NFTs are Non-Fungible Tokens, unique representations of the ownership of assets immutably recorded in blockchains. Early adopters are using them to represent their claim on digital collectables, artwork and many other unique assets.
It may be useful to contrast this with cryptocurrencies such as Bitcoin that are fungible. For Bitcoin to function as a currency, it has to be fungible. In other words, all Bitcoin are equal and mutually interchangeable. You can’t have a unique Bitcoin.
NFTs, on the other hand, are used to represent unique assets. Unlike banknotes or Bitcoin, no two NFTs are alike. They are unique and contain information that identifies them as unique in smart contracts.
NFTs are a great example of the innovation and growth occurring within crypto. There may be serious earning potential in this emerging market as companies combine them with other Defi tools to create marketplaces that enable anyone to create, trade, buy, and sell NFTs.
This article aims to introduce the world of NFTs and help readers get started by explaining how they work and what to look out for when investing.
NFTs work by storing information that can identify them as unique. They store this information in smart contracts. Smart contracts are sets of instructions written in code and stored on a blockchain. These smart contracts allow for detailed information to be added and permanently tied to an asset.
Primarily, NFTs are used to prove digital ownership of a particular asset. This can range from collectables in a video game to ownership of gold bars. What NFTs provide is irrefutable ownership status that’s recorded securely onto a blockchain and can be sold/traded.
A common scepticism - particularly relevant to digital art - is that surely someone can just take a screenshot of the image, or download a digital file of it, so it’s not truly scarce. However, the same argument applies to any famous piece of art. I can download a picture of the Mona Lisa or visit the painting and take a photo myself; it doesn’t mean I own the Mona Lisa. People have always been, and always will be, willing to pay a premium for original work.
Furthermore, this critique helps to emphasise a crucial aspect of NFTs. They are a representation of ownership of an asset and do not necessarily represent the asset itself. The smart contract will provide details of where the associate digital asset can be found.
Their value is in proof of ownership of a valuable asset. NFTs are like certificates that verify owners as owners. These certificates can be used to trade assets in new and innovative ways.
The recorded ownership status provided by NFTs has led to some exciting innovations.
Given the way NFTs provide an easily accessible ownership history, the value of an asset can be directly affected by its provenance.
For example, if a famous art collector purchases a piece of art via an NFT, the mere fact than an influential collector has owned it, means that this piece of art may be worth more. The NFT will record that this ownership has occurred and ensures that it is tied to the artwork.
An NFT representing the ownership of a guitar that a famous musician once owned could ensure that this value is recorded and attached to the guitar.
A rare fretless bass guitar sold at Bonham's for £237,562, with that price largely driven by the fact it had been previously owned by George Harrison
Another interesting aspect of NFTs is that they enable resale value to be tied to original creators for the rest of the assets life. Imagine you create a piece of art and then sell it. With NFTs, you can add a mechanism that ensures that for every additional resale you receive a certain percentage automatically.
NFTs can also make fractionalised ownership more accessible. It’s important to note that it’s not the NFTs themselves that are fractionalised as they are indivisible. Instead, owners can create NFTs relevant to pieces of a fractionalised asset making buying the asset more accessible.
These are just a few of the innovations that NFTs are enabling, and as with most things crypto, the space is new and continuously evolving.
A lot of the challenges lie in scaling the technology and establishing standard protocols and interoperability. As these challenges are increasingly better addressed, we will see more innovation and use cases for the digital trading of assets that are only made possible by crypto.
For now, though, where does one start with NFTs? And what are the essential things to look for when investing?
Non-fungible tokens can be purchased on many NFT marketplaces, including Rarible, OpenSea, Enjin Marketplace with many more opening up all the time.
You’ll need to have a crypto wallet set up to access these sites; they support popular browser based wallets such as Metamask or Fortmatic.
You can browse these marketplaces for any NFT you are looking to purchase. Their interfaces are intuitive. As you browse NFTs you can click on them to find more details on their owner and bid history as well as their price.
If you find an item you would like to own; you can buy it on-site using your wallet. There will be an option to purchase and then confirm the transaction. Once you do this, and the transaction is confirmed the NFT will be deposited directly to your ETH address and will be yours.
The NFT you have purchased will be stored in your wallet meaning that only you have access to it and you aren’t reliant on a third party platform for this access. The usual caveat around wallet security applies here.
The most common assets that appreciate are those used in blockchain games growing in popularity, with CryptoKitties being the most famous example. These NFTs are used to represent ownership of in-game assets. Decentraland is a crypto hybrid of Minecraft and Second Life, where you can own and trade real estate., with an NFT ecosystem worth more than $24 million.
If the game grows and becomes more popular, demand will increase for these assets and drive the price up. If you believe that a particular game will become more popular in the future, investing in the NFTs of that specific game may just pay off.
Investors need to pay attention to the provenance, reputation, and transaction activity of the NFTs that are of interest. If a token has lots of transaction history and has been attached to reputed creators or traders, you can be more confident about a sound investment.
Deciding what NFT to invest in - like with anything - isn’t easy. Whilst the market is undoubtedly growing with many NFTs appreciating, there are always risks involved, not least is a bubble around values. Not every NFT will appreciate in value, and buyers can be hard to find.
Some NFTs have sold for huge amounts. Take for example, CryptoPunks, an NFT collection of limited supply art images depicting punks. Their supply has been limited to just 10,000 with the rarest ones selling for hundreds of thousands of dollars.
The biggest CryptoPunk sale has recently been recorded for over $750,000 dollars. These are crazy amounts of money for ownership of pixelated images but their value is in their scarcity.
The value of an NFT based piece of art entitled 'The first 5,000 days' by Beeple, sold at Christie's Auction house in London on March 11, 2021
As with any type of investing, it pays to stick to what you know. If you are a sports fans, look at how NFTs are being used. NBATopshot for basketball and Sorare within soccer are two good examples where analogue methods for creating collectibles - cards and stickers - are quickly being replaced.
It doesn't take much imagination to see how this could extend to other niches, from Harry Potter to Pokemon.
Another approach to entering the world of NFTs, which will provide more practical experience, is creating one for yourself.
Making your own NFT is probably the best way to understand the concept and generate potential value. You have control over what assets you want to be represented, and there is little cost aside from time and effort (and transaction fees).
Creating an NFT is known as minting, and various platforms facilitate this process. The marketplaces mentioned earlier such as Rarible can be used and then you can list your NFT for sale.
First, you have to decide what asset you would like your NFT to represent. This could be a song you have recorded, a photograph you have taken or a 3D model you have created. NFTs support a vast range of files, including visual, music, 3D etc.
Once you have your asset in a traditional media file, you can upload it to your chosen platform and mint an NFT from it. This process will involve filling out the details such as a description of the asset, royalty percentages and more. Note - you will need to pay relevant transaction fees to confirm the creation of your NFT so ensure that you have funds available in your Ethereum wallet.
After you have minted your NFT, you can now list it for sale on a marketplace, and if people like it, you might get a sale. Going through this process will help you understand how it works, and the power NFTs put in creators’ hands.
NFTs are a fun and engaging sector within the crypto world. Their use is growing fast and so now is a great time to get involved. If you fancy yourself as being able to spot undervalued assets, NFTs can provide a way of leveraging that talent.
If not, create your own from a piece of creative work you are proud of and make your work directly available to an audience.
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