Barron's Streetwise - NFTs and the Million-Dollar Rock

Episode Date: August 27, 2021

Jack tackles bored apes and CryptoPunks to explain what's behind the mania in non-fungible tokens. Learn more about your ad choices. Visit megaphone.fm/adchoices

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The Barron Streetwise podcast is on vacation this week. Oh boy, I can see you're not taking this well. I should have broken it to you more gently. You know what? Dry those tears. We're going to answer a few listener questions now, including the one you just heard, and we'll be back with regular episodes starting next week.

Did you see this past week that someone paid $1.3 million for a cartoon rock? And I don't mean a hand-drawn rock of some cultural significance. This wasn't from an original Flintstones storyboard or anything like that. It was simple internet clip art, the kind anyone can download for free. So why would it sell for an amount of money equal to more than 20 years of median U.S. household income? And, quick follow-up question, does anything matter anymore? Is life just a Matrix-style simulation scripted by writers running so low on new plot devices that they've added a cartoon rock bubble?

Should I just change my asset allocation to 100% fudge? I want you to hold off for now on the fudge rebalance. In a moment, I'll try to make sense of the million dollar rock and the broader mania and what are called non-fungible tokens or NFTs. And I'll say a few words about the stock market. Listening in is our audio producer, Jackson. Hi, Jackson. Hey, Jack. Any important business to discuss before we get to our first question? Can you hear that? I think my neighbor's doing jump squats.

Are we sure it's jump squats? Because lunges can sound a lot like jump squats. You want to split the difference and call it a burpee? Please don't ever ask me that again. Who do we have for our first question? We have Chris from Massachusetts. Hi, Jack. Thank you for taking my question. I'm a longtime investor in my early 50s. My wife and I have saved and invested consistently over the years, and we've accumulated a solid diversified portfolio. Sound investing philosophy was something we always tried to impart to our children,

who are now early in their working careers. While they do own some stocks, they also seem excited about newer investment vehicles. One has been buying SPACs. Another is talking about investing in a Bitcoin mining operation. Our other child's significant other has sights set on designing NFTs. I haven't driven a minivan in about 20 years, but I'm starting to feel a bit out of date. Should I stay the course and continue to invest in actual companies that have profits? Or am I missing an opportunity? And what advice should I be giving this next generation for the long term? Great question, Chris. Many listeners and readers have told me something similar, and

so have some CEOs and top investment strategists. Their kids are excited about assets that didn't exist 20 years ago and whose prices have little or no connection to measures of fundamental value like cash flows. It's not easy to talk about staying the course in stocks at a time when Dogecoin, a dog-themed parody cryptocurrency with unlimited supply, is up more than 5,000% this year. Parents want to foster investment interest and they don't want to sound like valuation scolds, but they also don't want their kids to develop bad habits or get blown up financially. What I can tell you is that it's totally possible to get started in investing by trading garbage and to then graduate to saving money long-term and quality assets.

I know because I got my start flipping garbage. term and quality assets. I know because I got my start flipping garbage. Back in the mid-1990s, while working as a stockbroker, I took a gamble on a company called Comparator Systems, whose ticker back then was IDID. It said it was developing futuristic technology, a fingerprint scanner for rapid identification. I liked that the trading volume seemed to be rising, but mostly, I liked that I could buy a lot of the shares with the few thousand bucks I had at the time. Stocks traded in fractions back then. I bought Comparator for 360 fourths per share, or a little over four and a half cents. The stock soared to more than a dollar, almost two dollars, before Nasdaq, which was trying to shake its reputation for being a

penny stock Wild West, halted trading. The New York Times called it Nasdaq's billion dollar absurdity. Comparator was eventually delisted and investigated, and some executives paid settlements without admitting or denying wrongdoing and agreed to never run a public company again. But for me, the whole affair was anything but a painful lesson. I was too clueless at the time to sell all or even most of my shares. In today's meme stock terminology, I was trying to be a diamond hands, or someone who doesn't let go, when I should trying to be a diamond hands or someone who doesn't let go, when I should clearly have been a paper hands. Even so, I made a nice profit and put it toward

taking a break from work and backpacking around the world. The experience did not leave me with an endless urge to find the next comparator. It left me wanting more math and less drama in my investment approach and i haven't flipped garbage in decades make sure your kids know a few things about their speculative trading chris first you don't have to buy into the whole storyline to participate in the hype if bitcoin were the future of money i'd probably be able to spend it more places today because it's more than a decade old but it might get awkward buying a a sausage McGriddle and coffee with something that just went from half a penny to $50,000 in about a decade. To me, the thing that's impressive about Bitcoin isn't its utility for everyday finance, but that it represents purely distilled speculation. distilled speculation. There's a finite supply and a highly liquid market, and there's absolutely nothing to suggest it's worth $50,000, which means there's also no way to prove it's not worth that

much. The ideal allocation for me is zero, but if your kids want to buy Bitcoin or meme stocks or SPACs for gambling, just make sure that they understand they're gambling so they won't be tempted to bet the family endowment. Second, make sure they understand that people mostly talk about their success and keep quiet about their failures. Call it the Instagram effect. It makes it seem like everyone's getting rich, but plenty of people are losing and more surely will eventually. There's a side point to that one, which is if you want to be popular, skip the story about how well your portfolio was done. And instead, tell the one about running through the woods with your pants around your ankles because you accidentally chainsawed a log with bees in it and a bunch of them stung you and you thought a couple had gotten into your

pants, but it turns out they were just stinging you through your pants. So you dropped your pants for nothing, much to the amusement of three workers you'd hired for the day. That sounds close to home. It's about 300 yards. Now, Chris, if you want to hear more about cryptocurrency or SPACs or meme stocks, we've done episodes on all of them. To me, there's a nonsense hierarchy with SPACs and meme stocks at the top because they represent actual companies, albeit of widely varying quality, and then cryptocurrency and NFTs, or non-fungible tokens, on the bottom. We haven't talked much about NFTs yet. The word fungible means able to be replaced by another identical item. If you've ever used the word fungible and you weren't talking about NFTs,

you might be a commodity trader because for trading purposes, one barrel of West Texas crude is as good as the next. A non-fungible token is digital proof that you own something unique. That proof is made possible by blockchain technology, especially the Ethereum blockchain. NFTs were conceived as a way for artists to make money on their work, but they've been popularized by traders focused on digital scarcity and not necessarily art. Have you heard of Bored Ape Yacht Club? A website earlier this year offered 10,000 iterations of an ape cartoon as NFTs. Twitter users began changing their avatars to these apes to boast of having bought one

of the NFTs. One recently sold for more than a million dollars. This past week, Visa, the transaction company, paid $150,000 for another NFT called CryptoPunk. It's now the unique owner of a simple face with green eyes and lipstick rendered in big block pixels. An executive at the company said Visa wanted to show its support for the crypto community. Data from an NFT trading platform called OpenSea suggests volume passed more than a billion dollars this month. Last week, Logan Paul made over $5,081,490 selling digital trading cards of himself known as NFTs. Christie is set to become the first major auction house to sell a purely digital artwork known as an NFT. Now the work is a monster.

The mystery buyer who paid a record of almost $70 million for a digital artwork. A clip art of a rock just sold for about 400 ether. The rock I mentioned earlier is called Ether Rock. These appear to have started with a simple rock image downloaded from goodfreephotos.com that was then turned into a hundred variations, each with a slightly different tint. The website for them states plainly that these serve no purpose beyond conferring pride of ownership. One buyer in August paid about $4,800 for EtherRock number 42 and sold it 19 days later for $1.3 million. If you're wondering, that rock is tinted reddish brown.

It's kind of a rock color. If traders seem more excited about the technology than the art, it might not be a great sign that there are disagreements about the reliability of the technology. One common criticism is that blockchains that track NFT ownership typically store links that point to websites with the art, not copies of the art itself, which means those links might have to be maintained indefinitely. I'm sure that's solvable. The larger point to keep in mind is that the buyer who paid $1.3 million for a rock didn't really pay for it in dollars. He or she paid 400 Ether, which at the time was worth about $1.3 million.

See, the trading value of cryptocurrency has risen much faster than the real-world ability to spend the stuff on useful things. So the world is now awash in crypto millionaires. If you're one of those and you know that the value of your cryptocurrency is based on hype, but you don't want to sell just yet, you might want to diversify into tangential assets that are based on similar hype. To be honest, I can't prove that shifting some ether to cartoon rocks doesn't qualify as risk reduction. And that's what I think is largely behind the NFT mania, a massive sudden supply of cryptocurrency looking for new homes.

And Chris, let's keep in mind that the entire boom in cryptocurrency has occurred against the backdrop of near-zero interest rates and big deficits and significant money creation. That's one last thing to make sure your kids understand. We haven't yet seen how cryptocurrencies, to say nothing of NFTs, perform under normal economic conditions. And no, the fact that big institutions are getting involved in crypto doesn't mean its future is assured. It means those institutions don't want their customers to do too much of their thrill-seeking with smaller rivals who might use those interactions as a springboard to one day compete for other

financial services. Bottom line, Chris, don't worry too much about your kids dabbling in dubious assets. Just make sure they know the conditions won't look like this forever. And then knowing a thing or two about cash flows and dare I say dividends will prove plenty useful down the road. Jackson, quick burpee update. What's the latest? Nothing yet. It kind of stopped. That's good. You know, an editor of mine used to say, here's a topic, go write me a Jack Howe talker. And I think I turned that last question into a real talker. But do we have time for a second question if I keep the answer short? Definitely. Hi, Jack.

This is Andrew from Chicago. I've always heard that the markets are forward thinking and the future is already built in to today's prices. But what I'm unsure of is how far into the future are we talking? Is this six months? A year? Two years? I'd love to better understand a more finite time frame. Oh man, Andrew, I could turn this one into an hour-long thumbsucker of a discussion, but I promise to keep it quick. It's a popular saying that markets are forward-looking. I say it myself. It's a polite

way of saying, tell me something I don't know because I already knew the thing you just told me, which means it's probably already priced into the stock. But I don't think that's entirely accurate, strictly speaking, that the stock market prices in the future. There's something called the efficient market hypothesis, which was developed in the 1960s and became the foundation for index investing. To oversimplify, it states that everything known is already priced in. So the answer to your question about whether it's six months or two years is it's both. All knowledge about future events are discounted back to present values and reflected in the current price. I think index funds are a great idea, but I'm not a big believer in market prices being an accurate reflection of known things.

The value investor Benjamin Graham used the allegory of a manic depressive business partner named Mr. Market to describe mood swings in stocks. Some days, Mr. Market is feeling low and he's willing to sell his entire stake for next to nothing. And some days he's overjoyed and he wants way too high of a price. Andrew, I think there's a long trend toward over-mathematization in finance, or what you might call physics envy among investors. There's this belief that if we build elaborate models, we can harness uncertainty. But investors aren't billiard balls that follow predictable paths. Their behavior can change over time. Anytime we say the market does X, what we really mean is it's done X in the past and so we think it'll do it again.

But the history of modern stock investing is short and the history of current conditions is even shorter. So there's a sample size problem. We don't really know that X will happen again. I've read many studies on investor behavior over the years that suggest we're prone to predictable mistakes. For example, we tend to assume that the way things have been recently is the way they'll always be. That can lead us to put too high of a price on positive news and too low of a price on negative news. Investors who are aware of that tendency can exploit it to find good deals. That skill hasn't proved especially useful or necessary during the massive bull run of the past decade when index funds have performed so well.

But it's a good skill to hang on to for the next bear market whenever it comes. Thank you, Chris and Andrew, for sending in your questions. And thank all of you for listening. Jackson Cantrell is our producer. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. Watch out for bees. And follow me on Twitter. That's at Jack Howe, H-O-U-G-H.

See you next week.