NFT or what to buy if cryptocurrencies aren’t volatile enough for you

I have been asked a couple of times by readers of these missives to part with my thoughts on Non-Fungible Tokens (NFT). Because I am not an expert on cryptocurrencies, let alone NFT, I try not to venture into this field too much – a lesson many other people should heed as well, in my view.

But I have shared my views on Bitcoin and my hopes for central bank digital currencies. As for NFT, I still cannot understand why anyone would want to buy not an artwork itself, but instead, the receipt that one owns a digital artwork that still can be replicated infinitely in undiminished quality everywhere. And that is essentially what an NFT is. It’s as if you shop on an online supermarket for food and then pay for the food but the food never gets delivered to you. All you have is the right to look at a picture of the food you ordered and that picture is the one everyone can see on the webpage of the online supermarket.

Be that as it may, I am here to talk about investments and it just so happens that two researchers recently built a hand-collected index of NFT prices from June 2017 to May 202. This enables them to compare the average investm4nt performance of NFT with the average investment performance of cryptocurrencies (they use Ether as an example), stocks, and gold.

Because NFTs are so new and have gone through the roof in the last two years, the numbers in terms of risk and return are comical and make absolutely no sense. How am I supposed to interpret an annual standard deviation of returns of 200% based on monthly geometric returns?

Annual volatility and return of NFT vs. other risky assets

Source: Kong and Lin (2021)

But to put it into more palatable terms, the average monthly return of NFTs in their index ranges from 6% to 44% with a monthly standard deviation of returns between 44% and 74%.

Ok, that still doesn’t make a lot of sense to me.

Better then to compare the ratio of return per unit of risk (i.e. the Sharpe-ratio) for the different asset classes. And here, it turns out that NFTs aren’t that special anymore. They essentially have the same risk-adjusted returns as the Nasdaq index or the S&P 500. So, think of NFT as US stocks levered up 10 to 15 times while cryptocurrencies are like gold levered up 5 to 10 times.

Sharpe-ratios in comparison

Source: Kong and Lin (2021)

Now I can start to grasp what is going on here. And more importantly, looking at it this way explains why 53% of buyers of NFT sell their holdings within six months again and only 15% hold their NFT for more than 3.5 years. NFT are not an investment, they are a speculative trading toy similar to naked options and futures. If the price goes your way, you win big, if it goes the other way, you are ruined very quickly as well.