What are NFTs and how do they work in the art world?

When “Everydays: The First 5000 Days” by the digital artist Beeple sold at auction in February 2021, it made headline news.

The $69,400,000 sale price was noteworthy in itself, as it instantly made Beeple, also known as Mike Winkelmann, one of the world’s most valuable living artists. However, what really caught the public’s attention was that the hefty price tag wasn’t for the digital work itself, but for the NFT (or non-fungible token) associated with that work, this being the first time a major auction house had offered an NFT for sale.

Confused? You’re not alone. The concept of NFTs is a tricky one to understand but in essence, they are a unique piece of digital code that certifies the authenticity of a digital item. This item could be a work of art, a piece of music, a simple document or any other digital asset. The NFT is created and stored on what’s known as a blockchain, which is effectively a decentralised online database that is used for keeping records and is virtually impossible to change or falsify – and therefore represents an indisputable record of ownership.

Although a digital item can be replicated an infinite number of times – we all know how easy it is, for example, to copy digital documents – an NFT representing that item cannot. The NFT’s uniqueness therefore gives it scarcity value, just like any traditional work of art, thus potentially driving up its price, depending on demand.

NFTs have been around for at least five years, and are frequently traded on online marketplaces such as OpenSea. However, it was only once they started going for record prices at traditional auction houses that much of the mainstream art world began to accept them as legitimate items that could be bought and sold by collectors.

Is fraud and copyright infringement a risk?

One important factor that both auction houses and artists alike are having to take seriously when it comes to Web3 – the term used to describe a new approach to the World Wide Web using blockchain technology – is the prevalence of fraud, theft and scams. These are particularly rife in the digital world where there is a proliferation of imitation and too-good-to-be-true get-rich-quick schemes from fraudsters.

However, New York-based digital artist Amber Vittoria believes that if you take reasonable precautions, you’re no more likely to be scammed than in any other way. “Scams exist everywhere,” she says. “I get email scams all the time, phone calls, spam. It’s easier to not be fooled by these because we’re used to that technology. But with Web3 – the internet based on blockchain technology, it’s so new that we’re all still learning.”

Benjamin Kandler, Project Lead for Digital Art at auction house Phillips, says the company sees an important part of its role as protecting and guiding its clients. “We ensure that any NFT sold is authenticated and each smart contract [i.e. each blockchain transaction] is audited,” says Benjamin. “We also educate our collectors about how to safely store and collect their digital art.”

One upside of NFTs is their inherent transparency, which actually helps to protect against fraud, says Nima Sagharchi, the Head of Digital Art at Bonhams. “Because everything’s on the blockchain, you can examine a smart contract and see who’s selling something,” he says. “It’s probably 100 times more transparent than in the traditional art world because anyone can view those transactions.”

There are hundreds of millions of pounds a month being spent in this market. There’s no way that’s all going to go up in smoke.

“And because we work directly with platforms and the artists themselves, we have a direct line to the person that made it, which helps us avoid any copyright or intellectual property issues,” he adds.

Thanks to the efforts of auction houses to help clients overcome the various barriers to entry, Nima believes NFTs are here to stay – despite recent stories of many high-priced NFTs being over-valued. “There’s too much volume out there now for them to be a flash in the pan,” he says. “There are hundreds of millions of pounds a month being spent in this market. There’s no way that’s all going to go up in smoke.”

Read the next article in this series, 'The unexpected Renaissance of digital art is changing auction houses'.

The views expressed above are those of the author and do not represent the opinion of Cazenove Capital. This article is intended to be for information purposes only and should not be relied on as investment advice.