What are NFTs?
- Non-fungible tokens (NFT) are tokens that represents a range of tangible and intangible items, from digital art to virtual real estate and even digital sneakers
- Think of it like a digital token that can be used to present anything in the real or digital world.
- The token can be easily traded between people and that the transactions are transparent to the whole world. For example, let say you wanted to buy a used Macbook. Rather than just having a monetary exchange (e.g., paying for it with cash), imagine you are also provided a token that will tell you if the seller was the original owner, or how many times it’s changed hands and by how much.
- The idea of digital assets is not a new concept. EVE is an online video game where players own spaceships and venture out on space exploration and battle. One notable event was “The Massacre at M2-XFE” where in 1 battle, an estimate $378,012 in real world value was destroyed.
- Though the spaceships were digital, they had real world value because of a person’s willingness to pay for a better spaceship. The value of a spaceship was determined by both rarity and demand, no different than the NFT market today.
- EVE is only one example, but this trade between digital assets to real world currency has been around for decades.
How Do NFTs Work?
- To understand how NFT’s work, it’s important to understand the basics of what is the blockchain and how does it work. You can read a simple introduction in our article here.
- Similar to leveraging the blockchain to transfer funds or bitcoin between users, the technology can be used to transfer digital assets in the form of a token
- Therefore, it inherits all the benefits of the blockchain (i.e., security, transparency, immutability) and ultimately trust between the buyer and sell.
- With trust, it creates artificial value because a buyer can trust the information provided in the blockchain when buying a piece of art (i.e. previous purchase price, how many copies of the art was minted, how often is the art traded) and all of this information can be used to determine the “worth” of the piece of art.
Example of an NFT Transaction
- Ricky is looking to buy a digital art.
- Ricky finds an awesome artwork of a digital cat in an NFT marketplace.
- Wendy the seller is looking for 1 Ethereum for the art work.
- Ricky can check on the blockchain if Wendy was the original owner, and if not, who is.
- Ricky can research the original owner and check how much art has been minted and how has the value grown over the years.
- With all the variables in mind, Ricky thinks that 0.5 Ethereum is the right price for the piece of art
- Wendy reviews all her offers and accepts Ricky’s offer
- The transaction is sent to the blockchain and it validates that Ricky has in fact 0.5 Ethereum to send to Wendy and that Wendy in fact owns the art work
- Once validated, Wendy receives 0.5 Ethereum and Ricky receives a token which represents the ownership of the artwork.
- The transaction is complete
Risks of NFTs
- Fraud Risk: One notable risk is if a person remints the piece of artwork as their own. Though the digital painting is exactly replicated, unless you do your research and see who it’s minted by and if it’s from the original artist, you risk overpaying for a copy of the real piece of artwork.
- Volatility Risk: The value of digital assets is dependent on supply and demand. Similar to traditional art, what it’s worth is what the next person is willing to pay for it. Therefore, NFT projects have huge opportunities of making it big like Beeple [https://www.theverge.com/2021/3/11/22325054/beeple-christies-nft-sale-cost-everydays-69-million] but also huge risks of downside if the NFT project falls out of trend.
Notable NFT Projects
- CryptoPunks: The collection comprises 10,000 pixel-art characters inspired by the punk movement and the cyberpunk fiction genre.
- Bored Ape Yacht Club: This project is a collection of 10,000 Bored Ape digital collectables that has so far generated a trading volume of 170,657.34 ETH on OpenSea
- CryptoKitties: Digital game built on the blockchain to raise and breed digital kittens
- Decentraland: Decentraland is a project that allows people to buy parcels of land in a virtual world and build whatever they want on the plots they own.