In recent months, you may have seen headlines like: “Beeple collection sells for $69M,” “CryptoPunk 4156 Sells for $10.2M” or “Bitcoin/Eth/SOL/Dogecoin/Shiba hits new high.”1 These headlines underscore how cryptocurrencies and non-fungible tokens (NFTs) are becoming a bigger part of the investment world. Some early investors in this space have achieved truly extraordinary returns, and others have lost millions.
Unless you have direct experience, you’re probably a bit confused and unclear about how these new asset classes actually work, let alone how to properly advise clients about them. I’m not an expert on the esoteric or technological features of blockchain-based assets, but I’ve been involved with both cryptocurrency and NFT investing with some of the top minds in the space over the past several years.
Here’s a framework and a practical guide for how to advise clients about investing in NFTs and cryptocurrencies. Those already deep in this space will learn ways to better communicate these complex concepts to clients.
Cryptocurrencies: Risky Business
Hundreds of articles are available to provide you with an excellent background about how cryptocurrencies are structured and tracked and the utility they provide.2 For discussions with clients, I suggest that you think about cryptocurrencies simply as you would high risk shares of stock. While they aren’t regulated or valued as traditional stocks (they’re not valued based on present or projected cash flows), cryptocurrencies are valued in a myriad of ways. Sometimes, their value is based solely on hype and promotion and not on their actual worth.
They are, depending on how they’re stored, very liquid and can be traded virtually instantly for other cryptocurrencies, NFTs or fiat currency (that is, U.S. dollars or other traditional currencies).
There are hundreds of different cryptocurrencies. At the time of this writing, however, the top five—Bitcoin, Ethereum, Binance Coin, Tether and Solana—make up an outsized portion of the massive, trillion dollar market value of this asset class.
To be clear, while you might think about these as “stocks,” you must view them as incredibly high risk stocks. Additionally, you can’t currently store them as securely as you could a typical publicly traded stock. History also shows that they can gain or lose value at rates far faster than virtually any traditional stock.
I suggest you frame investments in cryptocurrencies as you would investments in highly volatile, small cap stocks. Within this, the “blue chips” in this space would likely be Bitcoin and Ethereum—two of the most accepted and stable currencies available, with a combined market capitalization of well over $1 trillion. Other currencies have typically been more volatile and risky. There’s no doubt that others will emerge. Many have already emerged, attracted attention and money and simply crashed and burned.
Setting up a cryptocurrency account. My own experience has primarily been with Coinbase. Setting up an account on this exchange is straightforward—you simply need to link a bank account or credit card to a new account to start trading. Coinbase provides custody—including vault storage—as a way to more securely store cryptocurrency holdings with 48-hour delays on any withdrawals, giving time to secure currency held in an account otherwise compromised by hackers.
Purchasing currencies is, again, similar to purchasing stock on an online exchange. You select from the list of available cryptocurrencies and purchase the amount you desire. Once you own different currencies, it’s possible to trade directly among different cryptocurrencies, rather than converting back to U.S. dollars first.
You can set up ongoing, scheduled purchases of any currency available on Coinbase. This can be an easy way to dollar cost average into cryptocurrencies.
Trust titling. Currently, it’s challenging to open accounts in the name of a revocable or irrevocable trust. For example, at Coinbase, you must work with Coinbase Institutional to set up accounts in the name of trusts or other entities. It requires more documentation than what’s typically required at traditional brokerage houses. When I went through this process, Coinbase required extensive documentation, including my currently named revocable trust successor trustees. While imperfect, there’s a benefit to an account holder in titling a Coinbase account in the name of their living trust to aid in providing access to successor trustees in case of incapacity and avoid exposure to probate after death.
NFTs: Like Collectibles
Many articles explain what NFTs are and how they work.3 In summary, NFTs are digitally authenticated, unique tokens that either contain or link to images, videos or other digital assets. Authentication records are stored via distributed blockchains.
To understand the concept in simple terms, let’s compare NFTs to three existing collectible categories: (1) original pieces of art, (2) certified/numbered prints of original art, and (3) sports trading cards. This is an oversimplification, as new classes of NFTs are emerging that go well beyond these categories.
Clients may question you as to why they need to purchase an NFT. They may think they can just right-click and save the NFT image to their computer. To respond, use Leonardo Da Vinci’s Mona Lisa as an example. Any of us can save an image of the Mona Lisa on our computer. We can print out a copy and put it on our wall. We can use it as a screensaver. However, this doesn’t make the original, verified Mona Lisa painting less valuable. In fact, the more an image is spread and used by others, arguably the more valuable the original, authenticated version becomes.
A one-of-one NFT is, essentially, like an original work of digital art. Purchasing the NFT is on par with purchasing a third-party authenticated original “painting.” In contrast to traditional art, authentication isn’t provided by an auction house or museum—it’s irrefutably proven on the distributed blockchain, so no third party is needed for proof.
Numbered NFTs (for example, one of 250 in a series) might make you think of numbered prints or collectible baseball cards as a comparison. Again, anyone can take a photo or image of a baseball card, but value lies in owning an authenticated, physical copy of a card. With NFTs, instead of owning a verified physical copy, you own a blockchain authenticated “print” of an original piece.
To resell a high value sports trading card, you typically need third-party authentication and a “grade” of the condition of the card via a specialist at Professional Sports Authenticator, Beckett or other grading service. Again, with NFTs, no third-party verification is needed, and sales can occur instantly online, making NFTs more liquid than traditional trading cards.4
The NFT world is adapting rapidly, and billions of dollars of investment are flowing in. New categories of NFTs are emerging. Some NFTs now include commercial and legal rights to develop intellectual property based on the NFT, with big-name Hollywood producers getting involved.5 Some may even grant membership at golf clubs.6 However, attorneys advising clients purchasing NFTs should be aware that ownership doesn’t necessarily transfer the underlying copyright in the work.
There’s also social value in owning NFTs. Many investors and celebrities (for example, professional basketball player Stephen Curry and rapper and songwriter Snoop Dogg) have used the images of high value, exclusive NFTs that they own as their profile pictures for social media accounts.
Purchasing NFTs
U.S. dollars. To purchase NFT sports cards or licensed National Basketball Association or Major League Baseball “moments,” you can use U.S. dollars at NBA Topshot (nbatopshot.com) or Topps MLB NFTs (Toppsnfts.com).
To purchase NFT art with U.S. dollars, the easiest and most recognized site is NiftyGateway.com. Here, you can use cash transfers or credit cards to purchase NFT artwork via “drops” (time-limited or drawing-based opportunities to buy brand-new works) or via the secondary marketplace.
Ethereum or other cryptocurrencies. The vast majority of NFTs are only available for purchase “on chain” with other cryptocurrencies. Ethereum is the most common currency used for buying or selling the majority of NFTs.
Purchasing NFTs with Ethereum isn’t something I would recommend for any “newbie” to the space, because it requires a solid understanding of the ecosystem and of online storage and transfers.
Two steps. For those already familiar with NFTs who wish to make purchases, two steps are required:
Step 1. First, set up a form of online crypto wallet. Metamask is the most common wallet used. Think of this as a way to take Ethereum from one online exchange to another, virtually. Many other options exist.
To set up a Metamask wallet, download it as an extension for your Internet browser and/or as a stand-alone app on your smartphone. Take extreme care to preserve the user-generated password and the “seed phrase” (that is, a randomly generated list of 12 words provided when the wallet is created). The seed phrase must be preserved—ideally written down and saved in a secure place—as it’s the only way to recover the wallet and its digital contents if the wallet is ever deleted or otherwise lost. The user is responsible for keeping the wallet secure—there’s no third-party support available if a user loses a password and seed phrase or if they inadvertently let a nefarious third party gain access to the seed phrase.
Step 2. Once set up, you can send Ethereum or another currency from your Coinbase account or other type of storage to the Metamask wallet, using the distinct address associated with the wallet. The Metamask wallet can then be used to “shop” on third-party NFT marketplaces when a user accesses the marketplaces using the browser with the Metamask extension or via the Metamask app on a smartphone. Think of the wallet as a virtual debit card but without an intermediary or institutional support.
Once a purchase is made with Ethereum in the wallet via an online marketplace, the Ethereum is transferred to the seller and the NFT is transferred into your wallet, where it can be listed/sold on the same or other online exchange. NFTs can also simply be held in a Metamask wallet.
OpenSea.io is the largest online marketplace for NFT trading. Many others exist, including Superrare.com and Foundation.app.
Venture Capital Risk Profile
Learning about cryptocurrencies and NFTs can be overwhelming, but reframing them to compare them with existing asset classes can help us discuss these new investment categories with our clients.
These new asset categories are here to stay, but it’s critically important to understand just how risky these categories are. Even the biggest cheerleaders in the space are open about the fact that 90%-to-99% of NFTs on the market today will be poor investments over the long term. For example, entrepreneur and NFT thought leader Gary Vaynerchuk has said on Twitter: “98-99% of NFT projects from this ‘2021 NFT Year’ will end up being bad investments ... pls be thoughtful ...this is a gold rush and 99-2000 internet stock eras ...some big big winners but a lot of carnage, play with what u can afford to lose.”7 This is balanced, however, by the extraordinary returns possible for the NFTs and cryptocurrencies that stand the test of time.
Thus, it makes sense to frame investment in this space as similar to venture capital. The majority of these investments are likely to go to zero over time, but the winners can deliver 10x-to-100x returns. A broad-based, portfolio approach is necessary to capture a reasonable likelihood of gains without major risk. Investment in any one speculative cryptocurrency or NFT is more like gambling on a single start-up company.
Investment Considerations
There are myriad ways to invest in cryptocurrencies and NFTs. Ideally, however, investors will keep it simple. At the time of this writing, there are very few cryptocurrency exchange-traded fund (ETF)-type funds, and there are no NFT index funds available for trading with traditional brokers. I believe that this will soon change, and more traditional investment options will emerge. However, the few ETFs that do exist are unproven. Regardless of ETFs, you must be familiar with how clients can invest directly in currencies.
To invest directly in cryptocurrencies, let’s focus exclusively on proven and secure trading and custody platforms. Coinbase is the current market leader based in the United States.8 Other proven exchanges include FTX, Gemini and Blockfi. There are many other platforms available—an ever-growing list—but it’s best to work with a leading platform, even if trading fees are slightly higher than newer exchanges. Security and customer support are key, and the exchanges listed above are among the best in the space.
Unfortunately, there’s no easy way to invest directly in most NFTs. Few are available for purchase with U.S. dollars, but there are exceptions. Most require another form of cryptocurrency, most commonly Ethereum, via online wallets that must be connected with third-party NFT marketplaces.
It’s likely that easier and more secure options will soon emerge for investing in this space. On the flip side, the “wild west” aspect of NFT investing means that those bold or courageous enough to take on the challenge may benefit massively once regulatory and security concerns are better managed and when more institutional money pours into the space.
The recommended allocation is very specific to the investor, their age and risk profile and familiarity with blockchain-based investing. I’m an attorney, not a licensed financial advisor, but I would submit that it’s advisable for anyone with a longer investment time horizon to have some exposure to cryptocurrencies, with a focus on “blue chips”: Bitcoin and Ethereum.
I would only recommend that a client consider investing in NFTs if they’re willing to lose, or if they already have significant cryptocurrency holdings and are at least somewhat familiar with blockchain investment and trading.
There have already been a number of boom/bust cycles in the NFT space. Those who picked (and held) early winners (for example, CryptoPunks, works by Beeple, Bored Ape Yacht Club) have already been massively rewarded. However, the majority of NFTs haven’t and won’t deliver positive returns over the long run.
Yes, It’s Complicated
Does this all sound a bit overwhelming or complex? Unfortunately, it is. New tools are being developed to make this investment world more accessible.
Because of this, I don’t recommend NFT trading via a Metamask or other wallet for most—this should be left for only those more experienced and familiar with the space.
Be warned: While purchases and sales can be made instantly on these sites, prices can be extraordinarily volatile. I’ve personally purchased pieces on NiftyGateway or OpenSea that went up 5x-to-10x in value in a matter of days. I’ve also purchased pieces that have lost 90% of their value in a similar timeframe!
Additionally, storage is a challenge. There are hundreds of horror stories of NFT collectors losing their entire collections when hackers gain control of their online wallets. More secure storage is possible, but challenging. This is beyond the scope of this article, but it’s another risk that must be considered when allocating funds to this new space.
Once NFTs are purchased, it’s advisable to hold them in offline cold storage—a wallet that’s not connected to the Internet. Leading providers of cold wallets include Trezor and Ledger.9
Tax Treatment and Regulation
Laws and regulations are evolving rapidly and are likely to change.10 As of this writing, it appears that, at a high level, the Internal Revenue Service treats NFTs and cryptocurrency trades as they would the purchase or sale of a share of stock. Each purchase, exchange or sale must be calculated back to U.S. dollar values at the time of the trade to calculate the cost basis or short- or long-term capital gains.
While Coinbase and other cryptoexchanges are now offering some tax reporting tools, most online NFT marketplaces don’t. It’s up to the individual to track and report trades on their tax returns each year. New software tools are emerging to help holders to accurately track crypto trades for tax purposes.
Regulatory changes in the space also have the potential to dramatically impact values. I suggest coordinating with accountants familiar with this process.
Endnotes
1. https://news.artnet.com/market/most-expensive-nft-art-yearend-2052822; www.yahoo.com/now/10m-cryptopunk-purchase-smashes-time-111831029.html; www.forbes.com/sites/jonathanponciano/2021/11/10/bitcoin-hits-new-record-high-after-inflation-surges-to-30-year-peak/?sh=7e5cab7e7422; https://markets.businessinsider.com/news/currencies/dogecoin-price-record-high-doge-day-cryptocurrencies-bitcoin-ether-2021-4; www.cnbc.com/2021/10/27/meme-token-shiba-inu-hits-record-high-closing-in-on-dogecoin.html; www.reuters.com/technology/cryptocurrency-ether-hits-all-time-high-4400-2021-10-29/; https://decrypt.co/85457/solana-hits-all-time-high-of-260.
2. See Ivan Taback and Stephen L. Ham IV, “The Fiduciary’s Guide to Cryptocurrency: Parts I and II,” Trusts & Estates (May 2021 and July/August 2021, respectively), for an excellent reference.
3. Seewww.cnn.com/2021/03/17/business/what-is-nft-meaning-fe-series/index.html as one example.
4. See NBA Topshot, MLB’s partnership with Candy Digital for an example of how sports card collecting has been adapted to non-fungible tokens (NFTs), https://nbatopshot.com/ and www.mlb.com/news/mlb-strikes-long-term-deal-as-first-nft-partner-of-candy-digital.
5. Seehttps://decrypt.co/83255/bored-ape-yacht-club-nft-film-tv-music-guy-oseary.
6. www.cnbc.com/2022/01/05/linksdao-raised-millions-selling-nfts-to-buy-a-golf-course.html.
7. https://twitter.com/garyvee/status/1462521219287334915?lang=en.
8. https://coinmarketcap.com/rankings/exchanges/.
9. The details on safe, long-term storage are outside of the scope of this article, but seehttps://cointelegraph.com/nonfungible-tokens-for-beginners/how-to-store-nft-assets-a-beginners-guide for more guidance.
10. For details on the tax treatment of NFTs and cryptocurrencies, see supra note 2.