What is an NFT?
Some of the froth may have come off this year’s cryptocurrency rally, but crypto FOMO is finding new footing in a phenomenon that has left many scratching their heads in disbelief.
Crypto investors are spending tens of millions of dollars on digital art that only exists in the ether. NFTs are digital files underpinned by blockchain technology- the same technology on which popular cryptocurrencies like Bitcoin and Ethereum rest.
But unlike cryptocurrencies, an NFT is totally unique and the blockchain ledger it sits on verifies who the rightful owner is of that one-of-a-kind item.
An NFT is a digital asset that represents real-world objects like art, music, in-game items and videos. They are bought and sold online, frequently with cryptocurrency, and they are generally encoded with the same underlying software as many cryptos.
Although they’ve been around since 2014, NFTs are gaining notoriety now because they are becoming an increasingly popular way to buy and sell digital artwork. A staggering $174 million has been spent on NFTs since November 2017.
NFTs are also generally one of a kind, or at least one of a very limited run, and have unique identifying codes. “Essentially, NFTs create digital scarcity,” says Arry Yu, chair of the Washington Technology Industry Association Cascadia Blockchain Council and managing director of Yellow Umbrella Ventures.
This stands in stark contrast to most digital creations, which are almost always infinite in supply. Hypothetically, cutting off the supply should raise the value of a given asset, assuming it’s in demand.
But many NFTs, at least in these early days, have been digital creations that already exist in some form elsewhere, like iconic video clips from NBA games or securitized versions of digital art that’s already floating around on Instagram.
For instance, famous digital artist Mike Winklemann, better known as “Beeple” crafted a composite of 5,000 daily drawings to create perhaps the most famous NFT of the moment, “EVERYDAYS: The First 5000 Days,” which sold at Christie’s for a record-breaking $69.3 million.
Anyone can view the individual images—or even the entire collage of images online for free. So why are people willing to spend millions on something they could easily screenshot or download?
Because an NFT allows the buyer to own the original item. Not only that, it contains built-in authentication, which serves as proof of ownership. Collectors value those “digital bragging rights” almost more than the item itself.
How do NFTs work?
At a very high level, most NFTs are part of the Ethereum blockchain. Ethereum is a cryptocurrency, like bitcoin or dogecoin, but its blockchain also supports these NFTs, which store extra information that makes them work differently from, say, an ETH coin.
It is worth noting that other blockchains can implement their own versions of NFTs. Like physical money, cryptocurrencies are fungible i.e., they can be traded or exchanged, one for another. For example, one Bitcoin is always equal in value to another Bitcoin.
Similarly, a single unit of Ether is always equal to another unit. This fungibility characteristic makes cryptocurrencies suitable for use as a secure medium of transaction in the digital economy.
NFTs shift the crypto paradigm by making each token unique and irreplaceable, thereby making it impossible for one non-fungible token to be equal to another.
They are digital representations of assets and have been likened to digital passports because each token contains a unique, non-transferable identity to distinguish it from other tokens.
They are also extensible, meaning you can combine one NFT with another to “breed” a third, unique NFT.
Just like Bitcoin, NFTs also contain ownership details for easy identification and transfer between token holders. Owners can also add metadata or attributes pertaining to the asset in NFTs.
For example, tokens representing coffee beans can be classified as fair trade. Or, artists can sign their digital artwork with their own signature in the metadata.
NFTs evolved from the ERC-721 standard. Developed by some of the same people responsible for the ERC-20 smart contract, ERC-721 defines the minimum interface – ownership details, security, and metadata – required for exchange and distribution of gaming tokens.
The ERC-1155 standard takes the concept further by reducing the transaction and storage costs required for NFTs and batching multiple types of non-fungible tokens into a single contract.
Perhaps the most famous use case for NFTs is that of cryptokitties. Launched in November 2017, cryptokitties are digital representations of cats with unique identifications on Ethereum’s blockchain. Each kitty is unique and has a price in ether.
They reproduce among themselves and produce new offspring, which have different attributes and valuations as compared to their parents.
Within a few short weeks of being launched, cryptokitties racked up a fan base that spent $20 million worth of ether purchasing, feeding, and nurturing them. Some enthusiasts even spent upwards of $100,000 on the effort.
While the cryptokitties use case may sound trivial, succeeding ones have more serious business implications. For example, NFTs have been used in private equity transactions as well as real estate deals.
One of the implications of enabling multiple types of tokens in a contract is the ability to provide escrow for different types of NFTs, from artwork to real estate, into a single financial transaction.
What’s worth picking up at the NFT supermarket?
NFTs can really be anything digital (such as drawings, music, your brain downloaded and turned into an AI), but a lot of the current excitement is around using the tech to sell digital art.
As with crypto-currency, a record of who owns what is stored on a shared ledger known as the blockchain. The records cannot be forged because the ledger is maintained by thousands of computers around the world.
NFTs can also contain smart contracts that may give the artist, for example, a cut of any future sale of the token.
What's stopping people copying the digital art? Nothing. Millions of people have seen Beeple's art that sold for $69m and the image has been copied and shared countless times.
In many cases, the artist even retains the copyright ownership of their work, so they can continue to produce and sell copies.
But the buyer of the NFT owns a "token" that proves they own the "original" work.
Some people compare it to buying an autographed print.