What exactly is an NFT? How do they work? And why are people spending tens of millions of dollars on them? Let’s have a look:
What is an NFT?
A non-fungible token (NFT) is a unique identifier that can cryptographically assign and prove ownership of digital goods. Simply put, it is a type of cryptocurrency that runs on a blockchain. It is a token, or unit of currency, that is non-fungible, or unique, as it cannot be exchanged for something else. At a basic level, an NFT is a digital asset that links ownership to unique physical or digital items, such as works of art, real estate, music or videos. NFTs can be considered modern-day collectibles. They’re bought and sold online, and represent a digital proof of ownership of any given item. NFTs are securely recorded on a blockchain — the same technology behind cryptocurrencies — which ensures the asset is one-of-a-kind. The technology can also make it difficult to alter or counterfeit NFTs.
Why are they called non-fungible?
In economics, a fungible asset is something with units that can be readily interchanged — like money. With money, you can swap a PKR100 note for two PKR50 notes and they will have the same value. However, if something is non-fungible, this is impossible – it means it has unique properties so it can’t be interchanged with something else. It could be a house, or a painting such as the Mona Lisa, which is one of a kind. You can take a photo of the painting or buy a print but there will only ever be one original painting. To really get a handle on NFTs, it’s helpful to get familiar with the economic concept of fungibility.
Fungible items can be exchanged with one another with ease because their value isn’t tied to their uniqueness. For example, you can exchange a $1 bill for another $1 bill, and you’ll still have $1 even though your new bill has a different serial number.
Non-fungible items aren’t interchangeable. With NFTs, each token has unique properties and isn’t worth the same amount as other similar tokens.
How an NFT is different from cryptocurrency?
NFTs are generally built using the same kind of programming as cryptocurrency, like Bitcoin or Ethereum, but that’s where the similarity ends. Physical money and cryptocurrencies are “fungible,” meaning they can be traded or exchanged for one another. They’re also equal in value—one dollar is always worth another dollar; one Bitcoin is always equal to another Bitcoin. Crypto’s fungibility makes it a trusted means of conducting transactions on the blockchain.
NFTs are, however, different. Each has a digital signature that makes it impossible for NFTs to be exchanged for or equal to one another (hence, non-fungible).
How NFTs work?
Rather than acting as digital coins like Bitcoin, NFTs are used to sell items in online marketplaces. Essentially, they are like physical collector’s items, only digital. So instead of getting an actual oil painting to hang on the wall, the buyer gets a digital file instead.
An NFT is created, or “minted” from digital objects that represent both tangible and intangible items. They exist on a blockchain, which is a distributed public ledger that records transactions. Specifically, they are typically held on the Ethereum blockchain, although other blockchains support them as well.
NFTs are minted through an NFT marketplace, where a creator uploads a digital file and assigns characteristics that define how many copies of the file are available. Some works are one of a kind, while others can have multiple versions. NFTs are bought and sold through marketplace auctions using cryptocurrencies as payment.
They also get exclusive ownership rights, i.e. they can have only one owner at a time. Their unique data makes it easy to verify their ownership and transfer tokens between owners. The owner or creator can also store specific information inside them. For instance, artists can sign their artwork by including their signature in an NFT’s metadata.
The financial takeaway
While there may be many practical applications for NFTs in the future, they’re primarily used with digital art today.
For creators, NFTs create a seamless way to sell digital art that might not have much of a market. Additionally, there are ways in which creators can get paid fees for each subsequent sale of the art. On the flip side, collectors are able to speculate on digital art as well as have bragging rights on rare collectibles on the chain.
If you’re considering purchasing an NFT as an investment, know that there’s no guarantee it will increase in value. While some NFTs sell for thousands or millions of dollars, others may remain or become worthless.
NFTs have some special properties:
Each token minted has a unique identifier that is directly linked to one Ethereum address.
They’re not directly interchangeable with other tokens 1:1. For example 1 ETH is exactly the same as another ETH. This isn’t the case with NFTs.
Each token has an owner and this information is easily verifiable.
They live on Ethereum and can be bought and sold on any Ethereum-based NFT market.
In other words, if you own an NFT:
ü You can easily prove you own it.
· Proving you own an NFT is very similar to proving you have ETH in your account.
· For example, let’s say you purchase an NFT, and the ownership of the unique token is transferred to your wallet via your public address.
· The token proves that your copy of the digital file is the original.
· Your private key is proof of ownership of the original.
· The content creator’s public key serves as a certificate of authenticity for that particular digital artefact.
§ The creator’s public key is essentially a permanent part of the token’s history. The creator’s public key can demonstrate that the token you hold was created by a particular individual, thus contributing to its market value (vs a counterfeit).
· Another way to think about proving you own the NFT is by signing messages to prove you own the private key behind the address.
§ As mentioned above, your private key is proof of ownership of the original. This tells us that the private keys behind that address control the NFT.
§ A signed message can be used as proof that you own your private keys without revealing them to anybody and thus proving you own the NFT as well!
ü No one can manipulate it in any way.
ü You can sell it, and, in some cases this will earn the original creator resale royalties.
ü Or, you can hold it forever, resting comfortably knowing your asset is secured by your wallet on Ethereum.
And if you create an NFT, you can:
ü Easily prove you’re the creator.
ü Determine the scarcity.
ü Earn royalties every time it’s sold.
ü Sell it on any NFT market or peer-to-peer. You’re not locked in to any platform and you don’t need anyone to intermediate.