What are NFTs? Do they live up to the hype?
NFTs are the latest hype in a string of blockchain related technologies. In the past couple of months there’s been an explosion in their popularity, with the popular Nyan Cat meme GIF selling for 300 Ethereum (or almost $600,000). This might already sound a little crazy, but consider that a group known as BurntBanksy bought a 2006 Banksy print titled Morons for $33,000 with the intention of creating an NFT — only to burn it to ashes in a hope it would transfer value to the NFT itself.
Although the most documented applications of NFTs could be considered edge cases, the fundamentals of the NFT approach to ownership holds great potential.
What are NFTs?
NFT stands for non-fungible token — meaning an item that can’t be replaced like-for-like. Generally speaking, something is fungible if it is value defined, whilst those with unique physical or digital characteristics are non-fungible. Consider a pound coin or a dollar bill. If I spend a pound in one shop, but then get given a pound by a friend the value associated with those two coins is identical. The same would not be true of two different pieces of artwork.
A strength of NFTs is that the item being referred to may be physical or digital, as all an NFT does is keep an authoritative record of ownership alongside a reference to the storage location of the item. It’s important to note that because of the way an NFT is recorded, from a blockchain perspective it can only have one owner.
As digital artwork (whether that be an illustration, song, or video) can be exactly replicated, it is valuable to know who owns that asset. This is the focus of current excitement surrounding non-fungible tokens.
How do NFTs work?
When a creator lists an item for sale, or the item is subsequently traded, information associated with the item is stored as metadata on a blockchain. Owing to the potential size of assets, it is not possible to store a digital asset (e.g. an illustration) on the blockchain — it must be stored elsewhere and referenced via a URL, etc. Naturally, similar logic applies to physical items.
Although NFTs are not exclusive to any one blockchain, Ethereum is commonly used. Alternatives include TRON. As NFTs can be traded anywhere that the same blockchain is used, it’s deemed beneficial to opt for one which utilises a common blockchain. As a result of this portability, NFTs can be traded on a marketplace or peer-2-peer.
Aside from the underlying blockchain, the standard used is an important characteristic of an NFT. A common standard is ERC-721. ERC-721 doesn’t restrict where an asset (e.g. an illustration file) is stored — for example, it could be on an HTTPS site (e.g. https://georgefree.co.uk/picture.jpg). The standard only records where the content existed when the NFT was minted. Arguably lax record keeping is not ideal, however. Consider a file hosted at the domain name georgefree.com. If I sell the NFT associated with that file, the new owner needs to take control of that domain for the record to be complete — far from ideal. The lack of solidity in data storage is an area under heavy scrutiny, and development in this area is a key goal for many working with NFTs. A popular solution is to use the InterPlanetary File System (IPFS).
What are the benefits of NFTs?
Currently, the primary applications of NFTs is protecting the ownership of digital assets. This includes music, illustrations, videos, in-game purchases, and more. However, they’re also applicable to physical assets such as houses and land holdings, and are set to become an increasingly prominent part of sports ticketing; by creating a unique NFT for each ticket, ownership can be affirmed and ticket forgery/scraping made more difficult.
NFTs represent an opportunity for creators to earn an income. Consider how many digital artists gain traction today: Instagram. By posting their work individuals hope to gain exposure, but as a result essentially give away their work. By offering an NFT of the digital artwork they can sell their artwork whilst still posting a copy online for the world to download.
For NFTs to work with digital assets there has to be an enduring recognition of value in owning digital artwork, even though the content can be accessed and downloaded by the public. This is a very different circumstance to buying a painting with unique characteristics, where copies are not identical.
A less well known NFT feature is their ability to provide royalties to creators every time a token is resold. This approach clearly has the potential to be very lucrative for individuals who are producing content, and is likely to encourage them to sell their artwork using NFTs rather than more traditional approaches where royalty payments are not made on subsequent sales. Because royalty payments can be programmed in to an NFT, royalties can be paid without intervention. The ability to provide royalties means that NFTs are a great method for reselling things that are typically not allowed to be resold — for example, in-game items. If you own a paid-for skin for a game that you no longer play, currently the chances of you being able to sell that are slim as most developers aim to block such transactions to protect their revenue. However, if the creator can receive a royalty every time it is resold then corporations are more likely to engage.
At a lower level, using a strong blockchain to keep track of ownership has several advantages over traditional methods. The way in which blockchains such as Ethereum work means that it is nearly impossible to manipulate the data and steal ownership. What’s more, owing to the size of the network and financial reward associated with mining Ethereum, an NFT is extremely unlikely to ever go down — meaning a record of ownership will likely exist for longer than the item holds any value.
Naturally, the biggest benefit that NFTs gain by utilising a blockchain is traceability. The nature of blockchains like Ethereum means that unlike traditional methods of ownership verification and record keeping, all relevant information is kept in the public domain. Ultimately this means that ownership can be confirmed without trusting a potentially biased third party, such as a private company or a government.
Although the hype surrounding NFTs is focused on digital assets, in time it’s likely that emphasis will be shifted to physical items such as houses and cars. For the ownership of digital assets to remain relevant, financial value in the ownership of widely distributed digital data must persist.
One thing’s for sure: the concept of NFTs is extremely valuable, and aids progression towards a more decentralised society — where citizens are less impacted by the actions of a single government.