A Non-Fungible Token (NFT) is a unique digital asset that represents ownership or proof of authenticity of a specific item or piece of content, such as artwork, music, videos, or even tweets, using blockchain technology. Unlike cryptocurrencies such as Bitcoin or Ethereum, which are fungible and can be exchanged on a one-to-one basis, NFTs are indivisible and cannot be replicated or exchanged on a like-for-like basis due to their uniqueness.
What Is a Non-Fungible Token (NFT)?
Non-fungible tokens (NFTs) are assets that have been tokenized via a blockchain. Tokens are unique identification codes created from metadata via an encryption function. These tokens are then stored on a blockchain, while the assets themselves are stored in other places. The connection between the token and the asset is what makes them unique.
NFTs can be traded and exchanged for money, cryptocurrencies, or other NFTs—it all depends on the value the market and owners have placed on them.
For instance, you could draw a smiley face on a banana, take a picture of it (which has metadata attached to it), and tokenize it on a blockchain. Whoever has the private keys to that token owns whatever rights you have assigned to the token.
Cryptocurrencies are tokens as well; however, the key difference is that two cryptocurrencies from the same blockchain are interchangeable—they are fungible. Two NFTs from the same blockchain can look identical, but they are not interchangeable.
History of Non-Fungible Tokens (NFTs)
NFTs were created long before they became popular in the mainstream. Reportedly, the first NFT sold was “Quantum,” designed and tokenized by Kevin McKoy in 2014 on one blockchain (Namecoin), then minted on Ethereum and sold in 2021.
NFTs are built following the ERC-721 (Ethereum Request for Comment #721) standard, which dictates how ownership is transferred, methods for confirming transactions, and how applications handle safe transfers (among other requirements).
The ERC-1155 standard, approved six months after ERC-721, improves upon ERC-721 by batching multiple non-fungible tokens into a single contract, reducing transaction costs.
How NFTs Work
NFTs are created through a process called minting, in which the asset’s information is encrypted and recorded on a blockchain. At a high level, the minting process entails a new block being created, NFT information being validated by a validator, and the block being closed. This minting process often entails incorporating smart contracts that assign ownership and manage NFT transfers.
As tokens are minted, they are assigned a unique identifier directly linked to one blockchain address. Each token has an owner, and the ownership information is publicly available. Even if 5,000 NFTs of the same exact item are minted, each token has a unique identifier and can be distinguished from the others.
Blockchain and Fungibility
Like physical money, cryptocurrencies are usually fungible from a financial perspective, meaning that they can be traded or exchanged, one for another. For example, one bitcoin is always equal in value to another bitcoin on a given exchange, similar to how every dollar bill of U.S. currency has an implicit exchange value of $1. This fungibility characteristic makes cryptocurrencies suitable as a secure medium of transaction in the digital economy.
For this reason, NFTs shift the crypto paradigm by making each token unique and irreplaceable, making it impossible for one non-fungible token to be “equal” to another.
Examples of NFTs
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.
For instance, the popular NFT marketplace OpenSea has several NFT categories:
Virtual worlds: Virtual world NFTs grant you ownership of anything from avatar wearables to digital property.
Art: A generalized category of NFTs that includes everything from pixel to abstract art
Collectibles: Bored Ape Yacht Club, Crypto Punks, and Pudgy Panda are some examples of NFTs in this category
Domain names: NFTs that represent ownership of domain names for your website(s)
Music: Artists can tokenize their music, granting buyers the rights the artist wants them to have
Benefits of NFTs
Perhaps, the most apparent benefit of NFTs is market efficiency. Tokenizing a physical asset can streamline sales processes and remove intermediaries. NFTs representing digital or physical artwork on a blockchain can eliminate the need for agents and allow sellers to connect directly with their target audiences (assuming the artists know how to host their NFTs securely).
Investing
NFTs can also be used to streamline investing. For example, consulting firm Ernst & Young developed an NFT solution for one of its fine wine investors—by storing wine in a secure environment and using NFTs to protect provenance.
Real estate can also be tokenized—a property could be parceled into multiple sections, each containing different characteristics. For example, one of the sections might be on a lakeside, while another is closer to the forest. Depending on its features, each piece of land could be unique, priced differently, and represented by an NFT. Real estate trading, a complex and bureaucratic affair, could then be simplified by incorporating relevant metadata into a unique NFT associated with only the corresponding portion of the property.
NFTs can represent ownership in a business, much like stocks—in fact, stock ownership is already tracked via ledgers that contain information such as the stockholder’s name, date of issuance, certificate number, and the number of shares. A blockchain is a distributed and secured ledger, so issuing NFTs to represent shares serves the same purpose as issuing stocks. The main advantage to using NFTs and blockchain instead of a stock ledger is that smart contracts can automate ownership transferral—once an NFT share is sold, the blockchain can take care of everything else.
Security
Non-fungible tokens are also very useful in identity security. For example, personal information stored on an immutable blockchain cannot be accessed, stolen, or used by anyone who doesn’t have the keys.
NFTs can also democratize investing by fractionalizing physical assets. Fractionalized ownership through tokenization can extend to many assets. For instance, a painting need not always have a single owner—tokenization allows multiple people to purchase a share of it, transferring ownership of a fraction of the physical painting to them.
How Can I Buy NFTs?
Many NFTs can only be purchased with cryptocurrency supported by the exchange you’re using. So, you’ll need a digital wallet and some crypto to make a purchase. For instance, OpenSea accepts ETH, WETH, AVAX, USDC, and DAI.
You can purchase NFTs via other online NFT marketplaces like Rarible and SuperRare.
Are NFTs Safe?
Non-fungible tokens, which use blockchain technology like cryptocurrency, are generally impossible to hack. However, the weak link in all blockchains is the key to your NFT. The software that stores the keys can be hacked, and the devices you hold the keys on can be lost or destroyed—so the blockchain mantra “not your keys, not your coin” applies to NFTs as well as cryptocurrency. NFTs are safe as long as your keys are properly secured.
What Does Non-Fungible Mean?
Fungibility describes the interchangeability of goods. For example, say you had three notes with identical smiley faces drawn on them. When you tokenize one of them, that note becomes distinguishable from the others—it is non-fungible. The other two notes are indistinguishable, so they can each take the place of the other.
The Bottom Line
Non-fungible tokens are an evolution of the cryptocurrency concept. Modern finance systems consist of sophisticated trading and loan systems for different asset types, from real estate to lending contracts to artwork. By enabling digital representations of assets, NFTs are a step forward in the reinvention of this infrastructure.
To be sure, the idea of digital representations of physical assets is not novel, nor is the use of unique identification. However, when these concepts are combined with the benefits of a tamper-resistant blockchain with smart contracts and automation, they become a potent force for change.
Conclusion:
Non-Fungible Tokens (NFTs) revolutionize ownership and authenticity verification in the digital realm through blockchain technology. Unlike cryptocurrencies, NFTs are unique and indivisible, representing ownership of specific digital assets such as art, music, and collectibles. Their history traces back to early blockchain standards like ERC-721 and ERC-1155, while their applications range from digital art to real estate and identity security. NFTs offer market efficiency, investment opportunities, and democratized ownership while ensuring security through blockchain encryption. As NFTs continue to reshape digital economies, their potential lies in combining unique digital assets with the security and automation capabilities of blockchain technology.
FAQs:
- What is a Non-Fungible Token (NFT) and How Does It Differ from Cryptocurrency?
NFTs represent unique digital assets like artwork or music using blockchain technology. Unlike cryptocurrencies, which are interchangeable, NFTs are indivisible and cannot be replicated due to their uniqueness. - How Are NFTs Created and Traded?
NFTs are minted through a process where the asset’s information is encrypted and recorded on a blockchain. They can be traded and exchanged for money, cryptocurrencies, or other NFTs, depending on the market value assigned to them. - What’s the History Behind Non-Fungible Tokens (NFTs)?
NFTs existed before gaining mainstream popularity, with the first sale reportedly occurring in 2014. They follow standards like ERC-721 and ERC-1155, dictating ownership transfer and transaction confirmation methods. NFTs gained significant attention in 2021 with the sale of digital art by Beeple for over $69 million. - Can NFTs Represent Different Types of Assets?
Yes, NFTs can represent various assets, including digital art, collectibles like Cryptokitties, domain names, music, and even real estate. They provide unique ownership and can streamline sales processes, eliminating intermediaries. - How Can I Purchase Non-Fungible Token and Are They Safe?
To buy NFTs, you typically need a digital wallet and cryptocurrency supported by the exchange. Marketplaces like OpenSea, Rarible, and SuperRare facilitate NFT purchases. NFTs are generally secure due to blockchain technology, but proper key management is crucial to ensure safety.