Investing In Cryptocurreny VS NFTs
Weighing the risk and rewards of each asset
Given that NFTs are essentially a type of cryptocurrency, should we consider NFTs to be part of our crypto portfolio? Can we see crypto as the fungible part of the portfolio while NFTs are the non-fungible part of the portfolio?
Investing In Cryptocurrencies
It's useful to start by weighing the risks and rewards surrounding cryptocurrencies – because these considerations would likewise apply for NFTs.
Risk of investing in cryptocurrencies:
Lack of fundamental valuation method (unlike equities), although many would disagree that there are rigorous tested models now like the stock-to-flow model that has proven relatively reliable
Relative difficulty to use, and to transact
Lack of mainstream acceptability
Risks of stricter regulatory measures
Plenty of scams and hack in the space
Possibility of losing money to valueless projects (much like the ICO bubble of 2018)
Potential rewards of cryptocurrencies:
Asset with a way stronger alpha (percentage returns)
Disproportionate risk-reward ratio compared to other assets
Decentralisation means it cannot be clamped down
No one who held BTC for 4 years or longer has lost money
While Bitcoin and other cryptocurrencies can likely get you supernormal returns, there are also many forms of hazards that can potentially cost you. With the right tools and resources, many of these risks can be minimised but it definitely takes time for someone to be familiar with it.
In terms of diversification of portfolio, most people today would consider cryptocurrencies as a speculative asset. That is to say, it is not recommended to put too large an allocation to cryptocurrencies, and in a risk-off environment, the value of cryptocurrencies will likely suffer.
Investing In NFTs
If we were to consider NFTs as crypto-based assets, buying into NFTs is essentially a long crypto trade i.e. you believe that crypto will become mainstream or do well in the long run. Either that, or you are gambling with your money.
Assuming a rational individual considering a diversification of his crypto portfolio into NFTs, we can consider the pros and cons of doing so.
Pros of diversifying into NFTs:
Better alpha – a small investment can return a disproportionately large return
Exposure into a different area of crypto (as one can also diversify into DeFi projects and other classes of crypto)
You gain something that you can flex
Cons of diversifying into NFTs:
Most NFTs will not survive a crypto winter i.e. you have a high chance of losing your crypto compared to just HODLing
It is bad portfolio diversification
You are buying an illiquid asset
It is especially important to note that NFTs are illiquid – you need to find a buyer who is willing to pay the price you are asking for. In any typical market, when demand tapers and no new demand is generated, asset holders who need liquidity will be forced to reduce the asking price. This is the same for all bubbles.
It's a pretty straightforward equation: Demand, Supply, and Holding Power. Ask yourself these questions before proceeding with an NFT purchase.
Demand For NFTs
Do you foresee the current demand to sustain? Is there any development in the space that would bring in a fresh wave of demand? How does the demand measure against the supply?
Supply Of NFTs
Most NFTs projects create hype and FOMO around the scarcity principle. While that works for individual projects in the short-term, it's important to zoom out and consider the overall supply of NFTs in the market.
In terms of Avatar-type, Art-type, Gaming-type, Collectible-type NFTs, are there too much of them? Is there a niche area popping up that is different from these saturated NFT types? When there is an oversupply, NFT buyers and collectors will tend to be more picky, and we can expect to see consolidation then. Together with the tapered demand, prices can quite quickly spiral downhill.
Several of the 2017 NFTs that became worthless were revived in 2021 and sold at high prices. The question then becomes, will you still be holding those NFTs in your wallets by then, or would you have lost interest or lost access to them?
Just like any other investment, holding power is extremely important, assuming you are buying a legitimate asset. Good luck holding on to NFT projects whose developers quit and move on with other things in life.
Suggestions For NFT Investing
You might want to jump into the hype and ride the train up, and that's ok. I believe that even if you end up losing financially, you stand to gain in knowledge and experience. Nevertheless, here are some tips that might help you stay a bit more level-headed.
Invest only what you can lose
Do extensive research and lurk in their Discord channels and Twitter before committing to a project
Don't measure your portfolio based on Floor Price. If you have to value it, look at the last transacted price.
Try to distill the true value of each project, and understand what investors/collectors are after – is it a status, an access, returns, or something more?
Never buy in on FOMO – it can work sometimes, but most of the times, you will end up losing.
Personally, I see NFTs as a learning journey, and I am diving in because I see the opportunity to build a portfolio and business around NFTs. Should I suffer any financial losses, it is very much part and parcel of learning and that is a tuition fee I am prepared to pay.
It's alright if you are jumping in for a gamble too. Just acknowledge what you are after, and be comfortable with either outcome (: