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NFTs explode into $27B phenomenon as investors with 'bigger bags' put them to work

The non-fungible token (NFT) market has exploded this year into a $27 billion segment of the crypto market according to a new report from Chainalysis, which underscored what separates the most profitable digital collectors from the rest.

NFTs are a family of crypto assets that hold ownership of unique data linked to a blockchain — most often Ethereum (ETH-USD). They can be packaged as digital collectibles, works of art, music, video game items, real estate of virtual reality platforms, and even concert tickets.

Amid the rise of the emerging technology theme known as the metaverse, there is already an ETF that gives investors exposure to the space by investing in publicly traded companies active in the NFT space.

Meanwhile, the sector is drawing in talent. On Monday, Brian Roberts, Lyft's former CFO announced over LinkedIn that he’s joining Open Sea — the NFT trading platform —as its finance chief.

Most NFTs trade on specialized online marketplaces that act as an online hybrid between Ebay (EBAY) and an art auction house.

Similar to decentralized exchanges or other peer-to-peer crypto trading platforms, most NFT marketplaces don’t directly hold NFTs for customers. Instead, they provide users the platform where they can transact the assets between each other. By a wide margin, Open Sea is the largest of these platforms. According to Chainalysis, over $16 billion worth of money has flowed into it so far this year.

In terms of transaction size, the vast majority of NFT trading is retail investor-driven. However, the majority of the market's volume is made by NFT collectors and institutions, but far less than what’s been seen in the broader crypto market.

Ethan McMahon, the Chainalysis economist who authored the report told Yahoo Finance the data suggests clear patterns for what makes a successful NFT collector. The best ones end up being "highly plugged into the space," more sophisticated in crypto and have "bigger bags" of capital to invest at their disposal, McMahon stated.

"Whitelisting," or getting a discounted price at the intial creation of a new colection's release, appears as one clear advantage for collectors looking to make a decent return on their NFT. Collectors get whitelisting opportunities by showing up early to a project and often promoting it well before its release, McMahon explained.

“A lot of NFT collections live and die by the community that they build. They have really active Discord channels and Twitter presences. If you’re an early follower or subscriber to these projects you tend to get whitelisted,” said McMahon.

Collectors can also make a good return by "flipping” a pre-owned NFT on the secondary market. But as is the case with initial public offerings in stocks, the most difficult way to get a return on an NFT is by purchasing the asset from a creator without getting whitelisted.

Only 28.5% of NFTs purchased during their minting, then sold on a marketplace, end up profitable, Chainalysis data found. On the other hand, flipping yields a much higher chance (65%) for a collector to profit, according to the report.

The most popular NFT collections like Crypto Punks, Bored Ape Yacht Club or its derivative collections, see the largest swaths of trading volume accumulate around a release week, “where everyone’s just hyping into the project and doing all sorts of things to drive up its volume,” McMahon told Yahoo Finance.

On average, the best performing collectors on Open Sea make triple their initial investment every time they flip an NFT, whereas the lowest performing group returns an average loss of 0.9 times their initial investment.

Judging from their transaction data, these successful collectors also tend to make more NFT purchases across a wider variety of collections. Overall, they can spend more money on their initial purchases.

But the same high-spend strategy doesn’t necessarily mean better returns for all investors. For the least successful investors, “losses are compounded" as high transaction fees and failed transactions add to costs, Chainalysis found.

The origination of funds from top-performing collectors also shows they are already more sophisticated and experienced crypto investors with their funds coming from Decentralized exchanges (DEXs), protocols and lending contracts.

While the report highlights that legitimate money can be made in the NFT market, McMahon cautioned newcomers to first pay attention and "do your research" before "aping into the latest collection."

David Hollerith covers cryptocurrency for Yahoo Finance. Follow him @dshollers.

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