Nonfungible Token Definition: Understanding NFTs

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What is a non-fungible token (NFT)?

Non-fungible tokens (NFTs) are cryptographic assets on a blockchain with unique identification codes and metadata that distinguish them from each other. Unlike cryptocurrencies, they cannot be exchanged or traded on an equivalent basis. This differs from fungible tokens like cryptocurrencies, which are identical to each other and therefore can serve as a medium for business transactions.

What do you want to know

  • NFTs are unique cryptographic tokens that exist on a blockchain and cannot be replicated.
  • NFTs can represent real-world items such as artwork and real estate.
  • “Tokenizing” these tangible real-world assets makes buying, selling, and trading them more efficient while reducing the likelihood of fraud.
  • NFTs can also function to represent the identity of individuals, their property rights, etc.

The distinct construction of each NFT has the potential for multiple use cases. For example, they are an ideal vehicle for digitally representing physical assets such as real estate and works of art. Because they are blockchain-based, NFTs can also work to cut out the middleman and connect artists with audiences or for identity management. NFTs can cut out middlemen, simplify transactions and create new markets.

  • In early March 2021, a group of NFTs by digital artist Beeple sold for over $69 million. The sale set a precedent and record for the most expensive digital artworks sold to date. The work was a collage made up of Beeple’s first 5,000 days of work.

Much of today’s NFT market is centered around collectibles, such as digital artwork, sports cards, and rarities. Perhaps the most hyped space is NBA Top Shot, a place to collect non-fungible tokenized NBA moments as a digital card. Some of these cards have sold for millions of dollars. Recently, Jack Dorsey of Twitter (TWTR) tweeted a link to a tokenized version of the very first tweet, in which he wrote: “just setting up my twttr”. The NFT version of the very first tweet sold for over $2.9 million.

Understanding NFTs

Like physical money, cryptocurrencies are fungible, meaning they can be exchanged or traded for each other. For example, one bitcoin always has the same value as another bitcoin. Likewise, a single unit of ether is always equal to another unit. This fungibility feature makes cryptocurrencies a secure means of transaction in the digital economy.

NFTs change the paradigm of cryptography by making each token unique and irreplaceable, thus 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 expandable, meaning you can combine one NFT with another to “replicate” a unique third NFT.

Just like Bitcoin, NFTs also contain ownership details for easy identification and transfer between token holders. Owners can also add metadata or attributes relating to the asset in NFTs. For example, tokens representing coffee beans can be classified as fair trade. Or, artists can sign their digital work 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 (property details, security and metadata) required for the exchange and distribution of game tokens. The ERC-1155 standard pushes the concept further by reducing the transaction and storage costs required for NFTs and by bundling multiple types of non-fungible tokens into a single contract.

Perhaps the most well-known use case for NFTs is cryptokitties. Launched in November 2017, cryptokitties are digital representations of cats with unique identifications on the Ethereum blockchain. Each kitty is unique and has a price in ether. They breed among themselves and produce new offspring, which have different attributes and ratings than their parents.

Within weeks of their launch, cryptokitties amassed a fan base that spent $20 million in ether to buy, nurture, and maintain them. Some enthusiasts have even spent over $100,000 on the effort. More recently, the Bored Ape Yacht Club has garnered controversial attention for its high prices, celebrities and high-profile thefts of some of its 10,000 NFTs.

While the use cases for cryptokitties and the Bored Ape Yacht Club may seem trivial, others have more serious business implications. For example, NFTs have been used in private equity transactions as well as real estate transactions. One of the implications of activating multiple types of tokens in a contract is the ability to provide escrow for different types of NFTs, from artwork to real estate, in a single financial transaction.

Why are non-fungible tokens important?

Non-fungible tokens are an evolution of the relatively simple concept of cryptocurrencies. Modern financial systems consist of sophisticated trading and lending systems for different types of assets, ranging from real estate to loan contracts to works of art. By enabling digital representations of physical assets, NFTs are a step forward in reinventing this infrastructure.

Certainly, the idea of ​​digital representations of physical assets is not new, nor is the use of unique identification. However, when these concepts are combined with the benefits of a tamper-proof smart contract blockchain, they become a powerful force for change.

Market efficiency is perhaps the most obvious advantage of NFTs. Converting a physical asset to a digital asset streamlines processes and cuts out the middleman. NFTs representing digital or physical artwork on a blockchain remove the need for agents and allow artists to connect directly with their audiences. They can also improve business processes. For example, an NFT for a bottle of wine will facilitate interaction with different actors in a supply chain and help track its provenance, production and sale throughout the process. The consulting firm Ernst & Young has already developed such a solution for one of its clients.

Non-fungible tokens are also excellent for identity management. Take the case of physical passports that must be produced at each point of entry and exit. By converting individual passports to NFTs, each with their own unique identification characteristics, it is possible to streamline entry and exit processes for jurisdictions. Expanding this use case, NFTs can also serve identity management purposes in the digital realm.

NFTs can also democratize investing by splitting physical assets like real estate. It is much easier to divide a digital property between several owners than a physical property. This tokenization ethic need not be limited to real estate; it can extend to other assets, such as works of art. Thus, a painting does not always need to have a single owner. Its digital equivalent may have multiple owners, each responsible for a fraction of the painting. Such arrangements could increase its value and earnings.

The most exciting possibility for NFTs lies in creating new markets and forms of investment. Consider a property split into several divisions, each containing different characteristics and property types. One of the divisions may be next to a beach while another is in an entertainment complex, and yet another is a residential area. According to its characteristics, each land is unique, priced differently and represented by an NFT. Real estate trading, a complex and bureaucratic affair, can be simplified by incorporating relevant metadata into each unique NFT.

Decentraland, a virtual reality platform on the Ethereum blockchain, has already implemented such a concept. As NFTs become more sophisticated and become integrated into the financial infrastructure, it may become possible to implement the same concept of tokenized lands (different in value and location) in the physical world.

Frequently Asked Questions (FAQ)

What are some examples of non-fungible tokens?

Non-fungible tokens can digitally represent any asset, including online-only assets such as digital artwork and real-world assets such as real estate. Other examples of assets that NFTs can represent include game items such as avatars, digital and non-digital collectibles, domain names, and event tickets.

How can I buy NFTs?

Many NFTs can only be purchased with Ether, so owning some of that cryptocurrency — and storing it in a digital wallet — is usually the first step. You can then purchase NFTs through any of the online NFT marketplaces, including OpenSea, Rarible, and SuperRare.

Are non-fungible tokens safe?

Non-fungible tokens, which use blockchain technology just like cryptocurrency, are generally secure. The distributed nature of blockchains makes NFTs difficult (but not impossible) to hack. A security risk for NFTs is that you could lose access to your non-fungible token if the platform hosting the NFT goes out of business.

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