What are NFTs?
26 October 2021
A novices’ guide to Non-Fungible Tokens (NFTs)
You’ve heard a lot about NFTs, but you don’t understand what they are or what they’re for yet? Let’s break it down.
In this article, I’ll explain the concept of fungibility, what NFTs are, and how they work with some examples to help you understand their possible uses. As you will see, there are many.
By the end of this article, you’ll have some elements on what to look for before buying an NFT and what their prospects are in the future.
What is an NFT?
NFT stands for non-fungible token. But, before going into the details of non-fungible tokens, it is necessary to define the notion of fungibility.
An asset is said to be fungible if it is not unique and is interchangeable against an asset of the same type. For example, all fiat currencies are fungible. To be used as a medium of exchange, each individual unit must be interchangeable with any other equivalent individual unit. A one-euro coin is always interchangeable with any other genuine one-euro coin.
According to this definition, most cryptocurrencies are fungible or partially fungible assets. It is important to note the partial fungibility of some cryptocurrencies. Bitcoin, for example, is a partially fungible cryptocurrency because a coin is interchangeable with another one, but its entire transaction history is freely available. Thus, each unique coin can be tracked and identified.
Absolute fungibility implies a notion of anonymity to respect non-unicity. In this case, each coin is strictly identical and unidentifiable; we can cite the example of privacy coins like Monero or Zcash. Unfortunately, fungible tokens such as Monero are in the crosshairs of regulators, who are concerned about the layer of anonymity that could facilitate money laundering.
What are NFTs?
With the concept of fungibility clarified, we can now return to the heart of our topic: what are non-fungible tokens, and how do they work?
Non-fungible tokens are unique and identifiable. Thus, no token created will be exactly the same as the other - each will have specific characteristics that define it. They can only have one official owner at a time, and they function as verifiable proofs of authenticity and ownership within a blockchain network. Finally, NFTs are not interchangeable with each other and introduce scarcity to the digital world.
In fact, all these properties and characteristics mean that if you create an NFT, you can easily prove you’re the creator, you determine the scarcity, you can earn royalties every time it’s sold. You can sell it on any NFT market or peer to peer (you’re not locked into any platform, and you don’t need any intermediaries).
On the other hand, if you own an NFT, you can easily prove you own it, no one can manipulate it in any way, you can sell it, and in some cases, this will earn the original creator resale royalties. Of course, you can also hold it forever, comfortably knowing your asset is secured by your crypto wallet.
Various frameworks have been created to facilitate the issuance of non-fungible tokens. The most prominent is currently ERC-721, which is on the Ethereum blockchain. That said, many others are emerging with the recent hype of NFTs.
In fact, NFTs can be used by decentralised applications (DApps) to allow for the creation and ownership of unique digital items, collectables, and tokenised versions of digital or real-world assets. These can then be traded in open marketplaces that connect buyers with sellers like OpenSea, Rarible, SuperRare, or Foundation.
How are NFTs used?
In theory, the scope for NFTs is anything that is unique that needs provable ownership. However, as the NFT world is relatively new, let’s look at some kinds of NFTs that exist today to help you understand possible uses.
These are projects where the goal is to collect the assets of a game. The most famous is Cryptokitties, where the goal of the game is to obtain cats with atypical physical traits to be resold later. It is also possible to use your Cryptokitties in other games, to be transformed into a special card or to change the appearance of your character. Another example is the NBA, which has sold NFT digital cards for collectors: A ‘Cosmic LeBron James moment’ was sold for $208,000!
The potential of NFTs is really strong in gaming with projects like Enjin or Ultra. They can provide records of ownership for in-game items, fuel in-game economies, and bring a host of benefits to the players.
In a lot of regular games, you can buy items to use in your game. But if that item was an NFT, you could recoup your money by selling it on when you're done with the game. You might even make a profit if that item becomes more desirable. Game developers – as issuers of the NFT – could earn a royalty every time an item is resold in the open marketplace. This creates a more mutually beneficial business model where both players and developers earn from the secondary NFT market. This also means that if a game is no longer maintained by the developers, the items you've collected remain yours. Ultimately the items you grind for in-game can outlive the games themselves. Even if a game is no longer maintained, your items will always be under your control. This means in-game items become digital memorabilia and have a value outside of the game.
The NFT art category allows artists to put a work on a blockchain to make it unique. The value depends on the artist, rarity and audience appreciation; that’s why some of them are worth so much.
While NFTs are digital, they can also be created in various formats, such as images, GIFS, videos and music, just to name a few. Artists are free in the form and content of their creations. For example, in the music field, we find the group Kings of Leon, which released an NFT version of their latest album.
From the beginning of 2021, NFT sales have increased significantly. Recently, singer Grimes sold nearly $6 million worth of NFT art in less than twenty minutes. Meanwhile, the famous Internet cat, Nain Cat, earned almost $460,000 for his digital art. But the one who has been the talk of the town in recent days is the artist Beeple - whose real name is Mike Winkelmann - whose digital collage “Everydays: The First 5,000 Days” sold for $69.3 million in March at Christie’s, being the first NFT to be sold at a major auction house. Prior to this, the most expensive NFT sold was another Beeple work that was purchased by the American collector Pablo Rodriguez-Fraile for $6.6 million. This is an incredible increase in value, considering that he acquired it five months earlier for $67,000.
If you are someone who struggles with handling cryptocurrency addresses - those long jumbled alphanumeric codes that don't make any sense, then you will surely love projects like Unstoppable Domains. It replaces the unreadable cryptocurrency addresses with a readable name, like an email address. Now you can just type a personal domain name into your wallet and send currencies easily. You can send Bitcoin, Ethereum, and any other cryptocurrency with just one domain name. The system supports many crypto wallets like Coinbase, Huobi, Trust, and more.
Authenticity certificate for physical items
Attempts have been made to connect NFTs to real physical objects. The most famous example is Nike's CryptoKicks. The goal here is to verify the authenticity of a pair of shoes.
Since some collectors buy limited-edition sneakers to keep or resell, Nike patented a system using blockchain to link digital assets to a physical product, making that physical product completely unique. When someone buys a pair of CryptoKicks, they also receive a digital asset attached to the unique identifier of that pair of shoes.
With projects like Ternoa, you can create time capsules from your smartphone and easily add photos, videos, or messages. Each time capsule is encrypted and stored in a decentralised manner on the Ternoa blockchain for future transmission to the beneficiaries you designate at the time of its creation. The event that triggers the sending of a time capsule to its recipient is configurable. It is thus possible to create time capsules that are automatically transmitted when the creator's death is recorded in the official death registers.
Of course, all the above examples are only a small part of the infinite potential of NFTs, and no doubt that the most important uses have not been found yet.
What to look for before buying an NFT
The idea of buying an NFT because you like it is one thing; buying it as an investment is another. Don’t forget that NFTs are still very new, and, like Bitcoin, the price of cryptocurrency takes into account several other parameters that touch on the economy. Like a piece of art, some time had to pass before it could be recognised as valuable.
Therefore, it is difficult to say whether or not investing in one or more non-fungible tokens is a good or bad choice. If you are considering investing in NFTs, you will have to immerse yourself in a complex world, where each NFT market differs from transaction to transaction.
The most important thing to consider is the fundamental value of an NFT. Don’t rush - if you do not understand where the value of the NFT comes from, it is generally not a good idea to buy it. Ask yourself, is it useful? Is this utility worth this price? Are you willing to pay that price to have the satisfaction of owning the NFT personally?
In the same vein, watch out for FOMO (Fear Of Missing Out), that famous trend that influencers and vendors can sell you as "Careful, they are super rare and super valuable! There won't be enough for everyone! Prices will explode in the future!" This is the best way to get a bad deal.
Another area to consider when valuing NFTs is transaction costs. These trades can be costly due to recent network congestion, and this cost needs to be added to the cost of the NFT itself. Be aware that it is possible to find people who would pay hundreds of thousands of Euros for this type of trade. This is what makes NFTs so messy on the one hand and interesting on the other.
The future of NFTs
As NFTs continue to gain mainstream interest, more and more brands are expected to jump on board and start experimenting with publishing IP-based digital collectables to generate additional revenue and engage with their fan base or creating exclusive experiences with token access that could become sought-after collectables.
New business models will likely be tested for digital media creators to help them bypass platforms and monetise their content directly to their audience.
Of course, NFTs will not be enough to bring digital collectables into the mainstream; there are still many questions to be answered about how to transfer them to digital platforms, how to measure and offset the huge carbon footprint they generate, and how to properly display them in virtual environments as well as in the real world.
But the potential is there, and it is immense.
NFT closing thoughts
Here we are, the end of your journey about non-fungible tokens. So, what have we learned?
NFTs are unique, identifiable, and introduce scarcity to the digital world. With tokenisation of digital and real-world assets, NFTs have the potential to be one of the key components of a new blockchain-powered digital economy. They could be used in many different fields, such as video games, digital identity, licensing, certificates, or fine art - and even allow fractional ownership of items. Storing ownership and identification data on the blockchain would increase data integrity and privacy, while easy, trustless transfers and management of these assets could reduce friction in trade and the global economy.
However, although potential and the prospects are there, the NFT market is still very young, and the current solutions need to mature to be widely adopted. Don't get carried away by hype and FOMO, and always ask yourself where the value of an NFT comes from before you buy it.