NFT Basics

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If you follow the news on cryptocurrency you’ve likely heard about the hottest new craze – NFTs (Non Fungible Tokens). Headlines touting multi-million dollar sales at Christie’s and the exploding value of CryptoPunks (a specific NFT collection popular with celebrities) catch the attention of the public and are driving massive interest into this formerly niche technology. This article is a very entry level brief on NFTs as a technology and relevant applications.

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Fungible vs Non Fungible

In order to understand what’s happening with the wild valuations on NFTs one needs to understand the difference between fungible cryptocurrencies and non-fungible tokens. Fungible cryptocurrencies, like Bitcoin or Ethereum, are meant to store value, monetary or otherwise, in identical units of exchange. Think of a dollar bill - one slip of paper is assigned a value that we all agree on and use. Fraudulent bills, roller coaster monetary supply and the concentration of power with centralized institutions are all concerns with our current fiat system. These problems are addressed with fungible cryptocurrencies.

Non Fungible Tokens are completely unique digital assets that are used to confer ownership over something specific. These tokens, similar to Bitcoin, are housed in a blockchain framework but in this application the units aren’t the same. Each token is different, but the secure method behind blockchain technology still applies. These tokens can represent anything from music rights to legal proxy, artwork to shareholder votes and much more - there are no limits. In the Beeple auction at Christie’s from the first paragraph the specific asset was a digital image - a collage that the artist made over a long period of time - that sold for $69M. Whoever won that auction received ownership of the token in an Ethereum wallet managed by MakersPlace, a digital art marketplace.

The NFT Price Party

After the Beeple auction the world saw that there was money to be made in this new NFT space. Companies popped up around the world offering to create NFT collections for big name celebrities such as Lionel Messi’s collection with Ethernity. Other companies, like OpenSea, created markets for individual artists to publish their work. LarvaLabs, creator of the CryptoPunks project, created millionaires nearly overnight with their Punks collection of digital assets. With these eye-popping prices, people rightfully want to understand what’s driving the valuation. While some assets come with certain rights (like exclusive use in a given platform, like a profile picture on Facebook, etc.), many of these pieces of digital artwork are valued at market price in the purest sense. Leonardo da Vinci’s ‘Salvator Mundi’ (Savior of the World) masterpiece sold in 2016 for $450M to a Saudi royal at a Christie’s auction making it the most expensive piece of art ever sold. The same valuation method applies to these NFT art pieces - whatever someone can get for them, by whatever means.

Other Applications - Smart Contracts

While digital art is a useful application of the technology there are countless other value-add uses. In my opinion, the most promising development in the NFT universe right now is smart contracts (IBM’s guide here). In essence, smart contracts are a programmable contract built on an Ethereum network that handles trust for you based on given parameters. With a smart contract you can program an asset to be placed in an escrow account that only releases to the other party if a certain number of conditions are met (i.e. funds deposited, work done, etc.). My go-to example for this is real estate. Your deed could be represented by a digital token and sold via a smart contract. It would be placed in escrow until which time the buyers deposit the selling price in a given currency into the escrow account. The transactions are subsequently verified on the blockchain and the deed would be transferred. No closing costs, scheduling conflicts or headaches necessary.

Startups around the world are building ways to bridge this gap between digital assets stored in blockchains and the tangible, physical world. Tasks such as international payment processing, mortgages, insurance, and endless more will be augmented in some way by this blossoming technology. The elephant in the room, however; how will governments respond? Stifling regulation and haphazard language in legislation could kneecap this entire industry at any time, so major players are watching carefully for what will happen next.

About the Author

Ryan Daigneault is a Financial Analyst and writes occasionally on AI, Blockchains, Economics and other topics. He can be reached at [email protected].