You’ve probably heard about the latest fad in the blockchain world that has people spending millions: Non fungible tokens, commonly known as NFTs. These unique digital assets are developed using the same blockchain technology as the cryptocurrencies that many people are familiar with.
NFTs took the digital world by surprise in 2018 with the advent of the famous CryptoKitties, which involved collecting and breeding digital cats that resided in the Ethereum blockchain. Fast forward three years and NFTs have dramatically evolved. Now, we are living in an age where a Twitter post (by Twitter founder Jack Dorsey) has been sold for $2.9 million, and digital artwork is selling for hundreds of thousands of dollars.
While this might seem impractical – having a good understanding of the NFT market will help you understand why NFTs hold so much apparent value.
So what exactly is a Token?
For the uninitiated, a token can be described as the atomic unit of the decentralized ledger technology, blockchain. Just like how BTC and ETH are the native coins (cryptocurrencies) of the bitcoin blockchain and the Ethereum blockchain respectively, tokens are digital assets or utilities (cryptocurrencies) that live on another blockchain.
For example, some of the most popular tokens on the Ethereum blockchain are MakerDAO, Basic Attention Token, Plasma Finance, and Augur, to mention a few. You can think of a token as the currency or asset of a particular type of smart contract.
There are two main types of tokens:
- Fungible tokens and
- Non-Fungible tokens.
A closer look at Fungible and Non-Fungible Tokens
Fungible tokens are the most popular type of tokens in the cryptocurrency space. Fungible tokens represent currencies or digital assets that can be exchanged for other tokens at the same price and still hold the same value – a good example is FIAT currency or Bitcoin. They are also volatile in that they have to adjust to the changes in the market prices. Within the financial market, fungible tokens provide liquidity and are very convenient for trading.
In short, a fungible token is a unit that can be exchanged for another unit of equal monetary value. “Real” money is a fungible token – you could go to a currency exchange center and change American dollars for British pounds. Each has an equal monetary value in the other currency.
Non-fungible tokens, on the other hand, represent unique assets or utilities. Unlike fungible tokens, non-fungible tokens cannot be swapped for other non-fungible tokens since they have different properties – for example, a painting like the Mona Lisa cannot be realistically exchanged for Monet’s Water Lilies paintings. Every non-fungible token has its identifying information attached, making it unique and different in terms of properties and value.
What is an NFT in crypto?
Coinmarketcap, describes Non Fungible Tokens as a special cryptographically-generated token that uses blockchain technology to link with unique digital assets that cannot be replicated. These assets range from digital art, digital land, music, images, in-game items, and videos to real-world objects like tokenized real estate properties.
NFTs stand in contrast to typical digital creations like images, as the latter is almost always infinite in supply. Essentially, the developers create digital scarcity by limiting the NFTs in circulation to increase rarity and value.
Although NFTs have spread to various industries, they are synonymous with digital art, digital collectibles, and gaming. They are most commonly developed as a specific token built on the ERC-721 standard on the Ethereum blockchain network. However, as of 2021, the usage of NFTs is starting to spread to other blockchains like the Binance smart chain (BEP-721 protocol), Tron blockchain (TRC-721), and Tezos blockchain (TZIP-12).
How are NFTs Different from Cryptocurrencies?
As mentioned above, popular cryptocurrencies like bitcoin and dogecoin are fungible tokens, and the following properties can characterize them:
- Identical & Equal in value – Cryptocurrencies are identical in value; one bitcoin is always equal to another.
- Divisible – Fungible tokens can be divided and merged. For instance, 1 bitcoin can be divided into two 0.5 BTC, while four 0.25 BTC can be merged to form 1 BTC.
Non-fungible tokens, on the other hand, are characterized by the following properties:
- Rare – NFTs are limited in supply; for example, there are a total of 10,000 Cryptopunks characters in existence, and no two are exactly alike.
- Indivisible – Most Non Fungible Tokens are not divisible into smaller units. You either purchase it as a whole or not. For example, one top shot NBA NFT clip by Lebron James is not equal to another top shot NBA NFT by another player.
- Unique – NFTs have a permanent identification information tab that records the uniqueness of each NFT. The record is more like a certificate of authenticity.
How do Non Fungible Tokens work?
Non Fungible Tokens exist on a blockchain; specifically, they are held as assets or utilities on special types of smart contracts. They are created or minted from digital objects that represent both tangible and intangible items and digital or real-world assets.
Essentially, NFTs are like physical collector items or ownership of various assets but are digital. For instance, instead of getting an actual painting on your wall, buyers receive a digital piece of art with their ownership information attached.
It’s crucial to note that NFTs do not imply digital art and collectibles only. They present an excellent opportunity to introduce a tokenized economy. For instance, developers could tokenize a building in the real estate sector where some tokens could grant simple ownership titles for a fraction of the real estate. At the same time, the tokens could also grant special privileges like access rights to specific events or premium services.
According to Shermin Voshmgir in his book Token Economy: How the Web3 reinvents the Internet, such tokenization of existing assets in the real world can give investors a chance to expand their portfolio and provide the market with more liquidity. Non Fungible Tokens can also grant token holders different levels of control over their assets.
Where do NFTs get their value?
Depending on the assets the NFT represents, the value of an NFT is weighted across four components:
- Ownership history
- Future value
Investors use the four components to evaluate if a Non Fungible Tokens is worth investing in, while developers use them to evaluate how they can increase the value of a Non Fungible Tokens to attract more users and investors.
Utility value is derived from how the NFT can be used. Two major categories of NFTs that have high utility are in-game assets and event tickets. Another approach to the utility of an NFT is the different applications it has. For instance, the value would be much higher if in-game NFTs could be used across different games.
An excellent example of an NFT with high utility was the Crypto Space Commander battleship sold for $45,250 in 2019.
2. Ownership history
The value of Non Fungible Tokens is also tied to the issuer and its previous owners. Non Fungible Tokens with a high or popular ownership history are often highly valued and are issued mostly by celebrities, athletes, or brands. For example, the first-ever tweet on Twitter by Jack Dorsey was sold for $2.9 million.
3. Future Value
The future value of Non Fungible Tokens is derived from both valuation changes and future cash flow. In most cases, valuation is driven by scarcity of supply and speculation. At times, these are the main driving forces behind price appreciation.
On the other hand, future cash flow is the interests or royalties earned by the original owner of the Non Fungible Tokens. For instance, SuperRare allows Non Fungible Token creators to earn a 3% commission every time their NFT is sold to a different party. This presents a model wherein future Non Fungible Tokens can be leased and collateralized to create additional cash flow, liquidity, and a sustainable market.
4. Liquidity Premium
Higher liquidity generally means that the Non Fungible Tokens are developed on a blockchain with a relatively high NFT trading volume. The primary reason investors choose specific categories of Non Fungible Tokens is the liquidity associated with the market. High liquidity generally reduces the risk of holding Non Fungible Tokens.
For instance, ERC NFTs can be traded easily on the open market to anyone with ETH. Consequently, this increases the number of potential buyers and lowers the risk of holding the NFT. With unpopular NFTs, there is always the risk that the buyers may lose interest in the NFT, inherently causing its price to plummet.
In short, NFTs get their value in the same way as any collectible item: they’re simply worth what people are willing to pay. As mentioned, the item’s scarcity increases its value and market interest. It’s the same as someone paying thousands of dollars for a rare physical Pokemon card. The card holds no “real” value but is instead valued for its rarity and bragging rights.
What are NFTs used for, and How can they Impact Businesses?
Currently, the cryptocurrency space is still trying to figure out the best use for Non Fungible Tokens. The primary use of NFTs has been focused on digital art, collectibles, and in-game assets. However, the primary and intrinsic use of NFTs is that they can be used to tokenize assets and utilities that are typically different from each other in various categories and open up new models of investing.
Here are a few ways that NFTs are being used in the real world and how they can revolutionize businesses:
i. As a digital representation of analog assets and items
While NFTs are digital, there have been exciting initiatives to tie them to the physical world. Unisock, for example, allows its customers to buy $SOCK tokens that can be redeemed in their stores for a pair of socks.
Large traditional auction houses like Sotheby’s and Christie’s are also leveraging Non Fungible Tokens to preserve the ownership of the artwork. In a pilot collaboration with Artory in 2018, Christie’s deployed Non Fungible Tokens for a private art collection that was later sold for $323 million.
Given that ownership on the blockchain can be verified publicly, and only someone with private keys can initiate any transfer, Non Fungible Tokens present significant potential for revolutionizing the ownership of the artwork and digital assets as a whole.
ii. As a new landscape for intellectual property
What NFTs have successfully demonstrated is that there are a plethora of assets that can be tokenized. A song, piece of art, an image, or creative work can be turned into a tokenized asset, opening doors to new ways of handling intellectual property ownership.
Current models of intellectual property rarely benefit the artist. In most cases, the centralized organizations that handle the intellectual property’s resale take much of the profit. Moreover, once an asset is sold, it is detached from the artist. Future value or royalties of the asset do not benefit the artist in any way.
NFTs provide artists and innovators the chance to attach a smart contract that enforces a certain percentage of every sale to be sent to the original address. This allows infinite royalty payments with no restrictions within any jurisdiction. This not only applies to the artwork but to any intellectual property, from copyrights, patents, and trademarks to trade secrets.
iii. As a new access and ownership token
NFT can also manage any access rights tied to a special person, property, or a special event. Blockchain technology implements public-key cryptography. Thus it offers more secure and decentralized verified access-rights management than centrally managed solutions can provide.
For example, the rapper Post Malone teamed up with a cryptocurrency outfit to offer a select group of fans an exclusive opportunity via their $FYZNFTs Non Fungible Tokens. The NFT allows the owners to participate in Posty’s World Pong League via a live auction on Clubhouse and snatch up an animation NFT via a free drop to all Moon Club members.
Popular NFT marketplaces
There are various NFT marketplaces where artists can create their NFTs and where buyers can find the NFTs of their liking. Here are the top 3 NFT marketplaces:
OpenSea prides itself on being the largest NFT marketplace. It offers a broad range of NFTs: art, censorship-resistant domain names, virtual worlds like Decentraland, trading cards, sport, and collectibles, to mention a few. Most of the NFTs on OpenSea are ERC721 and ERC115 tokens built on top of the Ethereum blockchain. The platform features more than 700 projects. It also allows creators to create Non Fungible Tokens for free without needing a single line of code and to then sell them for a fixed price or in auctions.
Rarible is a decentralized NFT marketplace whose owners hold its ERC-20 token, RARI Token. Rarible focuses more on art assets. It allows creators to use Rarible to mint new Non Fungible Tokens to sell their creation, which may vary in categories like art, photography, games, metaverses, music, and domain names.
One distinguishing feature about Rarrible is that it awards RARI tokens to active users on the platform, those who buy or sell on the NFT marketplace. It distributes 75,000 RARI Tokens weekly.
SuperRare focuses on users who buy and sell unique, single edition digital artworks. Within the platform, an artist authentically creates each artwork in the network. The artwork is then tokenized as a crypto-collectible that can be owned and traded. SupeRare can be viewed as a combination of Christie’s auction house and Instagram since it offers a different way of interacting with art, culture, and digital collections. All transactions within SuperRare are made with ether, the native cryptocurrency to the Ethereum network.
Pros and Cons of the NFT market
Non-fungible tokens are currently very popular. However, just like any other revolutionary technology, Non Fungible Tokens have their pros and cons.
Pros of NFTs
- They give artists ownership over their digital assets. Non Fungible Tokens also allow creators to directly profit from their work without the need for centralized entities.
- They are immutable. Since Non Fungible Tokens are deployed on the blockchain, they cannot be altered, deleted, or replaced. Furthermore, proving the authenticity and ownership of an NFT is relatively easy on the blockchain.
- They can include smart contracts. Essentially, smart contracts are another property attached to the blockchain. Smart contracts allow creators to attach special instructions on the NFT. The instructions are initiated when certain conditions are met, such as receiving royalties on every sale.
Cons of NFTs
- NFTs are still a speculative market. Despite their unique potential, the NFT market is still highly volatile, and there is a question of whether they have intrinsic value or are just a fad.
- They can be stolen. Although the technology behind NFTs is highly secure, most marketplaces are not. As such, there have been various reports of NFT theft after various security breaches.
- Digital assets can be copied. Owning an NFT means that users own a certificate of authenticity. However, this does not guarantee that another developer cannot duplicate the art or digital asset and distribute it across the internet. Owning an NFT does not give users total control over the digital asset it represents.
What is the future of Non Fungible Tokens?
As NFTs gain popularity in the crypto space and other industries, investors worldwide are starting to look into ways of getting into the market. Corporates like Nike have already filed a patent for creating NFTs of their shoes on the Ethereum blockchain, while Formula 1 launched an auction for their formula-1 car branded NFTs. Moreover, top athletes like Brooklyn Nets NBA player Spencer Diwiddie have leveraged the NFT ecosystem by tokenizing his contract to allow his fans to participate in his success.
With the world becoming more digital and people shifting towards a decentralized ecosystem, Non Fungible Tokens present a viable solution for tokenizing intellectual property, assets, and services for artists, athletes, and developers. Non Fungible Tokens have expanded the use of blockchain technology beyond finance. Although Non Fungible Tokens are in their early adoption stages, they have the potential to vastly change the relationship between assets, individuals, and the digital world by introducing object-based verifiable digital scarcity.