Virtual investments

What are NFTs or non-fungible tokens?

During the recent 1st Philippine Copyright Summit, Andres Guadamuz of the University of Sussex described tokens as digital representations of a good or service written on a blockchain which can represent anything, be it a character in a game, a work of art, airline tickets, frequent flyer miles, provenance, or coins, and is represented as a smart contract.

A blockchain meanwhile, he said, is simply an open, permissionless, cryptographic, and decentralized ledger. And because these ledgers are public and decentralized and since anyone can check past, present, and proposed transactions, there is increased reliability in the system.

Smart contracts on the other hand are implemented in codes using a common language such as Solidity and pegged to a cryptocurrency for automated payments and transactions. These transactions and contracts get written into the blockchain. These codes, Guadamuz emphasized, are immutable and openly verifiable transactions.

NFTs are those that are unique, such as a specific silver necklace or painting unlike fungible goods which by definition are interchangeable, no matter what specific item one is selling or buying. Examples of fungible goods would be silver, gold, oil and grain. NFTs are smart contracts that represent a non-fungible good and will always link to that one item. According to Guadamuz, there are NFTs for everything – music, art, game items, sport highlights, and even collectibles and profile pictures.

He adds that while one can mint their own stuff, most people use intermediaries which are marketplaces that act as third parties between buyer and seller and may take commission and collect transaction fees to keep the network operating. Examples of these third parties would be OpenSea, Mintable, Rarible, Cent, Foundation, among others.

The NFT, which for instance represents a particular painting, is just a code that is uploaded to a blockchain, and is considered as a smart contract.

Guadamuz revealed that the average price of NFTs is lower than $15 for 75 percent of the assets and larger than $1,594 for one percent of the assets. The top 10 percent of traders alone perform 85 percent of all transactions and trade at least once 97 percent of all assets.

Virtual coins, digital tokens, or cryptocurrency are not NFTs and are considered as fungible.

Investopedia defines a cryptocurrency as a form of digital token or coin that exist on a blockchain, or a distributed and decentralized ledger. Bitcoin, it said, continues to lead the pack of cryptocurrencies in terms of market capitalization, user base, and popularity. Other virtual currencies such as Ethereum rate being used to create decentralized financial systems.

It said that while some cryptocurrencies have ventured into the physical world with credit cards and other projects, the large majority remain entirely intangible. There are about 8,000 cryptocurrencies in existence as of December 2021.

Cryptocurrencies, it added, are intended to be used for payments, transmitting value similar to digital money, across a decentralized network of users.

But there are also blockchain-based tokens that are meant to serve a different purpose from that of money. One example, it mentioned, could be a token issued as part of an initial coin offering (ICO) that represents a stake in a blockchain or decentralized finance project. If the tokens are linked to the value of the company or project, they can be called security tokens akin to securities like stocks.

According to the same article, Ethereum, the second largest digital currency by market capitalization after Bitcoin, is a decentralized software platform whose goal is to create a decentralized suite of financial products that anyone in the world can freely access. As of December 2021, it was trading at around $4,000 per ETH.

The size of the cryptocurrency space, it said, has grown exponentially in the past decade, with new innovations and a collective market capitalization of more than $2.5 trillion. As decentralized platforms, blockchain-based cryptocurrencies allow individuals to engage in peer-to-peer financial transactions or enter into contracts with need of a bank or monetary authority or a court.

But despite the thousands of competitors that have sprung, the article emphasized that Bitcoin, which is the original cryptocurrency, remains the dominant player in terms of usage and economic value. Each coin (BTC) was worth around $47,000 as of December 2021 with a market capitalization of more than $886 billion.

Initial coin offerings (ICOs) or token offerings are smart contracts based on blockchain technology to attract external financing by issuing digital financial assets such as coins or tokens, according to an article in the Journal of Risk and Financial Management.

As of January 2021, 5728 ICO projects have attracted more than $27 billion. From an entrepreneur’s point of view, ICOs are very attractive because they offer financing at all stages with almost zero transaction costs. From an investor’s viewpoint, ICOs are also interesting because they offer potentially faster exits and high returns. Nowadays, almost all ICOs take place on the Ethereum platform, the article explained.

But ICOs do not give any guarantees to investors. The article added that ICOs are very often called a financial bubble because of high risks, the lack of possibility of a fundamental evaluation of the project, and almost all risks are connected with insufficient legal regulation.

Our Securities and Exchange Commission (SEC) defined an ICO as the first sale and issuance of a new virtual currency to the public usually for the purpose of raising capital for start-up companies or funding independent projects.

But just like other securities or solicitations of investments from the public, the SEC said that entities offering ICOs must first get a license from the commission.

Meanwhile, the US SEC has said that while companies and individuals are increasingly considering ICOs as a way to raise capital or participate in investment opportunities and that while these digital assets and the technology behind them may present a new and efficient means for carrying out financial transactions, they also bring increased risk of fraud and manipulation because the markets for these assets are less regulated than traditional capital markets.

The US SEC noted that ICOs can be considered a securities offerings based on specific facts and fall under the SRC’s jurisdiction of enforcing securities laws. ICOs that are securities most likely need to be registered with the SEC.

In 2020, the US SEC announced charges against blockchain service company BitClave Pte. Ltd. For conducting an unregistered ICO of digital asset securities.

In the Philippines, the SEC just last Thursday said that play-to-earn platform Outrace has been soliciting investments without the necessary license. It noted that what Outrace offers has the characteristics of a Ponzi scheme, wherein returns to early investors are likely to be paid out from the investments of new investors and not out of the companies’ profits.

Meanwhile, the Bangko Sentral ng Pilipinas (BSP) has said that Bitcoin and other cryptocurrencies are not recognized by the BSP as a legitimate currency and these are neither issued not guaranteed by a central bank nor backed by any commodity. But virtual currencies were legalized and cryptocurrency exchanges are now regulated by the BSP under Circular 944. But NFTs are not excluded from the definition of virtual assets regulated by the BSP.

Security Bank, in a post on its website, said that for beginners, cryptocurrencies are difficult to understand since they are based on complex blockchain technology. Without proper understanding and doing intensive research, dealing with these provides a lot of risks that can lead to losses. And as cryptos become more secure and decentralized, it becomes hard for regulating bodies like government agencies to track individual users by their wallet IDs alone. This makes crypto one of the favored methods to do illegal transactions such as purchase of illicit items, terrorism funding, and money laundering.

And while there is great potential for gains when investing in crypto, the bank emphasized that there is also a great potential for losses. Each day, it noted, is bound to get sharp increases and losses due to the nature of crypto. Since crypto is decentralized, scam coins can easily pop out of nowhere and there are no regulatory bodies that can detect it so that developers can create a coin on their own and start a Ponzi scheme, it added.

There is a great advice given by Security Bank. Invest only in cryptocurrencies in what you can lose. And as long as you can handle the risks, there is no one stopping you from investing in crypto. Before diving into any kind of investment, whether in stocks or crypto, one must determine their risk tolerance first, it said.

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