A piece of art named “The Merge” by artist Pak sold for $92 (£75) million in 2021. While a sale of this magnitude isn’t unheard of in the art world, The Merge set a different type of record. Why? Well, The Merge isn’t a physical painting or a sculpture but a non-fungible token (NFT).

Others have also cashed in on the rising popularity of NFTs. “Clock” was created by Wikileaks founder Julian Assange (and Pak) as a digital counter of the days Assange spent in Belmarsh prison awaiting expedition to the US. The NFT fetched over £40 million at auction last year, with the funds being put towards Assange’s legal fees.

And rock band Kings of Leon made musical history as the first band to release an album as an NFT, with “When You See Yourself” making its debut in 2021. Fans were able to buy the token for $50 (£41), with sales open for two weeks after which time the NFT became a tradable collectible.

Although these eye-catching sums have attracted the attention of investors looking for returns from their money, it can be difficult to navigate through the available options. To help with this, let’s take a closer look at what investors need to know about investing in NFTs.

Remember: investment in any cryptocurrency is speculative and all your capital is at risk. You could lose some or all of your money. Cryptocurrency trading in the UK is unregulated and you will have no recourse to compensation if something goes wrong.

What is an NFT?

A NFT is a one-of-a-kind digital asset that can’t be copied or replicated, each with a unique identification code and metadata.

An NFT is the opposite of a ‘fungible’ asset which can be readily exchanged for an identical asset. Money is an example of a fungible asset. If a person lends someone £50, it doesn’t matter whether they are repaid with a £50 note or two £20 notes and a £10 note as they are the same. Cryptocurrency is also a fungible asset as aBitcoincan be exchanged for another Bitcoin.

Early examples of NFTs centred around digital art and collectibles, but now encompass a wide range of other assets. Some of the most popular NFTs are based on photography, trading cards, domain names, music and ownership of assets in virtual words.

As with other assets, NFTs can be bought and sold online, creating the opportunity for investors to make a profit if the NFT rises in value.

How is an NFT created?

NFTs are created through a process known as ‘minting’ in which a representation of the digital file is created and stored on a blockchain such asEthereumorSolana. This produces a record of ownership, prevents the file from being duplicated and tracks when the asset is bought and sold.

Most users choose an NFT marketplace to mint their NFTs, with the option of a centralised or decentralised marketplace as follows:

Centralised marketplaces

These are run by a single entity that controls the market place and its users. Centralised marketplaces may be more user-friendly and offer a secure platform for transactions. However, they have the power to restrict access to certain NFTs and users and typically charge higher transaction fees.

Decentralised marketplaces

These run on blockchain technology, meaning there is no central entity controlling the platform. This may provide users with more freedom and decentralised marketplaces often charge lower transaction fees. However, transactions can be slower and the lack of regulation may lead to copyright infringement or the fraudulent use of NFTs.

Users will also have to pay a ‘gas’ or transaction fee which is paid to validators for their services in keeping the blockchain functioning. This is usually payable on the ‘minting’ of the NFT, together with subsequent purchases or sales of the asset.

The gas fees vary by network and also fluctuate in real-time depending on demand. Ethereum is the largest network for NFTs but charges a relatively high gas fee, whereas Solana claims to charge lower gas fees. Flow andCardanoalso offer NFT transactions.

How can investors buy NFTs?

NFTs can be purchased privately, from traditional auction houses or via online marketplaces.

An NFT marketplace is a digital platform for buying and selling NFTs. This allows users to store and display NFTs, in addition to selling them to other users in exchange for money or cryptocurrency.

Each marketplace has its own features, in terms of the NFTs available, fees for transactionsand options for payment. We’ve producedour pick of the best NFT marketplaces, which includes the platforms featured below:

OpenSea:one of the largest marketplaces offering art, music, photography, trading cards and virtual worlds. The core currencies are Ethereum, Solana, and USDC but other cryptos are also offered, however, investors can’t pay in fiat currencies such as sterling or US dollars.

Rarible:another of the large marketplaces which allows users to trade in art, collectibles, video game assets and NFTs via Ethereum, Flow and Tezos.

NBA Top Shot:allows users to buy video clips and art of some of the great moments in basketball history. The site accepts credit and debit cards, as well as Bitcoin, Ethereum, Bitcoin Cash, DAI and USDC.

Binance:one of the largest cryptocurrency exchanges which entered the NFT marketplace in 2021. Offers artwork, gaming items, and collectibles. It accepts credit and debit cards, as well as a choice of 70 cryptos.

Nifty Gateway:known for hosting expensive and exclusive NFT sales from celebrities and top artists, including the aforementioned “The Merge” . It accepts credit and debit cards, as well as Ethereum.

SuperRare:a high-end NFT art marketplace which accepts Ethereum as the form of payment.

Platforms may accept payments in fiat currencies (such as sterling) or cryptocurrency, but investors will also have to open a crypto wallet. The key to the NFT will be stored in the crypto wallet, which can be held either online or offline.

If the NFT is a piece of art, investors can print physical copies of it or store the digital image, but the actual NFT owned is only the ID token. Investors don’t own the rights to the image or the original image itself unless those ownership rights are specified in the contract.

How are NFTs valued?

As with most assets, the value of an NFT is determined by supply, and more importantly, demand.

The most unique NFTs can command stellar prices. The second highest value on record was achieved by the artwork “Everydays: the First 5000 Days” which was sold by Christie’s auction house for $69 (£57) million in 2021.

The NFT was a collage of 5,000 pieces of work by Mike Winkelmann, the digital artist known as Beeple. Not a bad return given Winkelmann hadn’t sold a piece of his artwork for more than $100 (£82) until six months previously.

And in the sports sphere, a NFT of basketball legend LeBron James dunking the ball in an NBA Top Shot moment was purchased for $388,000 (£318,000) in 2021.

However, not all NFTs come with a hefty price tag. According to data from NFT tracking firm NonFungible, the average sales price of an NFT is currently $3,000 (£2,459) and some NFTs arevalued at less than a dollar.

There’s also been a marked downturn in the NFT market over the last year as the ‘crypto winter’ descended. Research firm NonFungible reported a near 80% drop in the global volume of NFTs traded between quarters two and three in 2022. It also pointed to an 84% decrease in profit on the resale of NFTs.

As a result, investors should carry out in-depth research before deciding to buy an NFT and be prepared to lose some, or all, of their money if prices fall.