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ETF trading Strategy: What works and what doesn’t?

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Trading in broad-based Indexes like NIFTY 50 and NASDAQ 100 have been a lucrative endeavour for me. I have been swing trading in them for quite some time now and the profits are phenomenal. The reason why I prefer trading in a broad-based Index is because they are the safest instruments for trading available. In this blog post, I will talk about my ETF trading strategy in detail. 

NIFTYBEES trading strategy helps me generate fairly consistent monthly income. Source – My Zerodha Trading Account

Financial Disclaimer

Investing is risky. The information provided here is for general information purpose only. It should not be seen as a professional financial advice. Before investing in equity, always consult your financial advisor, and always risk money that your are willing to lose.

What makes NIFTY 50 relatively safer? 

If you are looking to get some hands-on experience in trading, a broad based index ETF like NIFTYBEES can be a good start. 

NIFTYBEES tracks the performance of top 50 Indian companies across all sectors, and acts as the nation’s economic indicator. Other similar indexes are S&P500 and HANGSENG index. These indexes derive their value from the economic outlook of their respective countries. In the long term, they function as a lagging economic indicator, and in the short term, as a leading indicator. In simple language, the returns on broad index ETFs  like NIFTYBEES  are positively correlated to the economy.  If you know where the economy is headed in the long run, taking a stance on a broad-index is not difficult. 

Betting on Economy 

Betting on the economy is safer than betting on individual stocks. If the economy is too bad, people will get crazy and replace the government in subsequent elections. There is always a pressure on the government to make the economy right, and this is one reason why indexes like NIFTY50 are so safe for the long term. You can hold them for a lifetime if needed and even pass it as an asset to your future generation. It is safer than gold because it’s intrinsic value is backed by economic activity and not wishful thinking. Also, you can use such index ETFs for economic diversification of your portfolio from a long term investment perspective.

Sustained Uptrend

Broad-based indexes that track the economy of a country are  in perpetual uptrend because they reflect the hopes of the nation. The economy doesn’t even need to be good at present for these indexes to react positively. Just a future positive expectation of economic growth is enough to keep this index moving higher. Monetary and Fiscal policies of the central bank and government play an important role here.

My NIFTY trading Strategy 

My trading strategy for the NIFTY50 ETF is very simple. While there are riskier ways to trade in them (like taking intraday positions on leverage or trading derivatives like options and futures), I take the least risky route of delivery-based buying

My strategy is grounded in the philosophy that these indexes will continue to grow in the long run given the consensus projections about the state of the economy. Holding ETFs of such indexes in a demat account eliminates the risk of obligatory selling or buying which is often a case in intraday or forward contract instruments. So there is minimum risk involved from a long term perspective. Short-term downturn resulting from minor market-moving events (like quarterly reports, interest rate changes, Economic news) can lead to ‘unrealised loss’, but you can always wait for the storm to pass without having to take the loss. The downturn can also give you an opportunity to average your position by buying more units at attractive discounts.

Note- If you average your position, your profit target should also be adjusted to sync it with your long term trading strategy. 

Best for beginners 

This strategy is best for beginners who want to practice trading without taking too much risk. Once you start observing the movement of these indices, you will get an idea about the average level of volatility and the pace of trend. Your profit booking strategy will be dependent upon those factors. For example, I always book my profit at 1 to 2 point increase from my average buying price in NIFTY50 because that’s in line with the weekly spread of trading price range. Also, it fits into my long term trading strategy.

Should you time the market?

While it may be tempting to time the market and wait for the index to fall to a desired level before buying, it’s often a futile idea. Timing the market never works for index investing in my opinion. It’s better to buy at the market price and then average your position if the market falls.

Let’s say you buy the ETF at 100 rupee which is a record high level. From there, the index can either break the current price level and move higher or fall down. If it moves higher and reaches your profit target, you can make an exit. If it falls down significantly, you can buy more. This will bring the price of your holding lower. And then you can wait for the index to increase again (which it definitely will if the economic outlook remains positive).

Keeping Emotions at Bay

You need to keep emotions at bay when executing this strategy (and trading in general). If you plan to exit at 2 percent, do it. And do not regret if the index closed 4 percent higher after your exit. The index is not going anywhere and you can again make an entry the next day. It is very important to stick to your long term trading strategy without letting emotions come in the way.

Returns

I have been able to generate on an average 20 to 30 return percent per year through this strategy. I know there are ‘experts’ who claim to generate 100 to 500 Percent return through trading, but I don’t envy them. My trading strategy has minimum risk and limited profit. And I cannot afford to gamble away my capital. 

It might be possible to earn 500 Percent return through strategies like leveraged trades and derivatives, but if something can lead to 500 percent profit, it is equally likely to give 500 percent loss. I will have my peace of mind. Thanks ! 🙂

Leverage is dangerous 

Leverage is a dangerous thing for retail investors. It basically allows you to buy more stock with less money with terms and conditions. If you are new to trading and you want to sleep better, then avoid taking leverage positions. When taking leverage based trade positions, the risk of losing capital increases drastically, and for retail investors, especially new ones, it’s pure gamble.

Bottomline

Delivery based index trading through ETFs is a safe way to put your money to work. If you are new to trading and want to get a feel of how the market works, trading an Index ETF like NiFTy 50 or S&P500 can be a great way to get started. Once you become comfortable in this area, you can move to trading in a more specific sectoral index. I will soon write a blog post about my experience and strategy  in trading sectoral indices like the NIFTY IT index. 

Stay tuned. 

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Chinese Stock Market for foreign investors: An opportunity or a trap ?

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Chinese Stock Market for foreign investors: An opportunity or a trap ?

Disclaimer

The information presented here is for information purpose only. It should not be seen as an investment advice or endorsement of any financial instruments in particular. Before making any investments kindly consult your financial advisor.

Investing in stock market of other countries is becoming a popular form of portfolio diversification. Funds like PGIM Global Opportunity (among others) make it easy for retail investors in India to get exposure to the top global companies around the world. And not just in India; the trend can be observed in many countries around the world.

But do you know, a globally diversified portfolio (while providing a hedge) also makes us vulnerable to geopolitical and currency risks?

Chinese Regulatory Crackdowns

Recently, a regulatory crackdown in China caused a great deal of panic among investors around the world. These investors had their portfolios exposed to companies operating in China. The Nasdaq Golden Dragon China Index (which tracks performance of Chinese companies listed in US) saw a great selloff as a result, erasing billions of dollars from the market. Similarly, the shanghai composite index suffered great headwinds (which seems to continue as I write this blog post) over uncertainty of China’s corporate future and anticipation of further crackdowns. Personally speaking, my investment in a Chinese equity fund went down by 13 percent, with signs of further downturn. 🙁

China Shanghai Composite Index reacting to Chinese Crackdown on Education and Tech Companies.

What does this event mean for people looking to diversify their investments in China? Does the lure of investing in one of the most advanced economy in the world outweigh the risks that come with the so called political uncertainty of the Communist Party of China (CPC)’s regime ?

Not so uncertain

While such market-shaking events can send well-established investment funds and stocks into existential crisis, there is something important that we miss when explaining so called ‘uncertain developments‘.

These events are not very uncertain if you look at it from the Chinese perspective. Investing in foreign equity (especially those of nations which are not ‘western type democracies’) does come with risks. But these risks, in context of Chinese stock market, can be mitigated and managed well if you understand the political philosophy of China.

A misunderstood nation

In order to asses the risk associated with investing in Chinese stocks, it is very important to understand what is “Socialism with Chinese Characteristics“.

The West likes to believe in the narrative that “capitalism” is the main driver behind China’s economic miracle. But this is a half truth. The Chinese political system is very unique and it merges free market ideals with Marxist-Leninist ones, creating a hybrid socioeconomic system. This can sound quite esoteric to the outside world, but let us try to understand it in simple terms.

What is Socialism with Chinese characteristics ?

Socialism with Chinese characteristics refers to the policies of the Communist Party of China (CPC). It is a hybrid model of governance based on two core ideas :

  • Marxism–Leninism
  • Deng Xiaoping Reforms

What is Marxism ?

Marxism (named after Karl Marx) is an idea that examines the effect of capitalism (private ownership of companies) on society, and argues that communism is a better solution for socio-economic upliftment. Communism, in simple terms, defines a social and political arrangement where the means of production is owned collectively by people (the workers) rather than by privileged private owners. A Marxist society is a classless society, and quite utopian in a sense that there is no class struggle involved (i.e., issues like income inequality and worker exploitation is non existent.)

The role of Lenin

Lenin took Marxism to a different level all together. He proposed that communism can only be established through dictatorship of the working class. This dictatorship, he said, should be lead by revolutionary vanguards (select members of the working class who are class-conscious, politically advanced and possess leadership skills.) In simple terms, he meant that a one party dictatorship representing the proletariat (working class) can make the dreams of Marx come true by paving the way for communism.

Deng Xiaoping Reforms

But hardcore Marxism–Leninism backed fired in china under the leadership of Mao, pushing the country into a social and political crisis, an era which is known as cultural revolution.

When the power came into the hands of Deng Xiaoping, things began to change. Deng Xiaoping introduced reforms which is known as Dengism.

Dengism is nothing but an improvisation of Marxism–Leninism and Mao’s ideas to suit existing socio-economic conditions of China. Deng Xiaoping believed that Chinese upliftment can only be realized through modernization. At the same time, he wanted this modernization to sync with existing Chinese ideology and traditions. He was basically looking for a trade off between capitalism and socialism.

Deng believed that capitalism can increase productivity because it is based on the idea of incentives and self-interest. Capitalism was no doubt the reason behind the prosperity of the West, something Deng saw himself as he travelled the world. Deng, however, argued that socialism and capitalism are “peas in the same pod”, and that to truly achieve socialism, China must go through controlled capitalism. The capitalism he was proposing was hybrid. He wanted to harness the potential of free market forces without violating the socialist path (Marxism). He believed that a single party dictatorship can use capitalism cautiously to modernize Chinese society without comprising with Marxist ideals. And thus Socialism with Chinese characteristics was born.

Xi Jinping Thought – The current guiding principles of CPC

Xi Jinping is the current president of the Communist party of China. He improvised Deng Xiaoping‘s theory and also the reforms made by Deng’s successors (like Jiang Zemin and Hu Jintao) to create a political theory which is called Xi Jinping Thought.

Xi Jinping Thought defines what socialism with Chinese Characteristics should look like in the current era. Xi’s idea of good governance involves taking a people-centric approach for development, and creating a sustainable economic ecosystem fueled by innovation. While Xi considers free trade as an essential economic driver, he also stresses on the importance of using it carefully by creating a balance between capitalism and socialism.

How does CPC policies affect stock market of China?

In recent month we have seen CPC exercising heavy regulatory measures to ensure that power and wealth does not concentrate into the hands of a few business monopolies.

Do you remember the story of Jack Ma? He happened to criticize the political system of china, saying that new technology and big data can offer better alternatives for determining credit-worthiness of individuals and businesses than depending upon old collateral system controlled by CPC affiliated banks. And he even called the traditional state controlled financial systems an old man’s club run by people with pawnshop mentality. Not a wise thing to say when your fate lies in the hands of a dictatorship !

The CPC suspended Ma’s ANT Group IPO and sent a strong message to the corporate community in china that if you mess with the party’s principles, you are screwed !

Sweeping Reforms

In recent weeks we saw Chinese companies like DIDI taking a blow for abusing market dominance and misusing users data. We also saw how the new education policy caused companies like TAL to lose market value. (According to this new policy, private tuition companies should declare themselves as nonprofit organization and are barred from making profits. In simple terms, it’s an attempt to prevent private companies from taking over the education sector – a move that resonates with CPC’s core idea of socialism.)

The future of Chinese Stock Market

The crackdown on Chinese companies should not be seen as an unexpected black swan event. If you understand what socialism with Chinese characteristic is, you will realize that such regulatory shocks are quite expected.

Socialism lies at the heart of Chinese society, and CPC will never let ‘untamed capitalism‘ destroy it. Unlike the West, China will never allow private entities to get so big that they become a threat to CPC and to the socialist ethos that guide the nation’s policies.

CPC justifies its regulatory stance by arguing that formation of monopolies and uncontrolled capitalism can lead to income inequality. It can also expose China to problems of modernization that are plaguing western democracies. Problems like financial bubbles, hyperinflation, workers exploitation, climate crisis and so on.

Stock market is like a Legal Ponzi scheme

The stock markets in western democracies (like US) works like a Ponzi scheme. The gains in the market is a result of capital infusion, often in an uncontrolled manner. The older investors are paid off by the money of new investors and the cycle goes on. Uncontrolled money printing pays a significant role in keeping this Ponzi scheme going. As long as the governments keeps printing new money, the stock markets will continue to get capital inflows.

But there is a problem with such an approach.

The valuations of stocks often reach unreasonable levels backed by the superficial assumption about an asset’s future profitability. There are no robust regulatory framework to prevent such irrational asset bubble from building up. We have seen the crisis that such bubbles can create in 2008.

Stock Market with Chinese Characteristics

Chinese government wants to avoid the perils of an unregulated financial system. In simplest terms, the CPC wants stocks markets to be what it is supposed to be — a way for companies to raise funds, create value and reward the investors with genuine profits. This is very different from the idea of stock market in the west. The CPC actively monitors the state of capital markets in China, and would to anything to ensure that the financial power does not concentrate in the hands of few.

(In the West, is it completely normal to expect 100 percent gains on a stock that does not even turn a profit. All you need is a wishful thinking, a herd mentality, and uncontrolled money printing by the government. It is completely normal to seek double digit returns even when the economy is going into recession.)

The Bottom-line

If you want to play stock market like the Ponzi game, then I would suggest that you avoid Chinese stocks. The CPC will never let you make irrational profits by gaming the system. You can do that in a hyper-capitalist society with lose financial regulations (where stock markets move in opposite direction of GDP often due to uncontrolled money printing), but China has very tough regulatory framework for financial markets, and it’s not possible to game the system in anyway. Regulatory crackdowns are an important tool for CPC to ensure that the stock market reflects the reality rather than irrational exuberance.

My Chinese equity fund is down 13 percent, but I am not selling it away because I believe that Chinese stocks are good for long term investment. China follows what is called ‘Dual Circulation‘ meaning that while some industries are very much under the control of state, others run on free market model giving foreign investors a chance to benefit. If you do invest in China, expect the returns on your investment to be much more reasonable in the long run. The returns will often be in line with the country’s economic development.

Also keep in mind

When investing in the stock market of China, keep in mind that sectors like Education, Healthcare, and Banking will stay in strict regulatory control and there is not much opportunity there for foreign investors. If you are not an expert in fundamental analysis and geopolitics, I suggest that you invest in a broader index ETF like the Shanghai composite or Golden Dragon. The risk with index eTFs are much lower as they offer broad diversification across different sectors. Also, don’t put all your eggs in one basket and only risk the capital you are willing to lose. This is the most important advice on investment in any kind of equity markets.

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Home » Money and Finance

Before I begin, I would like to read a disclaimer.

I am not a financial advisor, and I am not professionally qualified to give financial advices. I am just a friendly neighborhood blogger who has learnt stock market all by myself. The analysis and tips I share on this blog is based on my personal investing experience and should not be considered professional financial advice. Before investing in any securities, kindly consult your financial advisor.

The middle-month Hypothesis

What you see in the chart above is the price trend of S&P 500 index for a period of three months, where each month is enclosed within the boundary of two vertical green lines. (Let us not ask which month this data belongs to because it is not relevant to the argument I am about to make.)

In the middle of each month, there is a significant dip in the stock prices (highlighted by red dots), and then an uptrend follows. The observation tells us that every mid-month there is a possibility of temporary index correction, and the pattern seems consistent for the timeframe presented in the chart. If you buy the index ETF during that time, there is a good chance that you will generate a good return in next fifteen days, according to this hypothesis.

If you think this is a consistent pattern, you can create a trading strategy around it and harness the herd psychology. This is what technical analysis is all about. Technical analysis is nothing but looking for patterns in the charts and making predictions based on those patterns. In a way you are betting on how a group of people will think and behave based on how they thought and behaved in the past. People’s behavior ultimately guides price action in stock market.

But hold on

There is no guarantee that the S&P500 index correct itself in the middle of every month. This is just a hypothesis that can easy be proven wrong. Let us test this hypothesis by looking at data from a different set of months.

You can clearly see in the chart above that Month 1 shows us a middle finger by disobeying our middle-month hypothesis. There are no significant mid-month correction here, and the entire month seems to be bullish, falsifying our hypothesis blatantly. It’s logical to say that depending on such analysis and trying to time the market (by buying at the middle of the month) is a bad idea.

A Bogus Science

The above exercise explains much of technical analysis in a nutshell. Much of what they sell as ‘Technical Analysis‘ is a bogus pseudo-science. A lot like astrology. (Well, astrology is worse), but you get my point.

Mainstream Technical analysis tends to ignore a very important truth: Past events are not indicative of future. A lot of people claiming to be gurus of trading based on technical analysis have no clue what they are peddling. Oh, look a hammer ! A sausage ! A hanging man ! A flying penis ! They see all kinds of magical patterns in the charts. Who are these people? Oracles?

These self proclaimed oracles of financial world will give you all sorts of illogical trading wisdom, and none of them are useful. A better option is to depend on fundamental analysis. Although fundamental analysis too has its flaws, but it much more grounded in logic.

(Note – when I say technical analysis is bogus, I am not discrediting the methodologies that analysts in the financial industry uses to study investment behaviors and make predictive models (I have been a financial analyst in one of the world’s biggest financial institution). I am saying that much of what is peddled in the name of technical analysis (by experts and amateurs alike) are completely based in fantasy and wishful thinking)

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If you want to learn fundamental analysis, a good book to start with is Intelligent Investor by Benjamin Grahams. And if you purchase through this affiliate link I will earn a small commission from Amazon at no additional cost to you.

Also, if you want to understand money and how financial word works in simplest language possible, you can read my guide Paisa and the Passive: Financial Literacy in Plain English. Good news ! If you have kindle unlimited subscription you can read it for FREE !

Stock Market is a like a Ponzi Scam. But a good one…

We know that keeping money in the form of cash is problematic. The rate at which money is created is greater than the rate at which goods and services are produced causing inflation.

Inflation is a real money killer and people fear it. To protect themselves from inflation, many of us choose to invest our money. The important question is: What avenues are available for investment? Should we buy stocks ? Or bonds ? Or gold ? OR Fixed income instruments? Or Turtlecoins?

And the answer is

The best investment is an ‘imaginary idea‘. It is a valuation that people assign to an asset based on “opinionated” numbers.

One of the most significant factors that give importance to an asset is the assumption about potential cashflow they will accrue in their life time. A fixed income instrument with a face value of 100 that pays 10 percent will generate 159.37 in interest payments over a period of 10 years (compounded annually).

Similarly, the cashflow a stock will generate in 10 years depend upon how much profit it makes during that time period. There are many execution risks that can prevent a company from achieving the profit goals, but a carefully calculated CAGR can be used to create a good projection of future profitability by taking some margin of error into account. It may sound esoteric to you if you don’t know how fundamental analysis works. But don’t worry because I will give you a much easier way of making stock prediction so keep reading !

Index ETFs to the rescue

Stock market is a perfect Ponzi scheme, and you can take advantage of this structure to make money without being a called a fraudster (cuz this Ponzi is completely legal baby ; ) ).

When you buy a stock on the exchange, you are basically giving your money in exchange for an asset (the stock) hoping that it’s price will increase. The only way it’s price will increase is if someone is willing to pay more than what you bought it for. This willingness is determined by the expectation of the company’s profitability. The money you make depends upon the infusion of new money into the stock (remember stock market is Ponzi scheme where capital increase is function of capital inflow often based on often wishful assumptions about a company’s future profitability).

Predicting the future profitability for a company with good accuracy involves complex fundamental analysis, and most of us simply don’t have the bandwidth to do it ourselves. A better option for many is to invest in an index ETF like S&P 500 , which offers a good opportunity to benefit off this Ponzi scheme.

A little bit of central Banking

The money supply in US (and in most countries) is controlled by central banks, and the US FED’s responsibility is to carry out the congressional dual mandate : Maximum Employment and Price Stability.

By creating temporary inflation, the FED is able to boost economic growth. If the economy is growing it means that money supply is growing. More money in circulation means more money entering the capital markets.

The fate of S&P500 index lies in the hands of US economic growth. To determine if S&P 500 will continue to grow or not, you need to determine if economy will continue to grow or not. The infusion of new money into the Ponzi scheme (stock market) can happen only if new money is created. And new money is created when economy grows.

If you don’t know how the monetary system and the economy works, you can depend on economic forecasts by reputed agencies that gives out projections about US economic outlook. You can also make use of online resources like tradingeconomics.com. The below chart shows the GDP ( a measure of economy) over the years:


source: tradingeconomics.com

Despite the bummer in 2020 due to covid-19, the outlook for US economy looks positive according to consensus reports. Things will be back on track and the economy will continue to grow. A growing economy means more money in circulation and higher corporate earnings. These factors drive S&P500 higher because they are the leading indicators for long term price trends.

S&P 500 is like a Ponzi scheme that is not ending soon because there will always be new investors infusing fresh money into it perpetually as long as the population grows. The money that they will earn through their hard work will push the S&P500 higher. These young investors will get the stocks from us and we will take their hard earned money and retire. And this cycle will continue. The millennials will pay for baby boomers. The Gen X will pay for millennials and so on. This is a perfect financial plan unless there comes a black swan event that takes the US economy down.

The Takeaway

If there is any takeaway that you should take away from this blog post, it is that ETFs like S&P 500 are very good investment for many people who don’t want to get into complex stock selection process using fundamental analysis. In the long run, the returns on S&P500 is going to beat inflation and help you retire with a good corpus of cash. But again only if the US economy and the money supply continues to grow. I regularly invest in S&P 500 because I am betting on US economy, and I believe it is going to do great in coming few decades. If you learn to analyze the economic outlook, the strategy for investing in index funds will come naturally to you.

Good Luck !

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Non Fungible Tokens : What are they and Why should you care?

Home » Money and Finance

Just when we think we have seen it all, something new comes along and leaves us scratching our heads for an explanation. Something similar can be seen in the crypto world these days. Non Fungible Tokens (NFTs) are all over the internet, and it has made us all confused. What NFT means ? And why should you care ? 

What are NFTs?

NFTs are blockchain based tokens that represent ownership of an asset. The asset can be anything : photos, digital files, artwork, patent, or even a tweet or meme! To understand what NFTs are, we need to first understand two things:

  • #1. Fungibility
  • #2. Blockchain

#1. What is Fungibility?

Fungibility is basically the characteristic of any goods or commodity whose individual units are interchangeable and indistinguishable from each other. In most simple terms, fungibility is a synonym for replaceability and non-uniqueness. Let us understand it with an example.

Pure Gold is Fungible

We can say that pure gold is fungible because one unit of pure gold will have the same value no matter what form it is in. You can cast it into a coin, ingots or any other form, it will have the same value irrespective of shape or state it is in.

Money is Fungible  

Money is also a fungible token. One dollar will have the same value no matter what form it is in. You can represent it as a hundred ‘one cent’ coins, or a single paper bill, or a combination of multiple denominations.

What about Diamonds or Jewelry?

Well, they are not so fungible. Their varying cuts, colors, grades, and sizes makes them Non Fungible items. Two diamond rings can have very different prices depending upon how they are designed, even though the weight of diamond in both rings are the same.

Currency should be fungible but ‘Art’ should not

Let’s say you get your salary in cash every month and you deposit it in a bank in Mumbai where you live. You send pocket money to your kids in Delhi through online transfer. If your kids withdrew that money from an ATM in Delhi, would they get the same cash with your fingerprints over it that you deposited in Mumbai? Definitely not. Your kids will get a different set of paper currency, but it does not matter because the value of that currency will be the same irrespective of whether it has your fingerprints on it or not.

Can you say the same thing about a diamond ring that you wish to give to your partner on their anniversary? The ring you bought is very special and unique. It is not replaceable unlike cash. The only option you have is to transfer it over a courier service or hand it over personally. Therefore cash is Fungible and a diamond ring is non Fungible.

#2. What is Blockchain?

Now that you understand what non-fungibility is, let us try to understand Blockchain

Blockchain is a network of computers that maintain some data publicly. Since the data (let’s call it ledger) is distributed over all computers in the network, everyone has visibility on it. It is difficult to manipulate such a data set, and any genuine change needs to pass through a  complex algorithmic and democratic validation process.

Application of blockchain

Once application of blockchain can be seen in Banking. Rather than having central banks to store and process our payment information, we can have the blockchain do it. This reduces the chances of “corruption”. 

In other words, blockchain eliminates the ‘central point of failure’ by transferring the authority from a single entity (bank) to a group of computers connected through a network. All your payment info can be stored in that distributed ledger and it will be impossible to manipulate it.

The bitcoin network is an example of blockchain-based banking where you don’t need a central bank to keep record of transactions. This makes bitcoin free from any government influence. Blockchain in banking (also called Decentralized Finance or DeFi) can help us deal with challenges like uncontrolled inflation which happens when the central banks and governments print money uncontrollably and give it to unworthy corporations and individuals through vehicles like loans, grants and subsidies

Coming Back to NFT

Non Fungible Tokens share some characteristics with Bitcoin. The only difference is that bitcoins are fungible but NFTs are not. Let us come back to our example of sending pocket money to your kids. Let’s say you get paid in bitcoin and you transfer it to your kids through a crypto wallet. Because bitcoins are digital representations of money, there is no such thing as a unique bitcoin, just like a paper currency or gold. 

NTFs are different because they are unique. Think of them like diamond rings. The NFT you won as a record in the blockchain has some characteristics that make it unique and irreplaceable. You cannot split it into fractions because the asset it represents is not fungible like money. 

If an NFT represents a painting, you cannot transfer half of it to someone and keep the half. This might be possible with bitcoins. If you have 1 Bitcoin, you can transfer 0.5 bitcoins to a friend. But you cannot do the same with an NFT. It is illogical to think about splitting an NFT, but it’s like splitting the painting in two halves.

NTFs are a record of digital ownership. Bitcoins are also a record of digital ownership. The difference is that bitcoin represents ownership of a fungible item (money), while NFT represents ownership of a non-fungible item (artwork, movies, digital IPs, copyrights, patents, tweets, memes, cars, houses, and just anything that is unique). 

Why do we even need NFTs ?

Well, right. Why do we need them?

For the same reason that many people think they need bitcoins. A blockchain-based system to track  ownership of an asset eliminates the need of a central authority. With bitcoins, you don’t need banks to validate your transactions. With NFTs, you don’t need a central authority to validate that you are a true owner of some unique asset.

Supporters of blockchain say that it is better than the conventional way of keeping ownership records. For example, if you buy a house, the only proof that you have for its ownership is the purchase agreement. This ownership record gains its legitimacy from the seal of government. What if someone forged the seal and sold you a house that he does not even own? NFT can solve this issue by removing the need for depending on a government seal to identify the true owner of an asset. NFT does it through the blockchain.

How to get involved with NFT?

You can turn your digital files (or apparently anything unique that you own) into NFTs. When you create an NFT, you basically create a record in a blockchain network that you are its owner. This ownership is verified through an algorithmic process run by the computers in the network. Once your digital asset has an ownership record on the blockchain, no one can deny that you are it’s owner because the blockchain is almost impossible to manipulate.

You can transfer NFTs to other users in the network, but it is much like sending your anniversary ring to your partner than transferring cash to your kids online.

Problems with NFTs

NFT can seem like a brilliant idea, but just like any blockchain applications, there are some problems involved. One such problem is climate change. The amount of electricity that the blockchain network consume is huge, and it is not good for the planet. One solution can be to run this technology on renewable energy, but it is not so easy.

Other problems involve “asset mania” that can spring from irrational valuation of an asset based on “assumed importance”. Recently, a tweet’s ownership was sold through NFT for millions. Do you really think a tweet is worth in millions? It’s is up to us how we want to value something, but this aspect of human psychology creates volatility making NFTs a very risky investment.

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External Resources

Non-Fungible Tokens Wikipedia

Jack Dorsey, CEO of twitter, sells his first tweet as NFT

Breed digital cats on Crypto kitties

Shopify NFT