(Bloomberg) -- Cryptocurrencies had a breakout moment in 2021, and NFTs were some of the biggest stars. Now, as with any new and hot investing trend, financial pros are hoping to capitalize on the craze with products promising a way to piggyback on the market.
NFTs, short for non-fungible tokens, exploded across the worlds of music, art, sports and more, created by celebrities ranging from K-pop group BTS to former first lady Melania Trump. The value of such tokens — essentially digital certificates of authenticity — stems from their inability to be replicated, thanks to an algorithm that creates a barcode for an individual virtual work.
Because NFTs will be a key component of the so-called metaverse that tech leaders like Mark Zuckerberg view as the future of the internet, buying up tokens early means the potential for big gains later on. That’s led to a flood of cash into the rapidly expanding industry, with some NFTs selling for hundreds of thousands or even millions of dollars (although there have been big flops, too). In 2021 alone, at least $27 billion of cryptocurrency was sent to two types of Ethereum smart contracts that are associated with NFTs, according to crypto research-and-forensics specialist Chainalysis.
What about investors who are intrigued by NFTs but aren’t ready to jump directly into the market? There are a growing number of options.
In traditional finance, firms use indexes to diversify a client’s money, spreading out risk by betting on, say, 100 companies instead of just one. To capture the NFT boom, some firms that usually provide exchange-traded funds filled with stocks or bonds are now offering NFT versions. But it’s a much riskier proposition.
The challenges are numerous, especially because the world of NFTs is so new and fast-moving. Capturing the entire ecosystem in one index is a fraught task, because the market is so illiquid. Plus, what was once a highly valued NFT collection could quickly fall out of favor.
“We're getting inundated with all kinds of NFT opportunities or vehicles or indexes, but it’s growing at such a rapid rate,” said Ed Moya, senior market analyst at Oanda.
Still, even if these investment products aren’t perfect proxies, they do offer an avenue for gaining exposure and may improve over time as the market develops. With that in mind, here’s a rundown of a few of them, including the pros and cons:
An ETF That Tracks the NFT World
A recently released ETF from Defiance doesn’t actually hold NFTs but instead contains the stocks of companies involved with the digital-token ecosystem.
Launched in early December, the Defiance Digital Revolution ETF, ticker NFTZ, counts Japanese financial services company SBI Holdings Inc. and eBay Inc. as its two largest holdings. The fund is designed for those who are only beginning to delve into the NFT market and aims to capture all aspects of that realm, including crypto banking, blockchain technology and digital-coin mining, according to Sylvia Jablonski, chief investment officer for Defiance ETFs. “If you're an investor and you don't know anything at all about NFTs and on the most basic level you think this could be a revolution, that's where our fund would come into play,” she said. NFTZ also includes several more well-known companies such as Playboy-owner PLBY Group Inc., DraftKings Inc. and Coinbase Global Inc. The fee is currently $6.50 for every $1,000 invested and the fund rebalances quarterly, at which point companies that have announced new NFT ventures could be included.
At present, though, the fund contains fewer than 40 stocks, which likely leaves out many of the firms making inroads into NFTs, according to Oanda’s Moya.
“It’s like having an index to cover every major stock market index,” he said. “It’s not just art and music, it’s virtual worlds, sports, all these types of trading cards.”
Performance out of the gate for NFTZ is dismal, with the fund dropping almost 28% since its launch. The S&P 500 rose about 3% during the same period.
To Brett Harrison, president of crypto exchange FTX US, investing in companies involved with NFTs is a safer — yet less accurate — way to bet on the space.
“It doesn't mean you get 1-for-1 exposure to NFTs,” he said. “These companies are probably doing a lot more than just NFTs, but if you want to gain some broad-based exposure, doing it through equities that are adjacent to the industry is a good idea.”
For Accredited Investors
Matt Hougan, chief investment officer of Bitwise Asset Management, says it can be difficult for investors to access the NFT space — not least because the technology can be daunting and there’s an oversupply of options. But his firm had heard from clients who wanted exposure, and in mid-December, Bitwise launched the Blue-Chip NFT Index Fund, which is available only to certain investors who put a minimum of $25,000 into the product.
The fund, which tracks an index, buys and holds pieces from some of the best-known collections including CryptoPunks and Bored Ape Yacht Club.
“The rise of crypto has created this massive generation of digitally native wealth,” Hougan said in an interview. “That’s, in my view, likely to increase over time.”
Bitwise’s fund rebalances quarterly so that it’s always updating to the most-recent collections, he added. Since its launch, it has returned about 26%.
There are other options for investors who are able to put down a large chunk of money. Asset manager Arca in November launched an NFT fund, available only to its limited partners, that invests in non-fungible tokens directly. Many of those investments have cash flows or offer yields that funnel back to the holder.
Meanwhile, Wave Financial debuted an NFT fund in August that seeks to invest in tokens and infrastructure, including in things related to the metaverse. Collectibles comprise 70% of the fund, and the remaining 30% is made up of protocols and platform investments, as well as holdings of illiquid equities.
The obvious downside for everyday market dabblers is that only accredited investors — a classification referring to individuals who have a net worth of $1 million or more, or an annual income of $200,000 or more, among other factors — can buy in. Then there’s the question of how to appropriately value an NFT collection, and how to secure the desired ones for the fund.
“It'd be like imagining an index of Van Gogh paintings,” said FTX’s Harrison. “There's only so many in the world, and they're held by a small number of owners.”
The Coins Behind It All
For those wary of indexing approaches to the NFT world, buying the coins that underpin the technology is another way to bet on the space, and the future of blockchain in general.
NFTs are typically held on the Ethereum network, which acts as a public ledger to record transactions. Ether, the cryptocurrency of the Ethereum network, is often required to buy the tokens.
“As more people come to the space, they will need Ether to purchase NFTs,” said Sergio Silva, sales director at Fireblocks, a digital-asset custody platform. “Purchasing that token will give you the best exposure to the ecosystem as a whole.”
The price of Ether rose about 400% last year, after a 476% gain in 2020. Another coin called SOL runs on the Solana network, which is increasingly being used for NFT transactions. Its value increased by thousands of percentage points in 2021.
James Wang, head of tokens at Amun and former analyst at Cathie Wood’s Ark Investment Management, argues that buying Ether is “one of the best risk-reward methods to get exposure to NFTs.”
“It’s somewhat indirect, but a relatively low risk way to get exposure to NFTs,” he said.
(Updates market prices. A previous version corrected the ninth paragraph to fix the name of the issuer of the Defiance Digital Revolution ETF. )
More stories like this are available on bloomberg.com
©2022 Bloomberg L.P.
