From digital art to in-game digital assets, the recent emergence and rising popularity of non-fungible tokens (NFTs) is leaving individuals with a plethora of tax questions. This article is intended to provide some clarity for those looking to invest in this evolving asset class.
What is an NFT?
An NFT is a one-of-a-kind digital token that represents ownership of a unique digital item that can be bought and sold on the blockchain. Unlike fungible digital assets, such as Bitcoin or Ethereum, NFTs cannot be substituted with another identical token, creating digital scarcity. A Bitcoin can be substituted for another Bitcoin and the rights associated with both are identical. In most cases, the rights or traits associated with each NFT (represented in a “smart contract”) are what make these tokens unique. For example, NFTs include digital authenticity of artwork, digital ownership of a collectible or tradable card, and exclusive access to a real-life or virtual experience.
How Are Individuals Interacting with NFTs?
As described above, NFTs may represent digital art or other digital assets held for investment. However, NFTs are also popular in the gaming world. NFTs used in play-to-earn (p2e) games may be purchased or rented to earn rewards within the game, further unlocking additional features of the game, such as experiences or digital goods. A popular p2e blockchain game, Axie Infinity, allows players to breed or purchase “Axies,” which are magical creatures used for battling other players in the game. Each Axie is a unique NFT that may be used in the game, or the Axie token (the native token within the Axie Infinity ecosystem) may be sold on a digital asset exchange.
How Can an Investor Purchase an NFT?
For those looking to enter the NFT market, there are multiple online platforms where these assets are available. Secondary marketplaces such as OpenSea and Rarible allow individuals to become creators, sellers and purchasers of NFTs on the Ethereum blockchain, meaning investors must own ether (ETH) in a compatible wallet to transact. The large majority of NFTs exist on the Ethereum blockchain; however, NFTs also exist on other blockchains, such as Solana and Tezos. A digital asset wallet allows individuals access to their assets on the blockchain and creates and holds the private key required to authorize transfers on the blockchain. NFT purchasers commonly use Metamask as their digital asset wallet.
