What are NFTs and Crypto?

I am going to attempt to put my biases to the side for this letter! I don’t like crypto or NFTs, but I did purchase $200 of both Bitcoin and Ether a few years ago as a way to just dip my toes into the water. Spoiler: it’s worth a lot less now.

In order to understand both NFTs and Cryptocurrencies (crypto), we first must talk about a system they both use. The blockchain makes both NFTs and crypto possible. The blockchain is a decentralized system that keeps track of all purchases, sales, and changes. The blockchain relies on a large network of nodes (individual computers, servers, etc) that all store the blockchain, validate any changes, and record new transactions. This means there is not one authority that can control or easily change items in the blockchain. The diagram below depicts the difference between centralized architecture and a decentralized or distributed architecture.

An example of a centralized architecture would be the current banking system. If I want to send money to my account at USAA, the request goes from me to USAA who validates it and processes it. If I were to send money between crypto wallets, the request is validated by a network of computers who then record where the crypto or NFT is now located. The weakness in a centralized architecture is that I operate on USAA’s terms which could in theory change at any moment. A distributed architecture operates on a set of rules agreed upon by everyone and available to the public. If USAA’s system goes down, I can’t access my money. In the blockchain, one node can go down, and I will still be able to access my money.

So what is an NFT? NFT stands for Non-Fungible Token. An NFT is one that is unique and represents the authenticity and ownership of a specific item. Fungible tokens, on the other hand, are mutually interchangeable, and their value doesn't depend on any unique properties or characteristics. If ten people give me one dollar, each dollar is the same value regardless of the condition or who previously had the dollar. Even if you make ten identical photos and sell each one as a different NFT, their value will fluctuate depending on previous owners. An NFT that was previously owned by Elon Musk, for example, will be far more valuable than one owned by Wilson Meyer. The blockchain is how all the information for each NFT is stored including a description of what it is.

Can’t I just take a screenshot of an NFT? Yes you can! But that doesn’t mean you own it. Just like you can take pictures of art in a museum or even get prints hung in your house. Anything can be turned into a NFT: art, videos, music, digital real estate, or tweets. The information in the blockchain records what is associated with each NFT. The value for the NFT comes in the ability to say (and prove) that you are the true owner of a token and the associated art. Anyone can screenshot it, but only you have the actual token stored in your digital wallet. Beeple (a digital artist) became one of the most valuable living artists when his NFT The First 5000 Days sold for over $69 million dollars.

Okay, so we have established that the blockchain uses a decentralized system to keep track of NFTs. The benefit being that not one entity has total control over the system. So how does this apply to crypto? Cryptocurrency (crypto) uses the blockchain to maintain a decentralized system for money. Each different crypto uses a slightly different set of rules and systems that regulate how many coins exist. Their price, ultimately, is determined by demand on the free market, good ole supply and demand. The US dollar, on the other hand, is controlled by the Federal Reserve (the Fed for short) through interest rates and supply. The Fed has one main goal: maintain a steady, stable dollar with an annual inflation of 2%. During the COVID pandemic, Congress passed bills that required the Fed to print TRILLIONS of dollars which, combined with next to 0% interest rates, is the main reason we have such high inflation right now. The Fed is increasing interest rates aggressively to lower inflation by limiting the supply of the US Dollar. The interest rate is the cost to borrow money from the government. As the Fed raises the interest rate, it becomes more expensive to buy a home or get a loan. Crypto advocates argue that any government with this much control over the financial market is an inherent risk. They also argue that for developing nations, crypto allows them a freedom from the US Dollar-backed global economy not offered by anyone, including China.

Speaking of which, China has banned all crypto (except for the coin controlled by the government) in its country because it prevents them from controlling the economy as they like. That is a good indicator that crypto truly does remove a government's power.We are still in the infancy of crypto. It could become something fantastic; it could be worthless in ten years. I don’t know enough to predict what will happen, but I do see the potential. However, right now the price of crypto is far too volatile to be taken seriously.

If I bought a $120,000 Model S Plaid in October of 2021 with two bitcoins, the same two coins would have been worth only $33,000 by December 2022. Thankfully, with a 1.99 second 0-60 MPH, I would drive away faster than Elon Musk could check the price.

In my opinion, the first step is changing the perception of crypto as an investment. Too many people ask “are you investing in crypto?” When was the last time you were asked “are you investing in the euro?” Yes, there are billionaires who made their fortune investing in currencies, but popular perception is that crypto is an investment, not a currency. Until that changes, I don’t see a path forward for crypto.

That is a very quick crash course in NFTs, Crypto, and the blockchain that supports them both. The rabbit hole is very deep including conspiracies, mysterious founders, and money laundering.

Call to Action

As a skeptic of this world, I refuse to even recommend buying any NFTs or Crypto. If that’s something you want to do though, I totally support you! I will never judge someone’s interests.

What We’re Reading/Listening To:

Podcast: Planet Money - The $69 Million JPEG. The story behind the most expensive NFT is truly amazing. If you’ve got a 22 minute drive (or 11 minute for all those 2x listeners) coming up, this will surely entertain you.

Debrief on Deck

Next week, Mike is going to walk us through the budget making process. Hopefully you will find some excess cash to buy that bored ape NFT Mike keeps mentioning.

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on social media (Twitter and Instagram).

Until then, stay the course.

Disclaimer