You might have stumbled across the phrase ‘NFT’, but what on earth are they? THINK takes a look at NFTs, where they came from, and what they’re all about.
The title above is not clickbait but a ubiquitous philosophical question. While the answer may only be delivered by the test of time, one thing is certain: NFTs’ (non-fungible tokens) potential goes well beyond a way to trade overpriced pixels. To understand the powerful idea behind NFTs, however, one needs to look into where they come from, how they work, and what applications there have been in the mainstream arena.
While research has been trying to understand why cats are so popular on the internet, the first use of non-fungible tokens that gained widespread popularity was CryptoKitties, a game on the Ethereum blockchain network developed by Canada-based Dapper Labs. The game allows users to breed, collect, purchase, and sell digital kittens. In December 2017, transactions of Dapper Labs’s kittens congested Ethereum to such an extent that pending transaction numbers across the entire network reached all-time highs. The idea of NFTs has picked up since then, and today many people would be willing to stake their claim by purchasing all sorts of NFTs at stellar prices, hoping their value willshoot through the moon.
What is a non-fungible token though? Before we dissect it, we need to understand blockchain technology, as it is this unique ecosystem that gives NFTs their real value. Transactions in the blockchain are validated in a peer-to-peer manner, and related data is stored in the computers of many thousands of users at the same time (a simplified view of the convoluted technology for the sake of this article), making these transactions practically incorruptible. Meanwhile they are traceable in the ledger (a decentralised record of all transactions conducted on the blockchain). As the sender and sendee are anonymous, users can see the transactions and their amounts, but not the parties involved in the business. Blockchain enthusiasts swear that the technology will democratise finance and bring equality to financial transactions by cutting out middlemen such as financial intermediaries, allowing end-users to trade in a safe yet transparent manner.
An NFT is basically a token on a blockchain, much like cryptocurrency. However, while a cryptocurrency is essentially fungible, meaning one user can always swap one unit of bitcoin for another one unit of bitcoin, an NFT is unique, one of a kind, irreplaceable—non-fungible. Therefore, the owner of one particular CryptoKitty can be sure that there is no other CryptoKitty exactly like theirs. This guarantee lies in the workings of blockchain technology and gives real value to that one specific CryptoKitty. An NFT CryptoKitty, hence, is not a mere jpeg file or a set of pixels that can be copied and replicated to ad infinitum.
Fast forward a handful of years, and NFTs are breaking out of the realm of early adopters. Prestigious international publication The Economist enters the NFT scene. In September 2021, The Economist’s cover story reckoned that NFTs and the crypto ecosystem that serves as an engine to the technology could transform finance and the digital economy with time. The cover of the magazine depicted an Alice in Wonderland-esque scenario with a world ruled by NFTs down the rabbit hole. A month later, the paper practised what it preached. On 25 October 2021, The Economist auctioned an NFT of the cover image for 99.9 ether, the cryptocurrency of the Ethereum blockchain, worth around $420,000 at the time of sale (cryptocurrencies are highly volatile as compared to traditional money). The money went to charity.
Nevertheless, the practical utility of NFTs goes well beyond mere images as real-world objects can be linked to NFTs. Let us take, for example, a celebrity’s hairpin. As NFTs live on the blockchain, it is possible to include in the smart contract of the digital object—a hairpin NFT in this case—that the owner of the NFT has the right to collect the real thing. In fact, the physical hairpin must be shipped to them as they become the owner of it after buying the NFT. In such a scenario, the real-world object can only be validated by the digital object, the NFT. One is practically worthless without the other. The digital object, the NFT, therefore becomes the handle of the real-world object. The ownership and transaction history are recorded in the blockchain.
Another attribute of the NFT realm can deliver real value to artists. The creator of an NFT can set up a royalty fee and benefit from each subsequent sale of their creation. For example, if a painter turns their physical paintings into NFTs, just like with the hairpin example above, the buyers of the digital object will claim ownership of the real physical object (they may even receive ownership of the copyright, which depends on the terms related to the purchase of the NFT). If the creator sets up a royalty fee of 10%, for example, then any time that particular NFT is resold, the original creator will receive 10% of the purchase price. It is a fair deal for the creator as the demand for their product will fuel their earnings as long as the product is being sold again. The creator, therefore, will be incentivised to create content of value and will be fairly compensated years, if not decades, after their artwork has been produced.
The Dark Side of NFTs
As with any novel technology, NFTs come with downsides too, though. The actual visual of the NFT is recorded on the blockchain as a link in the description of the token. This characteristic creates room for unscrupulous sellers to break or change the links, conning the buyer into paying up for something of no value. Additionally, transactions are still relatively slow on the blockchain when compared to digital payments via bank cards of traditional financial institutions. Blockchain critics argue that the more users that adopt cryptocurrencies and the more transactions they initiate, the longer the transfer time would become, exponentially, making on-the-spot payment virtually impossible.
Blockchain-based crypto ecosystems, furthermore, use an immense amount of electricity, which is causing excessive problems at a time when climate change is casting a shadow on the silver lining of economic progress. Meanwhile lawmakers nervously scurry to drive a positive change through our chiefly fossil-fuel-based economies.
Last but not least, the identities of the vendor and buyer are unknown. From a law enforcement perspective, this characteristic fails to address the issues humanity currently faces with traditional monies, such as counterfeiting and laundering, for example.
NFTs are raising valid and immense potential in a world where digitisation has left no stone unturned in any industry. The potential paints a rosy picture of a future. Artists and creators could monetise their art fairly and receive compensation evenly. Transactions could be traced in a transparent way while protecting the identities of the transacting parties. This traceable history can guarantee that the buyer is purchasing a genuine product.
There is ample work to do, however, before blockchain technology can democratise economies and finances. The carbon footprint of operating the technology must shrink, and the use of such a solution must become as simple as downloading an application on a smart device. These are prerequisites for mass adoption. Only once these hurdles are overcome can NFTs live up to their real potential.