Deciphering the hype: A beginner's guide to Non Fungible Tokens (NFTs)
Written by Hussein Hallak, founder of Unleashed Ventures, Creator of The Quick & Dirty Guide to Blockchain, Author of The Dark Art of Mastering Life.
On October 18, 1995, Network Solutions transferred the ownership of Sex.com to Stephen M. Cohen. But there was a problem. Cohen got an employee of Network Solutions, where the Sex.com domain was registered, to change the ownership details by forging letters and submitting a fake fax.
So the transfer was done without the permission of the domain’s actual owner, Gary Kremen, founder of Match.com.
What followed is a five-year-long legal battle, and in November 2000, Network Solutions finally returned the domain as ordered by the court, and Karmen was once again was the owner of Sex.com.
How does this relate to Non-Fungible Tokens (NFTs)?
- See also:
Well, if Gary Karmen’s ownership of his domain was recorded as a non-fungible token on a blockchain network, the hijacking of Sex.com would never have happened!
Most of what you will read about NFTs focuses on how people with too much money are buying worthless things using NFTs.
Art that you can’t hang on your wall for $1.5m, the Nyan Cat meme for $590k, a video clip of LeBron James dunking for $200K, even Jack Dorsey’s first tweet for $10M!
Just like the discourse around Bitcoin, Blockchain, ICOs, and DeFi, the focus is almost always on the hype and not on substance.
Enabled by the technological breakthrough of blockchain technology, NFTs are an innovative solution to severe problems plaguing the music, art, and content creation industries.
So what the heck are NFTs? How do they work? And why should you care?
Let’s start with tokens
If we lived on Yap islands in the western Pacific Ocean before the 20th century, we would’ve used large stone disks called Rai as money.
Rai stones were not moved when spent but simply changed owners, and the community kept an oral ledger of its transactions.
It may sound ridiculous today. Stones, not to mention immovable ones, are not money!
Let’s say you were teleported to Vegas; you would think colourful casino chips are money.
Both the Rai stone and casino chips served as a visible and tangible representation of value, a token.
A token is a thing that serves as a visible or tangible representation of a fact, quality, feeling… etc. It can be a voucher you can exchange for goods or services, it can be a ticket that gives you access to certain privileges, or it can be a plastic disk you use to pay for games in an arcade.
We can say a token can be whatever you want it to be, as long as others agree with you on what the token is or what it represents.
What is a digital token?
A digital token is a unit of information exchanged between users or machines to facilitate and represent a real-world transaction. The transaction can be anything from an online money transfer to subscribing to a service.
What about crypto tokens?
With the introduction of bitcoin and the rise of blockchain technology, we got crypto tokens.
Crypto tokens are created through tokenization, a process of converting rights to an asset into a digital token protected by cryptography, tracked and exchanged on a blockchain network.
Crypto tokens usually represent a particular fungible or non-fungible asset or utility.
Fungible! What’s that?
Fungibility refers to the interchangeability of a good or asset. Put simply, when something is fungible, it means every other thing like it has the same value.
Fungibility is a core property or money.
Let’s say you have a 100 US dollar note. You probably don’t care if someone took it and gave you another 100 US dollar note in its place.
For you, it’s the same; it holds the same value.
One may be a little worn out, crumbled, or someone decided to use it as a temporary notepad. It’s still a 100 US dollar note, and it has the same value.
However, you wouldn’t feel the same if someone took your 100 US dollar note and gave you a Canadian 100 dollar note because they do not have the same value.
We can say US dollars are interchangeable and therefore fungible. However, US dollars and Canadian dollars are not interchangeable, therefore, not fungible.
How NFTs turned silly cats into a serious business
Crypto Collectibles or Non-Fungible Tokens (NFTs) are crypto tokens.
However, unlike fungible crypto tokens, each NFT is unique, different, distinguished from another NFT, and cannot be duplicated.
CryptoKitties is an excellent example of an NFT.
The first game of its kind built on the Ethereum blockchain, CryptoKitties is a product of Dapper Labs, which valued at $2 billion at the time of writing this article,
CryptoKitties was started by a DJ from Vancouver, Canada, who loves cats.
Each CryptoKitties token represents a unique virtual cat that people can purchase, trade, raise, and even breed with other CryptoKitties.
Think of them as digital trading cards that people can get to mate with each other 🙂
In reality, an NFT is just a unique number, an ID. We then attach information to make it mean whatever we want it to mean.
In the case of CryptoKitties, the ID points to a unique digital cat with specific characteristics (colour, eyes, shape, attitude, breed… etc.)
We can attach those IDs to any physical or digital asset or thing and make it so that the ownership of that ID means the ownership of the physical or digital asset.
So when you own an NFT, you get all the benefits from that ownership of the physical or digital asset it represents.
So a Non-Fungible Token is:
- Proof of ownership of a real or digital asset
- A unique ID number
- All the identifiable characteristics of the asset
- All the rights and privileges that come with ownership
- Coded, packaged, encrypted using cryptography.
- Recorded and tracked on a blockchain
Why do we need crypto tokens and blockchain anyway?!
Assets, tangible and intangible, are the cornerstone of business and trade. They are the resources we use to create, deliver, and capture value.
Tangible assets like real estate, vehicles, equipment, art collections, precious metals, fossil fuel, and crops are costly to move and transfer.
Intangible assets like patents, copyrights, music, digital art, and trademarks, while easier to move and transfer, are difficult to subdivide.
Depending on the asset, trades may have to go through extensive regulatory processes, centralized systems, and trusted middlemen, leading to high costs, the lack of efficiency, and security and privacy vulnerabilities.
These challenges make markets highly illiquid and not within reach of most people.
When an asset is tokenized, it becomes much easier to trade, and it can be made accessible from anywhere in the world. Tokens, after all, are pieces of information that can be transmitted on the internet and tracked using a distributed ledger (a blockchain).
Tokenization can be done without using a blockchain. That’s what the stock market is. With every stock you purchase, you own a fraction of a company.
However, maintaining and running a stock market requires extensive technology infrastructure, intermediaries to handle clearing and settlement, and regulators to ensure everyone plays by the rules.
When assets like stocks are tokenized using a blockchain-based system, there is no need for a central authority, intermediaries, or regulators to manage the exchange of those assets.
In a blockchain-based system, the rules can be built into the blockchain software and applied to everyone, eliminating the need for a regulating body.
So what’s the big deal?
When Gary Kremen registered Sex.com, he put his trust in Network Solutions.
Stephen M. Cohen was able to trick Network Solutions into giving him ownership of the domain without Karme’s permission.
But he could only do that because Network Solutions had the power to transfer the ownership.
What if we remove Network Solutions from the transaction and replace them with a decentralized system registration domain (a domain registration blockchain).
We can then issue Karmen a non-fungible token representing his ownership of Sex.com.
Cohen would have no central authority to trick, no one to persuade to transfer the domain ownership to him.
He would have to successfully hack all the computers that make up the domain registration blockchain without alerting anyone on the network, pulling off what’s close to a technological miracle, or he would have to purchase the NFT from Karmen.
Through the use of crypto tokens, real and digital assets represented by these tokens are now like digital stocks that can be traded, tracked, and recorded using an immutable distributed ledger, making the proof of ownership irrefutable.
This opens up unlimited innovative opportunities.
You are no longer relying on a central authority to regulate, give permission, price, distribute, keep track, or manage ownership.
So there is no risk of having the ownership of your real or digital assets wrongfully transferred without your permission.
What’s possible with NFTs?
Many will live their life without the prospect of seeing a Picasso in real life, but with tokenization, it is possible to change that.
Picasso’s masterpieces are in short supply and cost a fortune. The cheapest drawings are worth hundreds of thousands of dollars, and the most expensive was sold for $179 million.
So if we want to make a Picasso masterpiece available for many to own and enjoy the return on their investment, we must tokenize it.
That’s one way, but if the owner of the Picasso is not willing to share its ownership, they can still:
- Sell the rights to 100 high-end prints in real size; each can be represented by an NFT called PicassoReal
- Sell the rights to 500 high-end prints in a smaller size; each can be represented by an NFT called PicassoSmall
- Sell the digital right to own a digital version of the painting that can be represented by an NFT called PicassoDigital
If you decide to own a high-end print, say print 34/100, you also receive an NFT called PicassoReal proving that you are the owner of that print.
You can verify that the owner didn’t issue more than 100 PicassoReal tokens and find out how many were sold.
You can choose to hang on the print and sell it later for a higher price. When you do, you also transfer the ownership of the NFT to the person who bought the print to prove they are now the rightful owner of the print.
However, if someone got the print illegally or created a fake print, they can’t prove the ownership since they do not have the NFT representing that print.
Why are creators and artists excited?
Imagine you are Picasso in your early years, you are still unknown, and to earn some income, you sell your paintings and artworks for whatever people are willing to pay you.
A few years pass by, you gain some publicity, and now you have some galleries brokering the sales of your artwork. They are getting anywhere between 30-50% to do that.
Fast forward 10-20 years, and you are freaking Picasso; your paintings are selling for millions at auctions.
Awesome, right?! No.
You don’t see a penny of those millions because you do not own the art being sold, you don’t know who owns it, and you have no way of tracking it.
In yesterday’s world, artists and creators were beholden to industry, intermediaries, and platforms and had to adhere to their terms and conditions.
If Picasso was starting his artistic journey today, he could use NFTs to tokenize his artwork, be it physical or digital.
And as his name gains more recognition, he can keep track of all his artworks as they are being sold and traded. And through it all, he can earn royalties, sell directly without paying any commission to brokers or galleries, and he can enforce a specific usage for his work, so it can’t be displayed, sold, or traded without his permission.
Using NFTs, artists get paid, continue to get paid and maintain control over their work and creations.
Put simply, NFTs give the power back to artists and creators.
With proof of ownership, you can do quite a lot:
- Sell anything that someone else finds valuable – Jack Dorsey is auctioning his first tweet ever as an NFT, and at the time of this writing, it’s worth over $10 million!
- Earn royalties on what you own and what you create – All EulerBeats original owners will earn 8% of the revenues on each print sold of the original.
- Prove your ownership anywhere and everywhere as the value of the assets appreciates – CryptoPunks have sold for a cumulative $43 million.
Final words
In a few years, people will be using NFTs without the need to understand how they work. Just think, out of all the people using email, how many understand how it works?!
Whether the NFT hype continues or goes away, they are here to stay as a vital component of the new blockchain world taking shape right in front of our eyes.
There may be opportunities to make money with NFTs. However, as an innovation that’s still in its infancy, there is much to explore in the coming years. Those who are willing to go beyond and invest in learning and education will probably be the new world’s biggest winners.
Interested in a deeper dive read Non-Fungible Tokens (NFTs): The Ultimate Beginner’s Guide by the writer.