People are paying millions for clips that can be viewed for free. Welcome to the world of ‘NFTs’

A virtual art piece titled "Everydays: The First 5000 Days." Created by digital artist Beeple, it's the first NFT-based work of art to go on auction at Christie's.

Christie's

From art to sports trading cards, people are spending millions of dollars on digital collector's items.

These crypto collectibles, known as NFTs, have exploded in popularity lately. A video clip created by digital artist Beeple, whose real name is Mike Winkelmann, was flipped for a record $6.6 million last week. It had originally been bought for around $67,000.

Meanwhile, one of thousands of computer-generated avatars called CryptoPunks recently sold for $2 million. And a crypto art rendition of the Nyan Cat meme from 2011 sold for about $590,000 in an online auction.

Proponents of NFTs say they fix a big problem with the internet: artists not getting paid for the distribution of their content online. At the same time, critics see the NFT craze as another potential speculative frenzy in crypto that's sure to fizzle out eventually.

So what exactly are NFTs? And why are they suddenly being sold for millions? CNBC runs through everything you need to know.

What are NFTs?

NFTs, or non-fungible tokens, are a new type of digital asset. Ownership of these assets are recorded on a blockchain — a digital ledger similar to the networks that underpin bitcoin and other cryptocurrencies.

But unlike most virtual currencies, you couldn't exchange one NFT for another in the same way that you would with dollars or gold bars. Each NFT is unique and acts as a collector's item that can't be duplicated, making them rare by design.

You can think of them like the crypto alternative to rare Pokémon or baseball cards.

The rise of the internet meant that anyone could view images, videos and songs online for free. People are buying NFTs out of the belief that they'll be able to prove ownership of a virtual item thanks to blockchain.

NBA Top Shot, an NFT platform based on the U.S. basketball league, lets users buy and sell short clips showing match highlights from star players. The NBA licenses the reels to Dapper Labs, a start-up which digitizes the footage, making a limited amount to create scarcity. NBA Top Shot has facilitated over $280 million in sales to date, according to the website CryptoSlam. Dapper Labs earns a cut on each transaction while the NBA gets royalty payments.

Source: NBA Top Shot

Basketball isn't the only sport getting into crypto. French start-up Sorare lets users collect and play officially licensed soccer cards in fantasy games. According to NFT data tracker NonFungible, Sorare's marketplace has generated over $22 million worth of sales to date. Sorare last week announced it had raised $50 million from investors including Benchmark, Accel and Reddit co-founder Alexis Ohanian.

"It is an obvious industry use case for NFTs," said Lars Rensing, CEO of blockchain firm Protokol. "Trading cards and collectibles have always been a profitable revenue stream for clubs."

Meanwhile, art dealers are also getting in on the action, with auction house Christie's running an auction for a virtual art piece from Beeple. The auction is yet to close but the work has already been bid up to $3 million.

NFTs aren't a new phenomenon. CryptoKitties, one of the earliest examples, were once so popular they clogged up the network of digital currency ether. To date, these colorful online cats have generated sales of over $40 million, according to NonFungible.

Why are they so popular?

The coronavirus pandemic played a big role in the NFT boom. Last year, the total value of NFT transactions quadrupled to $250 million, according to a study from NonFungible and BNP Paribas-affiliated research firm L'Atelier.

That's in no small part because of stay-at-home restrictions that resulted in people spending a lot more of their time on the internet and saving cash from a lack of commuting. It's similar to the rise of retail traders betting on GameStop and other historically unloved stocks promoted on the Reddit board WallStreetBets.

Meanwhile, it also arrives at a time when bitcoin, ether and other digital coins have surged in value, with bitcoin briefly topping $1 trillion in market value last month.

"Right now we're living in a point in the world whereby the majority of the population is spending 50% of their time online and a significant amount of their time on a PC," Whale Shark, a pseudonymous NFT collector who claims to have amassed a collection worth over $2.7 million, told CNBC.

Skepticism

Many investors buy NFTs as a speculative investment in the hope that they'll be able to flip them at a much higher price than what they originally paid. But a growing number of people are also holding them long term as collectibles.

"Like any technological hype cycle, we're starting with speculative activity and usually that gives way to more fundamental value," Nadya Ivanova, chief operating officer of L'Atelier, told CNBC.

"NFTs started in 2017. A lot of it was about speculation. What we saw in 2020 is the market is actually maturing."

NFTs have lured in celebrities like Mark Cuban, Lindsay Lohan and Gary Vaynerchuk, while major brands are also getting involved. And people are finding other use cases for NFTs, such as virtual real estate and gaming.

Nevertheless, the NFT space has been met with skepticism from some artists and investors. Critics view it as another crypto fad akin to the initial coin offerings of 2017 that will eventually drift into irrelevance. Unsurprisingly, the firms behind such tokens disagree.

"I think that 99% of the projects that are in the space today might not exist two or three years later, very similar to the ICO boom," WhaleShark said.

Many NFTs are priced in ether, the digital token of the Ethereum blockchain. The digital asset briefly touched a record price of more than $2,000 last month before slumping about $600 in a matter of days, reminding investors of cryptocurrencies' wild volatility.

Correction: This story has been amended to correct the spelling of Reddit co-founder Alexis Ohanian's name.

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