Non-Fungible Tokens (NFTs): Unraveling the Digital Revolution

Non-Fungible Tokens (NFTs), a term that has stormed into popular consciousness in recent years, are a 2014 invention that leverages blockchain cryptography to generate a unique ID or “token.” This token is digitally linked to a file or any other asset, enabling it to be bought and sold on a blockchain-based marketplace. NFTs are akin to a digital fingerprint that serves as proof of ownership. Surprisingly, despite their meteoric rise, there are currently no specific accounting guidelines for NFTs. Since NFTs are always linked to an underlying asset, the accounting for most of them would likely adhere to the existing standards applicable to the underlying asset.

Authentication

Some NFTs are created solely to support authentication or validation, primarily for tracking items in a supply chain. These NFTs are typically valued in fiat currencies, not crypto assets, and any transactions logged on the blockchain are denominated in fiat currency like the U.S. Dollar. In most of these use cases, the blockchain is private and permissioned and has minimal impact on related accounting entries.

Ownership

Ownership NFTs are the most familiar to the public. Users pay crypto-denominated fees to create, buy, and sell these NFTs. Ownership NFTs provide a means for demonstrating ownership of digital objects. Authentic blockchain records can often be treated as proof of ownership when they show the NFT in a given wallet. In recent legal developments, courts in London and Singapore upheld that NFTs are a type of property and have attached property rights. In 2023, a California judge made a preliminary ruling that individuals who made satirical copies of Bored Apes had infringed on the trademark of the Bored Ape Yacht Club (BAYC), and BAYC has enforceable rights. The trial is pending, and damages have not yet been calculated.

NFTs – Single Use

This category encompasses NFTs with limited use and little to no resale value. It includes NFTs that are burned after a specific use or period of time. In terms of accounting, pending guidance suggests they are most likely to be accounted for as inventory and supplies or other current period expenses.

Examples include tickets that do not “transform” into a resellable collectible, single-year memberships, digital awards and badges with only sentimental value, and gaming items usable in only one game or platform.

NFTs – Reusable

The largest category of NFTs includes art, collectibles, avatar JPEGs, digital fashion, music, and much more. These NFTs have resale value and are not tied to a real asset or digital location. Buyers often purchase them with the intention of benefiting from value retention or appreciation over time. Some reusable NFTs may come with a physical component, such as a digital artwork that has a physical artwork twin or an avatar that provides access to clubs, events, and exclusive online spaces. The physical components and other perks may or may not be transferable upon resale.

Recent trends on NFT marketplaces are making royalty and creator fees optional, driving creators to push out work at a regular pace to keep consumers engaged.

NFTs – Perpetual

Perpetual NFTs represent a location in cyberspace, such as digital land or domain names. They are often owned with the purpose of generating revenue through sales or providing services through a virtual location. One intriguing question that may arise is whether digital land/locations can be mortgaged.

NFTs – Real Asset

Real asset NFTs are blockchain records created to represent a physical “real” asset, typically for purposes like simplifying ownership transfer, reducing associated fees, fractionalizing ownership, or managing assets through a Distributed Autonomous Organization (DAO).

In conclusion, Non-Fungible Tokens are a diverse and evolving asset class with various use cases, each presenting unique challenges and opportunities. As the NFT space continues to expand, it’s crucial for businesses, creators, and investors to adapt and understand the complexities and implications of this digital revolution. Accounting standards and legal precedents are still evolving in this space, making it imperative to stay informed and adapt to the ever-changing landscape of NFTs.