NFTs Explained: What they are, how they work, and their future
Exploring what makes non-fungible tokens special, why they are so popular, and the future of NFTs
NFTs have been all over the internet for the last few months. The goal of this post is to understand how NFTs work, what they actually are, and finally look at what the future of NFTs could look like.
The Basics — Blockchain
Before we try and understand what an NFT is, we need to be clear on how blockchain works. The goal of blockchain is to allow digital information to be recorded and distributed, but not edited.
A blockchain is like a database, that stores blocks of data. What makes it special is that these blocks of data are chained or linked together — hence the name blockchain.
The data in each block may have no relation to each other, but the adjacent blocks and the order in which they were created are very important. Very simply put, every block is linked to the data in adjacent blocks. So if you change the data in a single block, the data in the entire blockchain becomes invalid. This makes the blockchain immutable (once you add a block to the blockchain, you can’t modify it) and this property is what makes it special.
A normal database is stored on a central server and people with access to it can modify the data. Whereas the blockchain is distributed all over the world and the data does not belong to a single individual or entity. Every node on the blockchain network has a full record of the data that has been stored in it since its inception.
So if someone wanted to tamper with data in a blockchain, first they would have to validate all the invalidated blocks — which requires a reasonable amount of compute power. Next they would have to do it for 51% of all the nodes in the world that has a copy of the blockchain — which is pretty much impossible.
Now before we understand NFTs, let’s see what a token is.
Crypto Tokens
Crypto tokens broadly represent a particular fungible and tradable asset or a utility created over an initial coin offering (ICO) that is often found on a blockchain.
In cryptocurrencies, the tokens are the coins which are generated by the blockchain that they are on at the time of inception and distributed during the ICO. But a crypto token can represent any asset or utility and can be used as virtual substitute for anything.
The blockchain because of its immutability, guarantees ownership of these tokens. Transfer of ownership is also done safely on the blockchain. The Ethereum network introduces the concept of smart contracts or decentralised applications which can allow its users to create tokens and programmable, self executing code is used to manage the various transactions that occur on the blockchain.
Now let’s understand what non-fungible tokens are.
Non-fungible Tokens
A Non-fungible token or NFT is a unit of data on a blockchain, where each NFT represents a unique digital item.
We say something is fungible if it can be replaced or interchanged for a similar item. For example, currency is fungible. The same denomination of currency notes has the same value and can be exchanged for each other. Cryptocurrencies are also fungible.
But NFTs represent a unique digital item, which could have different monetary value. And thus it is not interchangeable. I cannot give you an NFT in exchange of another NFT, simply because they point to two different items each with its own value.
NFTs can be used to represent any unique digital item like images, audio, video, collectables in video games and any other form of creative work.
Creating NFTs
Creating NFTs is quite simple. Now say you created a digital painting and you want to sell it as an NFT. First thing to do would be to pick the blockchain you want to sell it on — ethereum is the most popular one.
Some popular ethereum NFT marketplaces are OpenSea, Rarible and Mintable. Most NFTs are built using a consistent standard known as ERC-721. These marketplaces are simply an implementation of this standard and add your NFT to the ethereum blockchain.
Next you can upload your painting somewhere like google drive or the interplanetary file system (IPFS) — which is a distributed file system. Then you go on one of the market places and create a new NFT — where you will need to connect your ethereum wallet (like Metamask) and fill up some details like name and description of your work.
Finally your NFT needs to be minted. This means to add a block on the ethereum blockchain that says that the NFT you created belongs to your account. This action required modifying the blockchain and thus costs some “gas”. Gas is basically the service charge to modify the blockchain and is usually quite cheap. So listing your work on an NFT marketplace is not free — it costs some money.
Once that is done, your ownership of the NFT is added in the blockchain and anybody can verify it, and buy your work.
But what makes an NFT worth $69.3 million ?
Beeple (Mike Winkelmann) sold the NFT for his work ‘Everydays: the First 5000 Days,’ for $69.3 million. It was a collage of all the art he had made for the first 5000 days since May 1, 2007. He has not missed even a single day.
So this means that, whoever owns this NFT owns the original piece of work. But they do not own copyright to it. Beeple still has he rights to it and can do whatever he wants. His work is all over the internet, and anybody can see or download it. So what does ownership even mean ?
When you own an NFT to a piece of digital art, it means that you own the original copy that the artist made. It doesn’t matter if people duplicate it or download it, the real thing is owned by you. It is accepted by everyone and this was signed by the creator and stored immutably on the blockchain. They are able to prove ownership to it and everyone agrees, because it is on the blockchain and can be verified by anyone.
Think of it as owning a rare painting made by a famous artist a long time back. It could be on display in a museum for people to see, or take pictures. People could even replicate it. But the original remains with you and will retain its value always.
There is also a community aspect to it. Value is determined and agreed upon by the community as a whole. People buy NFTs expecting its value will go up in the future, which would happen only if other people find it valuable in the future. So this has to do with the artist, their reputation and work. But even Beeple agrees that things are a bit crazy now, and the whole thing could be a bubble.
Future of NFTs
In this section I want to discuss the current and potential use cases for NFTs.
- Digital Content — this is one use case that is most popular now. It allows artists to sell directly to their audience, without any middle men. It also allows people to support their favourite artists in a very easily.
- Gaming — currently in game assets, purchased by players are stored on the game server. If they shut down the game for some reason, all your assets are gone with it. But by creating in-game assets as NFTs, players have full ownership. They could sell it for real money, exchange it on other markets, or even use it in other games.
- Physical Items — in the future NFTs could be used to own physical items like a car or a piece of land. Maybe even use NFTs as collateral, or document verification. Imagine an NFT passport. The fashion industry is also exploring NFTs to sell unique pieces of clothing.
- Patents and Intellectual property — people could easily patent technologies and discoveries using NFTs.
Environmental Impact
As all good things come at a price, blockchains in general are energy intensive because of the constant mining process required to sustain it. The mining is necessary to make sure that the blockchain remains decentralised and can be trusted.
So the carbon footprint is not necessarily because of NFTs. It is because of the blockchain technology that it is based upon. If there is a new technology that can guarantee the security, trust and is decentralised, the concept of NFTs can be easily applied to that platform.
Ethereum is currently going through a series of upgrades, known as Eth2, that will replace the process of mining with a new process called staking. This will remove computing power as a security mechanism, and reduce Ethereum’s carbon footprint by ~99.98%1. In this world, stakers commit funds instead of computing power to secure the network. They have already started with this, it is called The Beacon Chain and is expected to be merged with the curent blockchain by 2022.
Hopefully this post was helpful to understand this crazy world of NFTs and maybe even shed some light on why it is so popular.
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References and further reading:
https://ethereum.org/en/nft/#environmental-impact-nfts
https://en.wikipedia.org/wiki/Cryptocurrency
https://en.wikipedia.org/wiki/Non-fungible_token
https://levelup.gitconnected.com/what-makes-a-digital-image-file-worth-69-million-4d49a9eabcb7
https://www.investopedia.com/terms/c/crypto-token.asp
https://medium.com/@medipedia/the-various-types-of-crypto-tokens-26bab8f6622c
https://en.wikipedia.org/wiki/Mike_Winkelmann
https://ethereum.org/en/eth2/beacon-chain/
https://www.businessinsider.com/8-gen-z-vcs-predict-the-future-of-nfts-2021-3
https://www.coindesk.com/how-to-create-buy-sell-nfts
https://ethereum.org/en/nft/#internet-of-assets
