One of the most popular ‘investments’ of 2021 was in NFTs, or ‘Non-Fungible Tokens’. This weeks’ blog is all about how I went about explaining NFTs to my kids.
NFTs are a way for people to sell their digital art (and other digital products). Recently NFTs have made the news as people have started buying and selling digital art work for a lot of money. To help my daughters understand this concept, I first told them about how people make money from selling paintings and then moved to digital art.
What does Non-fungible mean?
The first question I got from my daughters, before I even tried to explain the concept of NFTs, was “What does ’non-fungible’ mean?”. It’s a great question as I only recently learnt the meaning myself. To explain, I said that something is ‘fungible’ if it can be replaced with something that is the same. For example, a $10 banknote can be replaced by any other $10 banknote so it is fungible. Something is non-fungible if you can’t replace it with something the same, e.g. a house is non-fungible as each house has a unique location so you can’t just swap one for another.
With the definition explained, I then started helping my daughters understand the concept of NFTs using a made-up case study of ‘Timmy the Artist’.
A Story To Help Explain NFTs To Kids
Timmy sells a painting
Little Timmy loved to paint pictures. He would create many different paintings when he wasn’t at school. His parents didn’t take too much notice as they just saw it as a hobby. Then one day Timmy created a painting which they thought was more impressive than anything they had seen him paint before. It was so unique. His parents took the painting to a local art gallery to show them and they were really impressed too and offered to sell the painting on their behalf. It didn’t take long before an art lover paid £400 for it!
After a year, Timmy was walking past an art shop and saw his painting in the window. It was on sale for just £22. Timmy was sad as his painting clearly wasn’t as good as his parents thought it was. He was also upset that the person who had bought his painting for £400 had sold it and lost a lot of money. Timmy decided to visit the art gallery to find out what happened. To his surprise, the art gallery owner told him that the painting in the art shop wasn’t the one Timmy had painted, it was a copy someone made and hence why it was only £22. As more people loved his original painting the art lover actually sold the painting to someone else for £3,000!
Timmy was shocked that someone would pay £3,000 for his original painting when they could buy a copy which looked very similar for only £22. The art gallery owner told Timmy that people love the feeling of knowing they own an original painting. Even though the copies look very similar, they will not be exactly the same. By looking closely at the different paintings they could always know which painting is the original and which paintings are copies. As there is only one original painting, there are lots of people willing to pay money for it and hence it has been going up in value. Timmy was so happy to hear that people were loving his painting!
Timmy sells a digital picture
With the £400 Timmy received from selling his painting, he bought a tablet computer which had a digital pen. He loved it and spent all his time learning how to create digital pictures on his new tablet.
After much practice, he was creating pictures which were even more impressive than the painting he sold. He wondered if he would be able to sell his digital pictures, like he sold his painting.
He went to the art gallery to show them his digital picture on his tablet and ask if anyone would be willing to buy it. The art gallery owner said that they wouldn’t be able to sell it easily. He explained that, unlike the painting, people wouldn’t be able to tell the difference between the original and copies so wouldn’t pay a lot for the digital picture.
Timmy was really upset as he had spent a long time creating his digital pictures. On his way home, he saw a newspaper headline saying an artist had sold a digital picture for £100,000! Timmy couldn’t believe it. He grabbed a copy of the newspaper and read all about the artist.
The artist had managed to sell his digital art by using an NFT. He learnt that by using a NFT, the artist had sold his digital picture with a special code attached to it. This code was logged onto a big network of computers (called the BlockChain). As his digital picture was the only copy with this code, even if people copied the digital picture, there would only be one copy of the digital picture with the special code attached to it. This meant that whoever had the picture with the code, was the person with the original digital picture. As some people love owning the ‘original version’ of art (assuming it can be proven they own the original), then they are willing to pay a lot of money, even if it can be copied exactly.
Timmy started to set up NFTs for his art work and was able to sell them to people who loved his art. This meant he could get paid in a similar way for paintings and digital art.
Timmy sees the downside of NFTs
Whilst Timmy was so happy to be making an income from selling his artwork to those that loved his pictures, he noticed some other people were creating very similar pictures to his and selling them for a profit.
The other pictures were the same as Timmy’s digital pictures but with a few colours changed. As they were ‘original’ due to the change in colour, those selling the pictures were making money despite not putting in all the hard work that he had done creating his initial painting. These people were just being greedy and using his hard work to make money.
Timmy kept creating digital paintings but was selective over who he shared them with, to that only people who really appreciate his art, rather than those looking to make money from it.
Key learning about NFTs
In a world where people are starting to spend more money on digital products rather than physical products, it makes sense that there is a way for people who create the digital products to get paid. NFTs is the technology that allows this to happen - which is a great development! One digital artist that I really like is 'Art By Amrita' as they are doing something very creative.
These digital products can be for digital art, gifs, video clips and much more.
As the story showed, despite it being possible for people to create an exact copy of Timmy’s digital picture, people are willing to pay a lot of money if they know they have the ‘original’ so selling it as an NFT meant he can capture which version is the original.
This has led to many artists selling their digital artwork. You may have heard about the ‘Bored Ape Yacht Club’ which have been selling for hundreds of thousands of dollars. It’s not just art. It’s any digital item. For example, the original tweet from the founder of Twitter was made into an NFT and sold for $2.9 million.
These might seem like crazy high amounts but people love collecting things and in a digital world, NFTs allow people to collect digital items.
The downsides of NFTs
Whilst the rationale for NFTs is great and is helping creators of Digital products to make money from their work, there are some things to be aware of when it comes to ‘investing’ in NFTs.
ONE: You don’t actually own the copyright to the digital product
Even if you have the digital picture with the special code ,this doesn’t mean you own the full rights to that picture. For example, you can’t start making money from people who want to put the picture on a t-shirt or a mug. That would still be owned by the artist. You only own the file with the original picture.
This fact is starting to impact people who buy digital products in computer games. Let’s say they are playing Roblox and they want a unique t-shirt for your character. They can buy the NFT for that. The downside is that they can’t use that same digital t-shirt on characters in other games, it’s only for that game. This means as soon as the game becomes obsolete, so will the NFT.
TWO: Speculation is risky
As the price of NFTs over recent history (over 2021) has increased significantly, there are many others who are buying NFTs as they see it as a way of ‘getting rich quick’, i.e. they are speculating that the price of NFTs will continue to rise significantly over the near future.
It’s important to note that, like investing in paintings, you only make money with NFTs if you find someone else who is willing to pay more for it in the future, i.e. known as the ‘greater fool’. The risk is that there is no one willing to pay more and you become the ‘greatest fool’ and lose money. Here is a blog on how to teach your kids about the greater fool theory. I would also recommend extreme caution when speculating with your money.
THREE: Scams and greed
As mentioned in the story, as people witness others making a lot of money from selling NFTs, they want to do the same . As they don’t have the skills of the digital artists, they just create something very similar and sell it as an original. Take for example the Bored Ape set of digital pictures. People are simply taking a copy of the picture, making some slight edits (colours, flipping the direction it is looking at or adding something small) and calling these new pictures original.
The other crazy thing I heard is that people are selling digital locations. So you can buy an NFT to own the digital location of the Eiffel Tower in Paris. This has no actual value (as you can’t live there or do anything with this digital location) but people are still paying lots of money for it (around 270k as at 27 Feb 2022). The worst part is that there are lots of platforms selling digital locations. So you could own the Eiffel Tower location NFT on one platform and I could own it on another platform and these would be separate NFTs. This is very worrying as I’m not sure people fully realise that there are multiple platforms with the same things on them.
As people are so keen to make money, they are willing to buy these things that don’t really make sense. These types of stories show that some people are exploiting the opportunity for their own greed. It won’t last and a lot of people are going to lose money.
FOUR: Impact on the environment
The big network of computers which log who has the original copy of all these digital products is on a blockchain called Ethereum. These computers use a lot of energy and this has a negative impact on the environment. This might change in the future as new blockchain technology is developed which uses less computer power.
NFTs are a great way for people to support those that are producing great digital products. We will no doubt be using NFTs for many different things in the future, e.g. certificates will most likely be NFTs so that there is a record, unique to you, in the digital world rather than just a piece of paper.
Whilst the idea and technology behind NFTs makes a lot of sense, there are worries about people seeing them as an ‘investment’. These NFTs don’t provide any income so you only make money if you find someone to buy your NFTs from you at a higher price in the future, i.e. the greater fool. At the moment it appears there are a lot of people willing to pay high prices for things as they hear stories of others making money, i.e. they are speculating. At some point, the trend will get overheated and prices will fall and this can lead to a lot of people losing money.
Therefore, if you see an NFT which you like, buy it based on how much you really like it and want to own it (to support the person who created it), rather than thinking that you’ll make a lot of money from it.
I hope this blog helps you explain NFTs to your kids.
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