NFTs: What They Are, How They Work, and What They’re Being Used for

Categories: GeneralPublished On: April 28th, 20215.9 min read

NFTs are the latest iteration of blockchain technology to garner press attention outside the world of digital assets and finance. They’re in headlines, videos and news feeds, with huge dollar amounts mentioned next to terminology that can be tough to understand from the outside. So let’s explore everything you need to know, from what NFTs are and how they work to where you can buy or create one.

What does NFT mean?

NFT stands for Non-Fungible Token. That’s counter-intuitive when fungibility is the major selling point for a lot of tokens, especially asset-backed tokens. Fungibility is the ability to be replaced by any other like a token. For example, a dollar bill is the sole, specific dollar in your hand; there’s no other bill with the same serial number, surface marking and history. But in terms of what you can do with it, each dollar is exactly the same. That’s fungibility. 

Most tokens are the same: you can’t hold them in your hand and their serial number is encoded on the blockchain, not engraved over the US Treasurer’s signature. But each one is the same as any other for the purposes of buying, selling, storing and trading. They’re like blocks of gold.

Non-fungible tokens are like gold jewelry. Their value lies in the fact that they’re not interchangeable, and each one is unique.

What is the point of an NFT?

NFTs give sellers the chance to take one-off, valuable information and encode it on the blockchain. That information can be an artwork; or it can be proof of ownership of a non-fungible asset. For example, stock in Mercedes is a fungible asset; each stock certificate has the same, interchangeable value. But your car is a non-fungible asset; its history uniquely affects its value and only one person can own it at once. 

Currently, NFTs are hitting the headlines as celebrity artists move in, seeing a new channel for the sale of digital artworks. This makes sense; digital copying is extremely easy, meaning a digital artwork like a JPEG can be replicated endlessly, eliminating the scarcity value of the original. But NFT artworks by artists like Grimes are now selling for millions of dollars; Chris Torres’ remastered GIF of the infamous Nyan Cat meme sold at auction for $500,000 in February 2021. 

NFTs can be used to demonstrate ownership of any asset, essentially forming a blockchain-based licensing system. 

What are the likely use cases for NFTs?

We’ve already touched on artwork, and much of the conversation today around NFTs focuses on ‘buying a GIF for $1 million,’ but there are several other use cases, many with roots in the surprisingly long history of NFTs, that will likely outgrow the art market in NFTs.

Virtual worlds, real ownership

First among these are is video games, particularly the immersive MMORPGs (Massively Multiplayer Online Role-Playing Games — think World of Warcraft) that increasingly dominate gaming. These games vary in emphasis, with some focusing more on gameplay elements and others functioning more as a virtual Second Life. What they all have in common, though, is an internal market for scarce goods.

Certain types of vehicles, clothes, armor, and swords can sell for hundreds in real-world US dollars; Second Life has real estate agents and clothing boutiques whose products sell for even more. (There’s even an antiques trade — in digital antiques!)

But these transactions are all under the ultimate control of Second Life’s parent company. The same can be said for World of Warcraft. As with any scarce, valuable item, proof of ownership is an issue — and it’s even worse when players want to move their items between platforms (impossible with traditional platforms) or trade on the value of their assets across platforms. (This should be starting to sound familiar; fiat currency users often face similar issues.)

NFTs allow users to transfer their assets between platforms, prove ownership or transfer to other users, and trade them. Currently, NFTs from virtual worlds are among the top 25 NFTs traded, including Decentraland and SANDbox.

Collectibles, assets, and even certificates

These virtual use cases point to further practical applications, like in the collectibles market. CryptoKitties, the first NFT, laid the groundwork — collectibles offered by the NBA that, in the words of DapperLabs’ head of partnerships and marketing, Caty Tedman, give “fans a piece of ownership over the action that happens on court”.

We can also expect to see NFTs used for real-world asset documentation, proof of ownership, and trading. Whereas traditional asset tokenization render non-fungible assets fungible — breaking up a $1 million building into a million tokens, for instance — NFTs function more like certification, proving ownership and allowing trading. This is applicable to property and shares, certifications, and even things like birth and death records.

How do NFTs work?

Most NFTs are ERC-721 tokens running on the Ethereum blockchain, though this could change as other chains emerge and Ethereum reconfigures itself. They’re made the same way as any other token, with the difference that the ERC-721 token standard was explicitly designed for NFTs, and intended for:

  • Physical property — houses, unique artwork
  • Virtual collectibles — unique pictures of kittens, collectible cards
  • ‘Negative value’ assets — loans, burdens and other responsibilities

How can you create your own NFT?

Creating your own NFT is simple. To create an NFT of your own using the existing token standard, you’ll need:

  • A digital wallet to make and receive payments
  • A small quantity of ETH to pay for the computation involved in the creation of the token
  • A connection to an NFT marketplace where you can trade

What does the NFT market look like right now?

The NFT market is booming, even if it’s described by some as a bubble. Admittedly, there is some truth in that description: digital assets of all sorts are notoriously price-volatile (with the obvious exception of some stablecoins). Nonetheless, there’s also a proven track record of digital assets being undervalued initially, only to prove themselves.

Right now, behind the high-profile, headline-grabbing use cases, there’s a growing NFT market covering arts, assets and more. NFT art marketplaces like SuperRare offer unique pieces across price points.

Meanwhile, OpenSea calls itself the biggest NFT marketplace, focusing mainly on collectibles, domain names, and even physical assets; with 4,000 ETH monthly turnover, 17,000 users and over 4 million assets, it could be a sign of things to come.

Most NFT marketplaces start from a focus on collectibles and digital art. Unlike the others though, Atomic Marketplace’s focus is on digitized ownership of assets. It’s a decentralized platform that allows multiple marketplaces to be constructed on the same contract and sharing the same liquidity pool.

There is undoubtedly tremendous potential in the NFT market, particularly as blockchain applications beyond cryptocurrencies move into the public eye. There’s a market need for innovative technology that allows almost any asset, physical or virtual, to be easily authenticated, traded, or sold across the growing decentralized economy. And in a world where data security is an increasing priority for businesses, investors and individuals, NFTs offer an alternative path to more secure asset ownership.

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