NFTs — What, How, and Why
A Small Correction: In this article I refer to Earth2 as a blockchain technology, however this is not the case. Question 82 on Earth2's FAQ page says using the blockchain is not a decision they have made yet.
When I first heard the term NFT in the news this month, the overwhelming narrative was: “People are selling digital art for millions of dollars! ThAt’S CrAzY!!!”
After practising my Google Fu for a few hours, I started to understand the broader significance of NFTs, as well as their relationship with blockchain and smart contracts.
In 5 minutes, I’ll explain NFTs, their use cases, underlying technologies, opportunities they create and limitations they have.
So, what’s an NFT?
NFT stands for Non-Fungible Token.
A non-fungible item is something unique, because its properties influence its value. An example would be a parcel of land, a trading card or a classical artwork.
This differs from an item which is fungible, which has no inherent difference between items of the same type. An example would be paper money, shares or cryptocurrencies.
A Non-Fungible Token is a transaction recorded on a blockchain, which records the ownership or existence of an object and its properties.
Underlying Technologies
At a minimum, NFTs need a combination of a smart contract and a blockchain to be created. Projects such as Ethereum, Flow, EOS and Cardano provide this functionality.
We’ll refer to Ethereum in this article, because it has the biggest community.
In essence, a blockchain is a ledger of transactions organised into groups know as blocks. A copy of this blockchain is held by computers known as “miners", who add transactions into a block and are rewarded with cryptocurrency when a full block is added to the blockchain.
Having multiple copies of the ledger ensures a single entity is not regarded the source of truth. Maliciously changing the contents of the ledger would require changing it on the majority of machines, which are spread out across the world.
Smart contracts are code scripts that contain internal memory. When a smart contract is run, it is recorded as a transaction and all the miners run the script to ensure it ran as expected. Software developers can write contracts to create NFTs and update their properties over time.
In order for Ethereum smart contracts to support NFTs, they must implement standards ERC-721 or ERC-1155, which specify the technical requirements for a code contract to manage them. ERC-1155 is the most recent standard created, which supports the creation of fungible AND non-fungible tokens.
Current Use Cases
Here are the 3 well-established use cases for NFTs:
- Buying and Selling Digital Goods— Items such as: digital art, trading cards, domain names, music files and video files can be given an associated NFT to record its ownership. Right now, online platforms exist so people can setup an online store, create their own NFTs (sometimes called “minting”), auction them and earn income. Companies that enable this include Opensea, Mintable and Rarible.
- Online Gaming — Games such as Decentraland and Earth 2 are selling in-game real estate to players which they can own, buy and sell. In Decentraland, users purchase NFTs called LAND which represent parcels in the game, allowing them to host static scenes, games or interactive applications. Earth 2 is selling tiles in real world locations and eventually plan to create a VR world that mirrors Earth, along with a resourcing system which will give LAND the ability to generate resources which can be traded or purchased in-game.
- Supply Chain Tracking/Analysis — Organisations can create NFTs to track products through their supply chain. That data could then be used to analyse the efficiency and/or sustainability of the process, as well as visualise the product’s journey to an auditor or customer. The SaaS company Everledger allows businesses to track and report on events in a product’s lifecycle, including: clothing, diamonds, gemstones, art, luxury goods and alcohol.
Opportunities
When discussing the opportunities presented by NFTs, it helps to think of them as an enabler of technologies which could revolutionise or disrupt the status quo.
From the example above, we’ve already seen how NFTs help artists define ownership of their work and find new ways to earn income. This could also be applied to physical objects (e.g. cars), while extending the functionality of those physical objects.
The team at Alpha Wallet prototyped a solution to handle common features of car ownership via mobile app, including: storing registration details, starting a car, locking and unlocking doors and selling.
For governments or other identity providers, NFTs could be used to generate authentic documents for citizens or users of their platform. Digital documents would reduce the speed, cost and security of the processes within the document’s lifespan, such as: lodgement, modification and revocation.
Broadening Everledger’s approach, NFTs could be used to document events within any process* to analyse its compliance, efficiency or sustainability. This data could then be provided to interested parties, including: regulators, customers, partners and suppliers.
In the context of companies like Decentraland or Earth2, NFTs could be a critical way for people to own resource generating land in virtual economies, which could impact the distribution of wealth in the physical economy.
Limitations
NFTs may be the mechanism to certify ownership or identity, but it only matters if enough people accept that ownership. Even though blockchains create systems where trust that isn’t reliant on one entity, there will be authorities required to endorse (and enforce) an NFT being generated.
This has been lacking for digital art NFTs where fraud is quite common.
For NFT issued by governments or identity providers, they are usually the source of authority. With that in mind, those authorities need to be trustworthy enough to safeguard the legal rights of owners.
NFTs also need to rely on the trust and effectiveness of their underlying technologies, such as the blockchain which stores the NFT and the smart contracts that manange the NFT.
The Ethereum project has been criticised for its lack of scalability, causing an increase in the cost of running smart contracts. Crypto projects such as Bitcoin and Ethereum have also been criticised for their high energy consumption.
Many of the technologies surrounding NFTs are past infancy, but more time is needed before they can be considered mature. Developers need the willingness and financial backing to support these projects as they improve.
Conclusion
NFTs are a small part of a much bigger change in the way ownership and identity are managed. They have the potential to change established industries such as retail, entertainment and procurement; as well as support relatively new industries, such as virtual real estate and virtual trade.
Platforms such as Ethereum have active support for NFT creation and management, but will need more work on them to improve their efficiency and viability. Figuring out the appropriate enforcement of NFT ownership and how that enforcement occurs will also need to be considered before mainstream adoption.
Putting this article together has been a great way for me to get educated on the state of crypto in 2021. If you have any feedback on this article, feel free to send me a LinkedIn message; and if you liked it — send claps!
*Side Note: The run of an individual business process is sometimes referred to as a ‘token’. In workflow management software, where a token is stored, a token can contain data about previous steps that occurred in the run.
