The news is packed with attention grabbing reports of NFTs being sold for eye watering sums. Just recently, an NFT called ‘The Merge’ created by the digital artist, PAK, was sold for $91.8 million, and Forbes has reported that the combined NFT market cap grew by 1,785% in 2021 alone.
NFTs are clearly a growing phenomenon, but what exactly are they? The easiest way to understand them is to break down the components of the phrase itself.
‘Non-fungible’ means something unique which cannot be copied, substituted or subdivided, even with an item of the same value. Whereas a £1 coin can easily be exchanged for another £1 coin, an original piece of artwork cannot be replaced with another piece. In such cases, you might have another painting worth the same value, but you have a different painting. The ‘token’ is the digital medium through which the non-fungible asset is acquired and held.
In their simplest form, NFTs are a digital method of owning non-fungible assets. They are held on the blockchain, which is a decentralised ledger, recording transactions on a ‘chain’ that cannot be erased. Assets, contracts and currencies are just a few examples of items that are recorded and held on the blockchain.
NFTs are typically traded and stored on the ‘Ethereum’ blockchain. One of the benefits of holding non-fungible assets on the blockchain is the open and permanent record created and maintained for the specific asset. As every transaction is recorded on the blockchain, this creates a digital certificate proving the authenticity of the asset, evidencing the chain of ownership from creation up to its current owner(s).
The integration with blockchain technology means that NFTs have three key features: they are verifiable, indestructible and indivisible. These qualities make them permanent, tradeable and capable of being authenticated.
NFTs can represent a wide variety of non-fungible assets. They are particularly popular for holding artwork because the record of ownership on the blockchain provides authenticity and reduces the opportunity for fraud. Although most NFTs are currently used for digital artwork, they can be used for physical artwork, too, and can act as a useful tool to increase confidence in the provenance of such assets.
There are many other examples of how NFTs are being used right now such as for photos, collectibles, pieces of music, videos, tweets and assets used in video games.
From the artist’s perspective, NFTs can be a useful tool for generating income. When NFTs are combined with smart contracts, artists can set the ongoing terms of sale governing their creative assets. This enables them to receive a cut of every onward sale of their work. For the music industry in particular, this has the potential to be powerful in supporting smaller artists by reducing losses associated with illegal downloads.
If this all seems a little hypothetical, it is anticipated that NFTs will one day be commonly used for every day physical assets. For example, your house deeds may be stored in an NFT as well as your driving licence, passport and birth certificate. Your store loyalty cards, purchase history and gym membership could also be stored in an NFT as a way of demonstrating that these belong to you. You could even have your theatre tickets delivered
to you in an NFT. As only you should have the required details to access your tickets, the theatre knows you are the rightful owner of them.
As well as holding important physical assets such as your ID documents, NFTs are likely to become an increasingly common investment vehicle for those seeking to invest in artwork, music and other creative mediums.
Estate planning considerations
As NFTs are likely to become pervasive in the coming years, it is prudent to consider how these assets are owned as part of your estate, and passed on when you die.
During your lifetime it is essential to keep secure and accurate records of your NFTs, detailing where they are held and how to access them. Not only will this ensure you do not lose access to your NFTs, but it will assist your personal representatives in dealing with these assets as you intended when you die.
You should bear in mind that, upon death, your will becomes a public document and, as such, any specific access details for your NFTs should not be contained in it. Instead, it would be advisable to maintain an up-to-date schedule of the access details in a secure location, and to make your personal representatives aware of where to find this information in the event of your death.
If you are a personal representative appointed to administer an estate with cryptoassets such as NFTs, you will need to be aware of the tax implications that arise. Such assets are usually liable for inheritance tax and possibly capital gains tax.
This is relatively new area, which we and our clients are following with interest.