Not All Blockchain Art is Created Equal

By Colin Johnson, CEO and Co-Founder of Freeport

Amazon intends to launch a digital asset enterprise focusing on NFTs (non-fungible tokens). Investors reading this might have deja vu considering we’re not in 2021, but the reality is blockchain-based art hasn’t gone anywhere. As Galaxy predicts the Bitcoin NFT market, which was nearly nonexistent months ago, will hit $4.5 billion by 2025, we can expect to see more, not less, blockchain-based assets.

Despite tech companies like Amazon, Starbucks, and Reddit heavily investing in NFTs, a new form of art ownership is peaking over the horizon: tokenized fine art. Whereas with NFTs, the token is the asset—with no alternative backing—this new approach instead uses tokens as a means of facilitating the ownership of real, physical masterpieces. Think of stocks, but for fine art investing, and all on blockchain. Knowing this, how should retail investors approach this new landscape?

As the CEO and Co-Founder of a company that offers tokenized fine art, I feel it’s necessary to offer a clear distinction between that asset class and NFTs for investors.

What are the differences between NFTs and tokenized art?

First, it’s important to define both assets. NFTs are digital receipts that exist on a blockchain, which tend to have a single image associated with them, like a JPG or PNG. The metadata of that receipt can not be replicated, hence the “non-fungible” part.

Tokenized fine art, on the other hand, utilizes fungible tokens to represent investment in physical works. The tokens act much like stocks, but with more utility by virtue of living on-chain. Once the art has been stored and insured, it is then fractionalized through SEC-qualified offerings (for example, Regulation A) to grant individuals the opportunity to own a share in the piece of art.

Are they correlated or uncorrelated asset classes?

NFTs are correlated with hype, and tokenized fine art is correlated with, well, art!

Despite both leveraging blockchain technology (some platforms offer fractionalized shares of fine art off-chain), NFTs and tokenized art are substantially different asset classes that represent two distinct types of investments. To start, most NFTs aren’t tethered to, or backed, by an asset with tangible value that exists in the real world. This means they can see drastic swings in price depending on the hype cycle. A given NFT’s value is often tied to a number of factors that include the blockchain on which it was built, the collection it’s part of, rarity traits, or simply the current zeitgeist of Crypto Twitter.

The value of most tokenized fine art, alternatively, is based on that of the physical piece, and therefore remains correlated to the broader fine-art market. While the upside tends to be more restrained, there are other benefits, such as fine art tending to hold its value in down markets and periods of high inflation.

How are they stored?

Both NFTs and tokenized art have their value recorded on the blockchain, however tokenized fine art has a second backstop: the physical piece itself. Generally, these pieces are insured and stored in highly secured vaults, including tax exempt freeport facilities that help keep sales tax down. This requires an added layer of trust in between the owner of the tokens and the asset itself, so purchasers should do their diligence on the source of the artwork and the company providing it.

NFTs, on the other hand, overwhelmingly represent digitally native assets (although they can represent a physical piece of art) which have a purely abstract connection to the real world. Users therefore have to rely on the word of the NFT creator and information stored on chain to verify the provenance of their digital asset.

How does ownership differ?

NFTs are typically fully owned by a single wallet, although platforms like fractional.art have begun to offer solutions for group ownership. Once you purchase an NFT, it lives in your wallet of choice on its respective chain. The NFT is publicly visible to other people and protocols, which is one of the qualities most important to NFT collectors, proving to friends the art really is in their wallet.

With tokenized physical assets, the tokens are also discoverable and visible on chain so owners can similarly flex the fact that they’re invested in the art piece. But the token itself generally does not have an image link directly tied to it. Instead, it exists like a stock, with many more community owners and much more liquidity than individual NFTs.

In essence, NFTs tend to have a purely digital provenance and one owner, while tokenized art allows multiple buyers to share ownership of one rare physical asset. So what are the implications for retail investors?

A different investment thesis

Both assets leverage blockchain and therefore share some forms of utility—like composability and discoverability. But from an investment perspective, the differences between these two assets are stark.

For retail investors, the motivations behind investing in an NFT are varied. They can be emotional—like the draw of becoming part of a community. They can also be purely speculative, as the potential for extreme upside (1,000%+) is certainly there when the markets are hot. That type of return on art-investment usually only comes with a token that’s fully detached from real-world assets. The downside, however, is that the fall is almost always equally steep.

A tokenized piece of art instead offers a more tethered value proposition that can rely on the underlying asset for price support. There are predictable price histories for name brand artists whose timeless works won’t fade at the whims of social media. It’s a more stable approach to art investing that takes advantage of the newest technologies.

Tokenized art also serves as an entryway to a previously exclusive investment class. Fine art has historically been off limits to all but the ultra-wealthy, excluding the rest of society from investing in blue-chip assets that have outperformed the S&P 500 over the last 25 years. In a similar vein, fine art serves as a crucial hedge against inflation due to its detachment from the wider financial markets.

When it comes to investment longevity, NFTs don’t have the proven track record of traditional art but they do have the momentum of a young, influential cohort of hype collectors that allow for unique new takes on the art world.

While they may be based on one technology, there are significantly different forces at play in the blockchain art space. Both NFT art and traditional art can go for millions of dollars on the open market. While the value of traditional art benefits from steady and consistent growth on a yearly basis, predicting the value of NFT art is much more challenging, and therefore not for the risk averse. Both have their places, depending on the risk tolerance of any potential investor.

About the author:

Colin is the CEO and Co-Founder of Freeport, a platform bringing fine art investment on-chain. Before Freeport, he spent 10 years in the consumer marketing space, where he focused on technology, payments, and partnerships inside some of the most recognized brands on the planet, including Apple and American Express. At AmEx, Colin led marketing partnerships with companies like Uber, Google, and Airbnb, before being recruited by Apple to join the Apple Pay marketing team. After moving out to California, he oversaw marketing for Apple Cash from product launch to being used by millions of Americans. Colin hails from Trenton, NJ and attended Princeton University for undergrad.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.