What are NFTs? How do they work, Non-Fungible Tokens Explained
What are NFTs? How do they work, Non-Fungible Tokens Explained
Tech Explained

What are NFTs? How do they work, Non-Fungible Tokens Explained

A non-fungible token (NFT) is a unique and non-interchangeable unit of data stored on a digital ledger (blockchain). NFTs can be associated with easily-reproducible items such as photos, videos, audio, and other types of digital files as unique items (analogous to a certificate of authenticity), and use blockchain technology to give the NFT a verified and public proof of ownership. Copies of the original file are not restricted to the owner of the NFT, and can be copied and shared like any file. The lack of interchangeability (fungibility) distinguishes NFTs from blockchain cryptocurrencies, such as Bitcoin.

The first NFT project was in 2015 on the Ethereum blockchain. The total monetary value of NFTs grew in 2021, with sales of NFTs exceeding $2 billion during the first quarter of the year.

NFTs have drawn criticism with respect to the energy cost and carbon footprint associated with validating blockchain transactions as well as its frequent use in art scams.

Description of NFT (Non-Fungible Tokens)

An NFT is a unit of data stored on a digital ledger, called a blockchain, which can be sold and traded. The NFT can be associated with a particular digital or physical asset (such as a file or a physical object) and a license to use the asset for a specified purpose. An NFT (and the associated license to use, copy or display the underlying asset) can be traded and sold on digital markets.

NFTs function like cryptographic tokens, but, unlike cryptocurrencies like Bitcoin, NFTs are not mutually interchangeable, hence not fungible. While all bitcoins are equal, each NFT may represent a different underlying asset and thus may have a different value. NFTs are created when blockchains string records of cryptographic hash, a set of characters identifying a set of data, onto previous records therefore creating a chain of identifiable data blocks. This cryptographic transaction process ensures the authentication of each digital file by providing a digital signature that is used to track NFT ownership. However, data links that point to details like where the art is stored can die and NFTs do not necessarily involve a transfer of any intellectual property rights of a work.

Digital asset

Put simply, a digital asset is anything that exists in a digital format and has a right to use (a right to copy, duplicate, reproduce, modify and otherwise use). So, for example, things such as documents, audio or visual content, images, and other similar digital data are all considered digital assets.

Blockchain

We’ve got a full article on understanding blockchain, cryptocurrency and bitcoin. In that post, we highlighted that a blockchain is a type of database – a collection of electronically stored information or data.

Unlike a regular database, a blockchain is a series of data ‘blocks’ that are linked together. This chain of blocks creates a shared digital ledger (collection of data) that records the activity and information within the chain.

Each blockchain ledger is stored globally across thousands of different servers. This means that anyone on the network can see (and verify) everyone else’s entries. This peer-to-peer and distributed ledger technology, as it’s known, means that it’s nearly impossible to falsify or tamper with data within a block.

Where do people buy NFTs?

The digital artworks can be bought on online marketplaces like Opensea.io, Niftygateway.com and Superrare.com.

Noted traditional auction houses have also stepped into the space: At a recent Christie’s sale, a digital artwork was priced at $69 million. Meanwhile, Sotheby’s announced this month that it’s launching its own NFT marketplace.

Non-fungible tokens vs cryptocurrency

It’s important to outline the distinction between cryptocurrency and non-fungible tokens. Although both are based on blockchain technology, the fundamental differences can help us to understand how NFTs work.

The key difference goes back to cryptocurrency being fungible. You can exchange a Bitcoin for another Bitcoin, for example. However, you cannot do so for an NFT. A non-fungible token is tied to one particular digital asset and cannot be replaced.

Why do NFTs have value?

As we’ve mentioned already, a non-fungible token is essentially a certificate of ownership for a digital asset. The value comes from the collectibility of that asset, as well as its potential future sale value. NFTs can be sold and traded.

Again, using art is a great example of the value of NFTs. In February 2021, digital artist Beeple sold the NFT for their Everydays – The First 5000 Days artwork for a staggering $69.3 million through Christie’s auction house.

Examples of NFT sales

It’s not just NFT art that sells well. There have been several notable sales of NFTs in recent months, although this has given rise to the speculation that there is a market bubble at the moment (more on that later).

Some examples of NFT sales include:

  • The first Tweet. Jack Dorsey, the founder of Twitter, sold the NFT for his first Tweet for $2.9 million
  • The ‘Nyan Cat’ GIF. The NFT for the colourful GIF sold for 300 Ether (a cryptocurrency), worth around $561,000 at the time.
  • The ‘Charlie Bit Me’ Video. The popular video of a baby biting his brother’s finger was viewed over 800 million times on YouTube. The NFT for the video sold for around £500,000.

The pros and cons of NFTs
So, non-fungible tokens are clearly popular right now. But what are the positives and negatives of NFTs? We’ve outlined some potential pros and cons below:

Pros of NFTs

Some of the advantages of NFTs that are often stated include:

  • They give artists ownership over digital assets.
  • They’re unique and collectable.
  • They’re immutable.
  • They can include smart contracts.

Cons of NFTs

Of course, as with every new technology, there are some potential downsides. The disadvantages of NFTs include:

  • It’s a speculative market.
  • Digital assets can be copied.
  • Environmental costs.
  • They can be stolen.

What can non-fungible tokens be used for?

Many people question whether there are use cases for NFTs. However, although the concept is in its infancy, several potential uses have already emerged. We’ve picked out some of the most notable ones below:

  • Tickets
  • Fashion
  • Similarly, a non-fungible token could show crucial data about the origins of an item, such as the materials used, where they were sourced from, and how far the item has travelled. As issues around fashion and sustainability become more pressing, this could help people make more ethical decisions.
  • Collectables
  • Gaming
  • Music
  • Films
  • Artwoks
  • Graphics
  • Animation

How to create an NFT

If you’re a budding digital artist, you might be interested in creating NFTs for your work. Luckily, there are several platforms available that can help you get started. On the whole, the process is fairly simple, and the various platforms will guide you through the process.

Are non-fungible tokens the future?

Hopefully, you now have an understanding of what NFTs are and how they work. We’ve seen that there are several potential applications for non-fungible tokens in the real world, but are they a technology of the future?

It’s hard to say whether NFTs will be widely used over the years to come. Clearly, there is a huge interest in them at the moment, as well as several potential benefits. However, the technology is in its relative infancy, and there are numerous challenges to overcome.

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