NFTs - Friend or Foe?

What Are NFTs and How Do They Work?

NFTs have been in the public eye for a while now. Despite this, few people know exactly what they are. Sure, we know it stands for a non-fungible token, but what does that mean?

Let’s explore the term and examine the uses of the underlying technology and create a brief coverage of its most important concepts.

The first concept that’s important to understand is fungibility. “Non-fungible” just means that an item is unique and can’t be replaced with something else. By contrast, both bitcoins and traditional currencies are fungible. Trading one bitcoin (or a US dollar or a Euro) for another will get you the same thing. One-of-a-kind trading cards, on the other hand, are not fungible. If you trade it for a different card (or money), you’ll get something completely different.

Digital Collectibles

So, NFTs are just like digital trading cards, right? Not quite, and we already have those. The T part of the abbreviation is key here. NFT is a token that verifies your ownership over a digital asset. Of course, it’s not a simple verification; most NFTs are a part of the Ethereum blockchain, and those who aren’t are a part of another one. This ensures the so-called “trustless” verification and practically perfect security.

But this is where it becomes tricky. You’re not technically buying an item. You’re paying money so that your name will be written in a ledger (blockchain) that says you’re the owner. At the moment, this gives you some bragging rights, the ability to use a hexagonal profile picture on Twitter, and the ability to resell your NFT. When it comes to the digital property itself (image, video, etc. ), there’s no way to enforce “ownership.” Anyone can simply right-click and save a picture you paid good money for and use it for anything they want; including minting their own NFT.

However, as the infrastructure expands and blockchain gains more widespread acceptance, things may change and provide more practical uses for NFTs.

Why Are NFTs So Popular?

They’re hardly new. The concept first appeared in 2014, but it didn’t get widespread, mainstream recognition until 2021. During the last year, total NFT sales reached $25 billion, which is over 250 times more than the $94.9 million in 2020.

Those numbers alone should be sufficient to explain a large part of the popularity. In addition, NFTs, as well as blockchain, have drawn the attention of celebrities and big companies. Everyone from Brie Larson and Eric Andre to Ubisoft and MasterCard seems to want a piece of the increasingly valuable pie. Even Winamp, a widely known media player for Microsoft Windows, which now has more than 80 million active users, started doing NFTs.

This, in turn, spurs further investments and increases their popularity. It’s a cycle that seems to be in a constant state of expansion, but it could easily be another bubble that one day may burst. Cryptocurrency and NFTs remain volatile investments, and that doesn’t seem to be changing. It’s best to follow the basic advice that applies to any form of investing (or gambling): never invest more than you can afford to lose.

The State of the NFT Market

While NFTs are still valued very highly, and the market is booming, they’ve suffered an immense public backlash. Celebrities endorsing them on social media face frequent ridicule, and both companies and individuals have backtracked their support after intense pressure from their fans. The website web3isgoinggreat compiles all the blunders and issues with anything related to web3, and NFTs are featured very frequently.

In addition, the NFT market has been rife with scams. As the market grows, it becomes an ever more tempting target for scammers and hackers. OpenSea users have been targeted by a phishing attack that resulted in the theft of $1.7 million in NFTs. Due to the nature of blockchain, these transactions are irreversible; and while these assets may be blocked, there’s no way to restore them to their previous users.

That being said, NFT and crypto marketplaces are still going strong. OpenSea is the leader in NFT sales and has become practically synonymous with NFTs and minting. Rarible and SuperRare are other popular platforms that support the trade and creation of all kinds of art, videos, collectibles, and music.

NFT Usage in Gaming

The two most common claims about NFT usage in gaming are the ability to sell and trade in-game items to other players and the ability to transfer items between games. Unfortunately, only the first one seems to be rooted in reality, and it doesn’t necessarily require NFTs or blockchain. Counter-Strike: Global Offensive had tradable weapon skins for years, and Valve’s Steam platform already supports trading games (with some regional limitations).

The second use might be problematic, as it would require an unprecedented level of synchronization between different games, platforms, developers, and publishers. Not all games follow the same basic logic and publishers are very reluctant to give that kind of control and access to their competitors.

That being said, due to the popularity of NFTs, it’s not surprising to find whole games based on NFTs. A prime example is Axie Infinity, a game that allows players to earn income by selling earned tokens. This play-to-earn model has even allowed a large number of people in the Philippines to earn significant income during the Covid pandemic.

NFT - Bored Ape Yacht Club

NFT Usage in Finance and Fintech

If used to their fullest potential, NFTs can be much more than jpegs on a blockchain. Digital ownership backed by smart contracts and blockchain has the potential to revolutionize how people do business and usher in an age of decentralized finance.

The use of distributed ledger technologies means that obtaining finance capital no longer requires large central institutions or intermediaries. As NFTs are intrinsically linked to a distributed ledger or blockchain, they provide secure and reliable digital receipts, allowing users to track the provenance of products and supply chains and tag real ownership details for both identification and ownership transfer purposes.

Of course, the question remains: Do people really want their transactions to be clearly visible on the immutable public ledger? While the transactions are “anonymous” in the sense that users don’t have to tie their identities to their wallets, as soon as their connection to a specific wallet is revealed, their entire transaction history becomes visible to anyone who can read the blockchain.

NFT Usage in Art

This is the most well-known use of NFTs. Pretty much everyone knows about the Bored Ape Yacht Club and similar procedurally generated NFT artworks. It’s important to keep in mind that NFTs aren’t artworks themselves, but they can serve as digital certificates of authenticity and proof of ownership.

High-priced NFT artworks can fetch some staggering prices. Pak’s ‘The Merge’ was sold for $91.8 million to a group of 28,983 collectors, while simple, procedurally generated CryptoPunks and Bored Apes have fetched millions per sale.

Pak’s 'The Merge'

And while they’re touted as tools that will allow the artist freedom to express themselves and eliminate middlemen, it’s somewhat difficult to see how that would be accomplished. NFTs are not necessary for the creation of different media, and artists could always sell their works directly. Conflating NFTs with digital artworks is a frequent mistake that allows for this and similar misconceptions.

One possible benefit would be incorporating automatic resale royalties feature in the smart contract of the NFTs blockchain segment. However, smart contracts aren’t the same thing as legal contracts. There’s nothing preventing a new owner from simply minting a new NFT of a purchased artwork and selling it as their own.

For example, there have been noted cases of people minting artworks they don’t own and selling them on NFT marketplaces. Complaints usually fall to deaf ears when it comes to platforms, and copyright holders have to resort to legal means to deal with this type of infringement.

Wrapping up

It’s always tempting to be an early adopter of new technology, as that has the potential to bring incredible rewards. And blockchain, where NFTs are recorded, is definitely a promising technology and one of the rising trends in software development.

However, while the NFT marketplace looks like an easy way for everyone to make money, the old proverb applies: for someone to make money, another has to lose money. Currently, they function as unregistered securities and are best thought of as very volatile and risky investment opportunities.

Using or developing an eco-friendly blockchain for verification and authentication purposes seems to be the best use for the technology, as most other applications are ripe for abuse.

Glossary of Important Concepts

Let’s cover some concepts important for understanding what NFTs are and how they work.

Blockchain - a digital ledger of transactions that is duplicated and distributed across the entire network of computer systems. This is a system of recording information in a way that makes it difficult or impossible to change, hack, or cheat.

Minting - the process of creating an NFT. It’s often called the process of converting digital files into digital assets storing them on the blockchain*. These digital assets will be stored in a decentralized database or distributed ledger and cannot be edited, modified, or deleted.

*Since it’s impractical to store overly large files on the blockchain, in practice, this means that the blockchain only contains an URL to the digital asset. The content of this URL can be modified, and unless the new owner gets access to the server it’s stored on, they technically have no real control over the actual asset.

Proof-of-work - a system where computers compete against each other to be the first to solve complex puzzles. This method of “mining” is very energy-intensive and secures the network by ensuring that only those that can prove they have expended resources are granted the right to append a new set of transactions to the blockchain.

Proof-of-stake - a system where validators are chosen to find a block based on the number of tokens they hold. Much less energy-intensive than proof-of-work.

Smart contracts - self-executing computer programs with the terms of the buyer’s and seller’s agreement directly embedded into lines of code. They’re often distributed across decentralized blockchain networks and are supposed to facilitate anonymous, trustless transactions and agreements without the need for a third-party authority. When it comes to NFTs, smart contracts are used to verify the ownership, handle the transferability, specify royalties, etc.

Trustless system - a system in which the participants involved do not need to know or trust each other or a third party for the system to function. No single entity has authority over the system, and the consensus is achieved without participants having to know or trust anything but the system itself.