFTs are digital-native collectibles, making them much easier to steal than physical collectibles. For example, a piece of malware or a clever scam could result in the loss of NFTs.
Scams - The digital nature of NFTs also increases the chances of scams. For example, fake Twitter accounts may advertise special drops, or OpenSea may host fake versions of NFT art.
Early Stage – NFTs do not have the same track record as other collectibles, which makes them risky. At the same time, new technology can make experiencing growing pains.
In conclusion, NFTs provide a rare chance to invest in early digital collectibles, although the industry is still developing. Therefore, uninitiated investors might want to stay away from the market until they iron out all of these problems. However, you might want to think about include NFTs in your portfolio if you're familiar with cryptocurrencies and digital tokens.
How to Value an NFT
The evaluation of any collectible item is highly subjective. For example, someone who doesn't watch baseball may be willing to pay nothing for a rare baseball card, while a baseball fan or avid collector may spend thousands of dollars. In addition, the amount people pay changes over time, as shown by fads like Beanie Babies.
Depite the subjective nature of valuing collectibles, certain principles can help provide a framework for coming up with the appraisal.
#1. Scarcity
We learn in Economics 101 that pricing is influenced by supply and demand. Therefore, if demand stays the same, the price would rise as the supply declines. Supply scarcity is a major factor in the value of many collectibles. Fine wines, for instance, increase in value over time since their supply is reduced as more people consume them.
Of course, an artist or platform is free to release additional NFTs to augment the available supply. Investors can see a fall in the value of their current NFTs if demand stays the same at that point. Investors should thus look for NFT collections with a constrained supply and artists or platforms that don't wish to compete with one another.
The use of a rarity score is the simplest method for calculating scarcity. These ratings essentially represent numerical representations of each NFT's relative scarcity depending on characteristics like attire, emotion, or accessories. When determining scarcity, collectors might look at the rarity of a specific characteristic or an overall rarity score that takes all the traits into account.
#2. Utility
While most collectibles don't have much purpose outside of collecting, many NFTs do. For instance, the play-to-earn game Axie Infinity features NFT-based characters. When you buy an Axie, you may earn passive revenue by renting the player to other people. These yield-generating NFTs can be valued by investors using traditional methods (e.g., DCF).
In addition to producing yield, NFTs might grant access to special events or material. As an instance, Bored Apes provides access to exclusive in-person gatherings with other owners. Ownership of Decentraland also grants access to nearby communities and online gatherings. Investors might wish to include the value of this access in their evaluation of an NFT.
#3. Price
Most investors strive to estimate an asset's value before making a purchase, but occasionally pricing can affect estimation. Investors can assess if they are overpaying or underpaying by, for instance, comparing the price of an NFT to the floor price (i.e., the lowest price in a collection) or average price of a collection.
Other investors could examine price movements and degrees of fear and greed. For instance, some investors may assume that the price would continue to rise for an NFT collection with a fast increasing floor price. They could even make use of technical analysis to gauge the strength of the trend or forecast when the price would diverge from an earlier trend.
#4. Liquidity
If there are no purchasers, even the most valuable work of art is useless. Similar to this, the value of an NFT largely depends on the availability of interested purchasers. Liquidity, or the volume of transactions, is the most effective technique to evaluate that statistic. Therefore, you may take into account the amount of transactions involving the artist or the secondary market volume within a collection.
The most well-known and liquid NFTs use the ERC standard, which makes it simple and frictionless to trade them across various platforms. However, some NFTs trade on unpopular blockchains or exclusive platforms. These NFTs could therefore be less liquid and, as a result, be valued lower.
#5. Background
The reputation and ownership background of the artist are important considerations for many collectors. For instance, a well-known artist will fetch a higher price than an unknown artist whose works are displayed in the houses of affluent collectors. In NFTs, where many investors consider ownership history, particularly among "whales," the same dynamics are present.
Similar to this, the size and longevity of the communities on Decentraland, Axie Infinity, and other NFTs greatly contribute to their worth. As a result, while evaluating a project's past, present, and future, investors may consider a variety of factors, including the project's whitepaper, the qualifications of the development team, and the number of Discord users.
#6. Technical
Different technical characteristics of NFTs might affect how they are valued. An exclusive platform may be used by creators, for instance, to mint NFTs. Despite the possibility that these platforms provide cheaper costs for authors, the absence of interoperability may have a detrimental effect on the cost. On the other side, those who directly mint NFTs on the blockchain have more possibilities but must pay more for gas.
Additionally vulnerable to assault is the fact that NFTs are digital devices. For instance, the owners of Axie Infinity NFT suffered a $620 million loss as a result of North Korean hackers spear-phishing a worker. As a result, investors should consider blockchain security while making decisions, especially for NFTs that trade on exclusive platforms.
Investors should also make sure that the data encoded into an NFT is hosted in a trustworthy location. Since there is no chance of a shutdown, on-chain metadata is often the safest; nevertheless, decentralised hosting (like as IPFS) is also a secure choice. After all, the NFT can lose all of its value if the metadata vanishes.
NFT Valuation Tools
A increasing number of community tools are available to creators, collectors, and investors who want to evaluate the worth of NFTs. These programmes take use of these and other criteria to do so. Moby, for instance, notifies you when the average price of particular NFT collections or the volume of their sales rise. Even artists may price their collections with the use of NiftyKits NFT Artist Calculator.
The most popular tools include:
- Dapp Radar
- Nansen
- Icy Tools
- Moby
- EtherScan
- OnChained
What's in store for the future?
The NFT ecosystem is evolving at an alarming pace. While the popularity of digital arts and earning games has declined slightly, NFTs will play a significant role in Web3 and the Metaverse. They can become essential forms of identity and enable the transfer of data across platforms, putting power back in the hands of users.
At the same time, NFTs will be crucial for tokenizing traditional financial assets. Partial real estate ownership through NFT tokens enables anyone to generate passive income from real estate projects. In turn, this could help democratize the multi-billion dollar market. These trends can open doors to new opportunities for investors.
However, these trends do not mean that NFT collectibles and play-to-earn games will cease to exist. Instead, they may simply evolve into new formats. For example, future NFT collectibles could be items that exist in the popular Metaverse platform rather than in the game itself. Or, they may confer certain community rights or capabilities to the holders.
A Brief Note on NFT Taxes
In terms of taxes, the IRS views cryptocurrencies, or virtual currencies, as property. Investors are faced with a great deal of uncertainty because the tax office hasn't offered any guidelines relating to NFTs. NFTs also belong to a separate category than virtual "currency" that are fungible since they are non-fungible by definition.
According to the majority of tax experts, NFTs held by their inventors will be regarded by the IRS as non-capital assets, whereas those held by taxpayers other than their creators would be regarded as capital assets. If so, any capital gain or loss from the sale or exchange of NFTs would be taxed as capital gains and losses, possibly at a higher rate because they are collectibles.
Also keep in mind that an NFT acquired for personal use that loses value (such as an artwork piece hanging on a wall) is not deductible under Section 165. (c). However, taxpayers may be able to claim a deduction for the worthless asset under Section 197 if they buy the NFT in the course of their business or trade.
Taxes must be taken into account while making financial decisions about NFTs and other assets. Since they often pay a higher tax rate, doing this is especially important for investors who fall into higher income tax categories.
The Conclusion
NFTs are now a multibillion dollar asset class that appeals to a wide range of investors. While it may seem crazy that Beeple's JPEG image sold for $69 million, NFTs are changing both traditional financial assets and digital assets in the metaverse. Finding genuine value in these assets is a difficulty for investors.
You may more accurately assess NFTs and determine if they merit a position in your portfolio by keeping in mind the six NFT valuation concepts mentioned above.
ZenLedger can help you manage transactions, calculate capital gains, and provide the tax paperwork you require each year if you trade NFTs or other crypto assets. You may lower your year-end tax burden by finding chances to harvest tax losses with the aid of the platform.
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