Published on: jumpstartmag.com
Diversification is a popular practice among sensible investors when building their portfolios. It implies selecting various types of assets across multiple categories, sectors and geographies, with different performance rates and risk profiles to create a well-balanced set of investments that can ensure consistent returns while lowering risks. Rather than concentrating all their wealth into one single financial instrument, investors distribute it among several, so if one or more assets fail to bring in the expected yields, the rest will be able to compensate for the loss. Basically, portfolio diversification is the practical implementation of the don’t put all your eggs in one basket adage.
When it comes to asset choice, there’s a wide variety of investment vehicles that can be used to put together a diversified portfolio, from stocks and bonds to real estate, mutual funds, hedge funds and many more. In recent years, many investors have started looking beyond traditional investments, dipping their toes into more novel asset classes like crypto and non-fungible tokens (NFTs) to boost their returns. The meteoric rise that NFTs experienced in 2021 turned them into significant contenders in the world of investments, and even if their popularity has somewhat dwindled in recent years, they’re still a noteworthy option.
But is it wise to buy NFT tokens for portfolio diversification, given their short history and well-known market volatility? A closer look at the pros and cons they offer will help us assess their viability and potential as an investment instrument.
What are NFTs?
First, let’s give a brief description of NFTs and their core characteristics. The concept that underpins NFTs came about in 2012 with the introduction of Bitcoin-based color coins, but it was the use of the ERC-20 standard on the Ethereum blockchain in 2017 that contributed to their development and widespread adoption.
In the simplest terms, NFTs are unique digital representations of physical or virtual items that get recorded on a blockchain and cannot be reproduced, being used to confirm ownership of the items they are connected to. The most common assets that get converted into NFTs are artwork, music, videos, and collectibles, but one can tokenize almost everything, including cars, real estate and other tangible objects.
Therefore, unlike other types of assets which can be copied over and over again, NFTs are inimitable due to their unique identification codes that are stored on the blockchain. This means that even if two NFTs look identical, they’re not interchangeable, like cryptocurrencies are, hence their non-fungible nature.
NFTs can be bought and traded repeatedly in various marketplaces, and their value depends on various factors, such as the type of asset they represent, their scarcity, utility, demand and even the creators’ status. Learning where to buy Ethereum and setting up a crypto wallet can help investors navigate the NFT market and manage their NFT collections with ease.
Using NFTs for portfolio diversification – pros and cons
Given the hype created around NFTs, one may be tempted to join the trend and invest in these popular assets for diversification purposes. However, before doing so, it’s important to be aware of both the benefits and the drawbacks that come with NFT investments.
Accessibility is one of the aspects that makes NFTs highly appealing to investors, as they offer the possibility of fractionalized ownership. This means that an NFT can be split into multiple tradeable parts, and investors can buy only a fraction of it, representing a fraction of the tokenized asset. Investors who may not be able to purchase premium assets due to their high price point can still own a part of it through NFT investments and, therefore, gain access to something that otherwise would be out of reach. This lowers investment thresholds for expensive items and opens new diversification opportunities for investors.
Moreover, NFT markets are not limited by geographical boundaries, so anyone from any part of the world can explore the available NFT collections and invest in their preferred assets or trade them with only a computer, good internet connection and some basic research on how NFT trading works.
Given that NFTs are underpinned by blockchain technology and the data that connects them to the items they represent cannot be tampered with, they ensure the authenticity of assets and easy access to ownership, which can be easily demonstrated should anyone try to challenge it. This also makes it impossible for NFTs to be altered or counterfeited, providing reassurance and peace of mind for buyers and sellers.
Additionally, rare or desirable NFTs may hold their value or even appreciate in the long term. So, if you’re lucky enough to own an NFT from an exclusive collection whose popularity increases, you could benefit from significant returns in the long run.
Despite all these perks, there are also disadvantages to take into account when considering NFT investments. First of all, regulations regarding NFTs are either non-existent or insufficient at best in most jurisdictions. In other words, the responsibility for keeping assets safe falls entirely on investors, as there are no laws or enforceable guidelines to protect against market manipulation and speculative practices, which are major concerns when trading NFTs.
It’s also important to note that frauds and scams also run rampant in the NFT space as anyone can trade different types of NFTs, making false claims and spreading misinformation about them. This makes it difficult for investors to determine the reliability of NFT projects or the marketplaces that enable their purchase. On top of that, NFT prices can be extremely volatile and change rapidly, so spotting the winners is rather tricky.
To sum it up, as an alternative investment venue, NFTs can serve as great diversification tools for investors. However, one should do their due diligence and approach these instruments with care and caution if one wants to improve the performance of their portfolios and manage risks effectively.