What are NFTs? What you actually own, the risks, and how they're taxed

In 2021, non-fungible tokens went from niche to headline news, with digital art selling for millions. The hype has faded, but NFTs are still used for art, collectibles, game items, tickets and memberships. This guide explains what they are, from Ethereum’s documentation, and what the IRS has said about taxing them.

What “non-fungible” means

Something is fungible if every unit is interchangeable: one dollar is as good as any other, and one bitcoin is as good as any other bitcoin. Something is non-fungible if each unit is unique, like a concert seat or a painting.

ethereum.org defines NFTs as tokens that are individually unique: each one has different properties and is provably scarce. That uniqueness allows tokenizing things like art, collectibles or even real estate, where one specific NFT represents one specific item.

How an NFT works

1. A creator mints the NFT by calling a smart contract, usually on Ethereum or a similar blockchain.
2. The token gets a unique ID and is recorded as belonging to the creator’s address.
3. When it’s sold or transferred, the blockchain records the new owner. ethereum.org notes that ownership is stored on the blockchain for anyone to verify publicly.

The token usually includes a link to metadata: a name, a description and the image or file it represents.

The standards behind NFTs: ERC-721 and ERC-1155

Most NFTs on Ethereum and compatible networks follow one of two published standards, which is why wallets and marketplaces can display and trade them:

• ERC-721 (first proposed in January 2018) is the original NFT standard. Each NFT is identified by a token ID inside its contract, and anyone can look up its current owner. An optional extension adds a token URI, a link to a file describing the NFT with fields for its name, description and image. That link is how the picture you see gets attached to the token.
• ERC-1155, the “multi token standard”, lets one contract hold any mix of fungible and non-fungible tokens and transfer several types at once, saving transaction costs. Its authors wrote it with blockchain games in mind, where developers may create thousands of token types, but said it isn’t specific to games.

Approvals: the setting scammers want

ERC-721 lets an owner approve someone to move one NFT, or approve an “operator” to manage all of their NFTs in a collection, through a function called setApprovalForAll. Marketplaces need this to sell on your behalf. A scam site that tricks you into the same approval gets the same power. If your wallet asks you to approve access to all your NFTs in a collection, make sure you know exactly which site and contract you’re dealing with. See token approvals and how to revoke them.

What you actually own

This is where many buyers get confused:

• You own the token, and the blockchain proves it.
• You don’t automatically own the copyright or other intellectual property in the artwork. Those rights depend on the license or terms the creator attaches, which can range from “personal display only” to broad commercial rights.
• The file the token points to may be stored off-chain. If that storage isn’t maintained, the image can stop loading even though the token still exists.

Before buying, read the project’s terms and check how the files are stored.

Creator royalties: not guaranteed

Many NFT projects promise creators a percentage of every resale. The ERC-2981 royalty standard gives NFTs a way to signal that royalty, always as a percentage of the sale price. But the standard itself says the payment must be voluntary: a blockchain transfer doesn’t always mean a sale, so royalties can’t be forced on every transfer. If a marketplace doesn’t implement it, no royalty is paid on secondary sales.

For buyers, that means royalty terms can add to the cost of buying on some marketplaces and not others. For creators, it means resale income depends on where their work is traded.

What NFTs are used for

• Digital art and collectibles, often with royalties for the creator on resales (where marketplaces honor them).
• In-game items that players can trade.
• Tickets and memberships that prove access.
• Domain names on blockchain naming systems.
• Representations of real-world items, where the legal link between token and item depends on contracts and law outside the blockchain.

The risks

• Illiquidity: there may be no buyer at the price you want, or at any price. Floor prices can collapse quickly.
• Fakes: anyone can mint a copy of a famous collection. Check the official contract address from the project’s verified channels.
• Phishing mints and airdrops: ethereum.org warns about airdrop scams where an unsolicited NFT lands in your wallet with a link to “claim” something; signing on that site can hand over control of your assets. See crypto airdrops explained.
• Malicious approvals: marketplaces need permission to move your NFTs. Approving the wrong contract can drain your wallet. Revoke approvals you don’t need.
• Wash trading: some sales are traders buying from themselves to fake demand.

Are NFTs securities? The SEC’s 2026 view

In its March 2026 interpretation, the SEC defined an NFT as a non-interchangeable crypto asset with a unique digital identifier, and sorted most of them into two of its five categories:

• Digital collectibles: crypto assets designed to be collected or used, which may represent or convey rights to artwork, music, videos, trading cards, in-game items or internet memes. Its examples include CryptoPunks and Chromie Squiggles. The SEC says digital collectibles are not themselves securities: like physical collectibles, they don’t give rights in a business. It notes that creators of artwork collectibles often give holders the right to display and commercialize the artwork, usually through an end user agreement.
• Digital tools: tokens with a practical function, such as a membership, ticket, credential or identity badge. Its examples include Ethereum Name Service domain names and an NFT conference ticket.

Two caveats from the SEC. First, a digital collectible that is fractionalized, so people can buy a share of a single NFT, could be offered as a security, just as fractional interests in physical artwork can be. Second, any non-security asset can still be sold as part of an investment contract if the issuer promises the managerial work buyers rely on for profits. See is crypto a security?

How NFTs are taxed (US focus)

The IRS includes NFTs in its definition of digital assets, so the usual rules apply: selling, swapping or using an NFT can create a capital gain or loss, and creators who sell NFTs may have income. See US crypto tax.

There’s an extra twist. In Notice 2023-27, the IRS said it intends to issue guidance on when NFTs count as collectibles. Until then, it will use a “look-through” analysis: an NFT is a collectible if the right or asset it’s associated with is a collectible. For example, an NFT giving the right to use a “plot of land” in a virtual world generally isn’t a collectible. An NFT linked to a digital file raises the question of whether that file is a “work of art”, which the IRS is still considering.

The notice gives a clear example: a gem is a collectible, so an NFT that certifies ownership of a gem is a collectible too. The tax code’s list of collectibles covers any work of art, rug or antique, metal or gem, stamp or coin, alcoholic beverage, and other tangible property the Treasury specifies.

Why it matters:

• Tax rate: according to the IRS, net capital gains from selling collectibles, such as coins or art, are taxed at a maximum 28% rate, higher than the usual 20% top long-term rate.
• Retirement accounts: under the same section of the tax code, if an IRA acquires a collectible, the purchase is treated as a distribution from the IRA equal to its cost. See crypto in your 401(k) or IRA.

In the UK and Canada, NFTs are generally treated like other cryptoassets for capital gains purposes. See our UK and Canada guides.

Before you buy an NFT

1. Verify the official collection and contract address.
2. Read the license: what can you do with the artwork?
3. Check where the file is stored.
4. Use a separate wallet for minting and trading, not your savings wallet. See hot vs cold wallets.
5. Assume you may not be able to sell, and only spend what you can afford to lose.