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A short introduction to NFTs

NFTs have hit media headlines recently; Christie’s recently auctioned one for over $69 million, Jack Dorsey (the creator of Twitter) sold his first tweet for nearly $3 million, heck, even the NBA is selling them (“limited edition guaranteed by the blockchain”). So, what are they, why is everybody going crazy about this, and more importantly, how can I get rich off them?

Non-fungible

“Token” is easy. We all know what a token is, just a simpler way of saying “thing that looks a bit like a coin or note”. But what about this weird term “non-fungible”? Well, it is a financial term which basically means non-interchangeable. Token A is not the same as Token B, we can’t swap one for the other as each is unique. Contrast this with, for example, money (or a commodity like oil). I can swap a dollar for another dollar because they are equivalent, they have the same value. Non-fungible objects are different: I can’t swap a Picasso for another Picasso as they are completely different. Gold is fungible, a gold ring isn’t. In the digital world we have fungibility with cryptocurrency, and non-fungibility with NFTs.

Artificial scarcity

Why do we want non-fungibility in the digital world? Well, the main issue here is we need to create scarcity. Scarcity brings value. It’s weird, even inefficient, but we create artificial scarcity in the physical world all the time, otherwise why would we create limited editions of, say, Nike sneakers? Why is a basketball signed by Jordan so much more expensive than a basketball that isn’t even if they bounce the same?

In the digital world, where we can create infinite indistinguishable copies of virtually anything with a simple CTRL-c/CTRL-v, scarcity is… scarce. If you are an artist who wants to sell a piece of digital artwork, or a company who wants to sell limited-edition collectibles, you need scarcity to justify the object’s value. Picasso (well, Picasso’s buyer) didn’t have to worry that after unleashing Les Demoiselles d’Avignon on the world there would suddenly be thousands of indistinguishable copies, completely obliterating the price of the original. But for digital artist Beeple this is a real problem. This is solved by NFTs, which are unique, so we can use them to tie ownership with digital assets.

A thing to note is that you have no guarantee the creator won’t screw you over by creating another NFT pointing to the same piece of art. Or that the creator is pointing to a piece of art that is actually someone else’s. Or even that owning the NFT gives you any rights over what it represents. But even in those cases an NFT will probably retain its value (it is after all the first NFT pointing to work of art A, and since all NFTs are unique you can prove it). It also won’t stop other people copying the art for themselves, what they won’t be able to do is copy the NFT and sell it though.

Smoke and mirrors and printing money

If this all seems like creating money out of nothing you aren’t far of the mark. However, this shouldn’t surprise you — the real world has been at this too. Just like Jack, who made millions out of Twitter and then blagged another extra $3 million by selling his “first tweet”, Pablo could equally have sold his rough drafts and even his easels once the actual painting was going around auction houses for a few million. Famous people the world over sell their autographs to their fans. People buy limited edition sneakers (or PlayStation 5s) and sell them immediately for double the price.

To those who say, “yes but in the real world you get something you can hang on your wall” I’d reply: “OK boomer”. Get over it, the digital world is here to stay, and it will be constantly imitating more and more things from the physical world. What makes a Picasso worth millions is not that you can put it up on your wall, it’s the hype (and behind the hype is, hopefully, the skill). Similarly, what makes money worth what it’s worth is scarcity (we abandoned the gold standard in the 70s, and even then, scarcity is what makes gold what it’s worth). The same goes for the virtual world.

A barebones NFT

At its most basic an NFT is just a unique ID. This ID is then added to a blockchain (more on that later) to register who the owner of that ID is. And that’s all there really is to it!

How do we get from here to $69 million? Well, enter one of the greatest inventions in human history: capitalism. Well, not exactly capitalism, but the concept that an object is worth, well, whatever someone else is willing to pay for it, regardless of how much it cost to produce in the first place.

NFTs can have quite a lot more than just an ID, you can add all sorts of other data as well: the creator’s name, creation date… and what that NFT represents, be it a short text or a URL (NFT sizes need to be kept small, so we can’t just embed an image or audio). The value of the NFT is then simply down to hype. Keep in mind URLs change, but NFTs don’t. But ultimately common knowledge can keep the value of the NFT alive long after that URL starts returning a 404 Not Found.

The blockchain

What makes all this possible, the technology behind this, is the blockchain. We won’t go into this in detail, but basically you can think of a blockchain as a distributed (many people have a copy of it) registry where anyone can add information, but nobody can delete or modify existing information. We could have solved the problem of digital uniqueness using some sort of centralised world-wide registry (or one per country) but it’s far easier and cheaper to use this decentralised model.

For transactions to be written onto most (though not all) blockchains you need to pay a fee. This fee is known as “gas” and goes to reward all the computers (nodes) on the network that are busy ensuring the blockchain runs. This applies to moving coins from one owner to another (or simply between different digital wallets of the same owner), but also applies to adding an NFT to the blockchain (and future changes in ownership).

The blockchain is where we write the data from the NFT, together with the “owner” (also just an ID). This way you can’t simply “copy” an NFT to steal it. Sure, you can copy the actual NFT file, but if you try to register it on the blockchain it will tell you that it already exists and has an owner. The owner can transfer ownership by registering this fact on the blockchain as a transaction (supposedly in exchange for some cryptocoins in return, which can then be kept or changed into a fiat currency at an exchange). As a side note: NFTs allow the possibility of “royalties”, where a set % of every resale will go to the original owner, allowing you to make money even after selling the NFT you created.

Just like nothing stops people pointing different NFTs to the same piece of art, or somebody else’s art, nothing stops you from adding different “equivalent” NFTs on different blockchains. But remember, various NFTs may all “represent” the same thing, but each of them is unique.

Split personalities

The original blockchain is what made Bitcoin possible, but this first-generation technology doesn’t support NFTs(well, there is a small fudge by which you could do something similar, known as “Coloured Coins”). For this we need to go to second-generation blockchains like Ethereum or Cardano — in total there are a few dozen public blockchains for you to choose from. This poses a problem for the future of NFTs: fragmentation. Currently Ethereum is king, but others are snapping at its heels and soon it may be difficult to decide which blockchain to use for your NFTs.

Gas price has much to do with this. The gas price of adding an NFT to the Ethereum blockchain is expensive, and subsequent transactions just add to the cost. This cost may be a drop in the ocean for something at Sotheby’s but make “cheap but plentiful” NFTs economically nonviable. Obviously, cost isn’t the only factor; a healthy application ecosystem, the actual features offered by the underlying blockchain, and a large community (of creators, programmers and potential buyers) will all influence people’s decisions.

Applying NFTs

So, what can we use NFTs for? We have already talked about the uses for digital art, but in the less-glamorous world of collectibles we can also create limited-edition digital assets, such as Pokémon, NBA videos or CryptoKitties. You can also use them to define ownership of game assets, and you will still own the Sword of Elron on Ethereum long after the company behind Troll Killer goes bust. You could even buy a cool submachine gun in one game and use it in another or resell it on the second-hand market (interesting for music resale as well). NFTs can also help identify who can attend an event, much like a digital cinema or concert ticket that can’t be copied.

Future NFT standards are looking into the possibility of allowing split ownership, and also somehow linking NFTs to real-world objects (they could be title deeds to a house, and even allow the possibility of unlocking your door or starting your car with a wave of your digital wallet). They could even replace normal paper contracts and licenses.

Show me the money

At the beginning of this article I promised to explain how to make you rich off NFTs. Well, a digital contract ain’t worth the paper it’s written on. To sell NFTs for a few million you have to basically create a few million’s worth of buzz and hype, and I haven’t a clue on how to do that. Become famous, I guess. Another avenue is to create cheap and cheerful NFTs and sell many (but not too many so as to make them worthless). For that you usually need a real product behind you to justify the NFTs, be it a game, a limited collection of hats, or an online poetry recital.

Usually you will be paid in the cryptocurrency of the blockchain where you uploaded the NFT. I don’t know if the big auctions are paid directly in dollars, but for certain Jack Dorsey’s “first tweet” wasn’t: you can see clearly the bidder put up $2.5 million in Ether (Ethereum’s coin) and by the time the auction closed this price had risen to over $2.9 million simply because Ether rose against the dollar in that time.

Conclusion

NFTs are a very interesting technology, allowing scarcity in the digital world. They will very probably have a big impact over the next few years, changing the way we do things and making some people quite rich while we ride the hype train. Ultimately the dust will settle, and they will become as normal to us as any other technology.

In the next article I will show you how to create your own NFT from scratch using Cardano (as it is cheaper — less gas — to write to the Cardano blockchain).