NFTs are a form of cryptographic token that represent non-divisible ownership in an item, unlike the usual value of exchange commonly represented by cryptocurrencies, like Bitcoin (BTC) or Ethereum (ETH). Currently best suited for the digital space, NFTs can tokenize a variety of intellectual properties, from art, to event tickets, to financial contracts.
Still in its early stages, the rise of NFTs has taken the art world by storm and resulted in a massive influx of cash into digital artwork and other intellectual properties. As an example, a recent NFT token created as an experiment by a New York Times journalist went on to be sold for $560,000.
NFT tokens have programmable applications that allow the blockchain to self-verify, guarantee royalties for creators, and allow its use as collateral, all without the need for outside intervention from third-party entities, like clearinghouses or government entities. All NFT transactions are peer-to-peer and take place directly within the blockchain.
The most popular NFT applications are currently secured by smart contracts on the Ethereum blockchain. We cover the mechanics of NFTs in their current state, potential value propositions, and their implication for the future.
What is an NFT and what does it stand for?
An NFT, which stands for “Non-fungible token,” allows for the creation of distinct, verifiable, and traceable stakes of ownership in a variety of intellectual properties. This ownership takes the form of a unique cryptographic token, or “NFT” that can be created to directly represent its underlying property, whether that be an image, written piece, or song.
While the concept of ownership stakes may not seem revolutionary as far as property rights go, the key distinguishing factor between NFTs and copyright and intellectual property laws lies in its underlying principle of “non-fungibility.”
The economic definition of “fungibility” implies that an asset is interchangeable and replaceable by another identical commodity. As a prime example, cash is the perfect example of a form of exchange that is fungible; there is no difference between dollar bills as long as they sum up to the same value. Every single dollar bill is worth exactly the same as another dollar of the same denomination. Generally speaking, a dollar is worth a dollar to everyone, regardless of whether it’s four quarters, or a single dollar bill.
By contrast, non-fungibility implies uniqueness; a non-fungible good cannot be replaced by definition, because there exists no identical good for it. A classic example of this would be a masterpiece work of art like a Monet or a Rembrandt. While people can make prints and copies of it, they would never be able to replicate the original work exactly.
However, non-fungibility does not mean impossible to replicate, as goods like digital works can easily be copied with little effort. What non-fungibility does confer in the context of NFTs is a mark of authenticity and a process for peer-to-peer verification through the widely accepted Ethereum blockchain.
How do NFTs work and how do they compare to other cryptocurrencies?
Like its currency counterpart, ETH, NFTs on the Ethereum blockchain are developed into coins and held within wallets in the same manner as ETH (the currency of Ethereum itself). NFT Tokens by contrast, represent an ownership interest in an asset, like artwork or an event ticket.
At their core, NFT coins resemble other cryptocurrency coins like ETH or BTC, but feature traits that make them more akin to assets rather than currency. We draw a side-by-side comparison between NFT tokens and Ether coins below.
|NFT Tokens||ETH Coins|
|Non-fungible – Each NFT is tagged with a unique identifier for which no duplicate exists||Fungible – Cryptocurrency coins like BTC and ETH are designed to be interchangeable and identical in behavior|
|Certificate of Ownership – Designed to be assigned to one owner and verified for authenticity||Store of Value – Designed to be transacted and mined|
|Indivisible – An NFT exists as a single unit and cannot be subdivided into smaller units||Divisible – Can be split up into smaller shares and traded. Smallest unit is a “Wei”|
|Value is relative – Value varies in line with the underlying asset it represents and what the market will pay to acquire it||Value is market dependent – Value is measured relative to other cryptocurrencies or fiat/hard currencies, and on the use of smart contract and decentralized apps.|
|Easily transferable – Can be sold and assigned to new owners in exchange for other goods, services, or currency||Easily transferable – Primary purpose is a medium of exchange and is used as a currency for any given transaction|
|Held in crypto-wallet – NFTs are stored in your crypto wallet like any crypto coin||Held in crypto-wallet – ETH coins are stored in your crypto wallet like any crypto coin|
Currently, the blockchain is the key component to what makes NFTs work. The new NFT token standards are an API (a software mechanism which allows two separate programs to communicate) that allows developers to manufacture NFT tokens. This includes ascribing them with the metadata that entails the unique ID, right to transfer, and ownership details for each NFT token.
The most popular forms of NFTs on the market carry the following traits:
- Public Verification of Ownership and Transfer History
- Secure Direct Peer-to-peer Transfers
- NFTs on the Ethereum Blockchain
|Pro Tip: Are NFTs Art?|
To be clear, NFTs are only the representation of ownership to a particular asset. For technical reasons, the NFT itself does not contain the digital manifestation of whatever it represents.
For example, if you own the NFT token to a digital illustration, the NFT represents the certificate of authenticity of that artwork and the rights to ownership of it. The NFT however, is not the illustration itself. Digital assets are stored elsewhere off the actual blockchain.
Public Verification of Ownership and Transfer History
NFTs are imbued with metadata that ascribes certain traits (or metadata) to them and are assigned by the original creator of the NFT. For a content creator, this includes an immutable public key that is attributed to each NFT they create. For any owners that acquire that NFT through a secondary sale or transfer, that includes a private key that is ascribed to that particular token.
While NFTs can be bought and sold, the underlying metadata remains the same and serves as both the certificate of authenticity for each NFT as well as the public record of everyone who has ever owned that particular NFT, as well as its current owner.
Secure Direct Peer-to-peer Transfers
Each NFT transaction is completed entirely on a peer-to-peer basis and updated/authenticated in real-time through the Ethereum blockchain. This avoids the transaction fees and oversight over the process required of third-parties in traditional sales, like clearinghouses for financial products and art auction houses for artwork.
Once a transaction is confirmed by the blockchain, it is extremely difficult for others to attempt to hijack a transaction or steal ownership of a particular NFT. Records of the transaction are recorded and verified through the entire blockchain.
NFTs on the Ethereum Blockchain
As of the day of this writing, most NFTs are built on the Ethereum blockchain. As a result, the overwhelming majority of NFTs host Ethereum within their “DNA.” This makes them easily tradable across any other product that uses Ethereum as its basis.
Any transfer of ownership, sale, or royalty is automatically transacted and updated across the scale of the entire Ethereum blockchain. This makes for a timely verification and transactional process.
However, because NFTs function on the Ethereum blockchain, that means to purchase any NFT, you will need to first acquire ETH coins and use those to purchase the NFT. This will typically require you to convert your dollars or other cryptocurrencies into ETH and then exchange a requisite amount of ETH to acquire your target NFT.
|Pro Tip: Ethereum and NFTs|
While the vast majority of NFTs have been created on the Ethereum network, other blockchains like Tezos, Tron and Neo either feature or have begun development of their own NFT tokenization blueprints.
What are NFTs used for? Examples and Value Propositions
There exist a variety of use cases for NFTs, ranging from gaming, to web domains, and even investments. As of the time of this writing, the most popular use case for NFTs has been in art and gaming. However other avenues have opened up and are gaining in popularity:
- Digital Art
While some of these use cases are more fleshed out than others, much of the blockchain is still in its experimentation phase with the technology. As a result, large fluctuations in its value and evolution of NFTs are likely.
What’s the future for NFTs?
NFTs have seen valuations run up significantly within the past few years, from being an isolated cryptographic novelty to becoming something that now commands millions of dollars in transactions. The key innovations of non-fungibility, non-divisible ownership, and built-in verification set the stage for NFTs to establish a new class of cryptographic assets and further enhances the blockchains that they exist on.
However, there are still some limitations that NFTs face and may need to contend with. For one thing, attempts to tokenize physical assets like real estate and illustrations with NFTs have only recently come with varying levels of success. In reality, the transfer of an NFT coin cannot perfectly align itself with the transfer of the physical asset itself.
Even in the realm of digital assets, there exists an NFT-to-asset disconnect. When an NFT is transferred through the blockchain, the NFT itself does not contain the asset in question but is instead, only attached to that media as a “stamp of authenticity.”
In reality, an NFT cannot effectively enforce things like trademarks or copyrights without the input of government entities, at least not in its current form. Additionally, while it’s easy to associate an NFT with a given asset; maintaining that connection, the physical (or digital) transfer of that asset, and the enforcement of rights of all parties involved after the transaction may still need to involve enforcement authorities.
The programmability of the Ethereum blockchain combined with the creation of NFTs as a new concept of of cryptographic value storage opens the door to a slew of useful applications that will likely continue to crop up over time. However, investors should remain vigilant and properly understand the limits of new technologies without allowing themselves to be blinded solely by soaring valuations.
There are a number of obstacles that NFT developers still need to contend with and these updates will likely take time. In the meantime, we’re optimistic that we’ll continue to see new use cases arise as this promising technology continues to grow and evolve.
Are NFTs in a Bubble?
In the interim, it’s likely that many NFT assets have grown to inflated levels with high levels of speculative activity taking place on NFT platforms. While that’s not to say there isn’t more room for these valuations to run, from an investor perspective, we caution readers to approach NFT investments with the same level of caution they take with highly-speculative assets.
This includes conducting extensive due diligence on the background of your intended purchase and having a well-articulated rationale for the purchase and where it stands within your portfolio and the current market cycle.
This does not indicate that NFTs as an application are “useless” by any means. As is the case with many fledgling technologies, there exists an early hype phase where prices are bid up by speculators and early investors. We believe that there is still much to be excited about when it comes to the underlying technology that makes these transactions possible. Prudent investors should take care to distinguish technological potential and price inflation as a result of speculation.