If you look around the internet enough, it’s not hard to come by a vast array of definitions for and descriptions of NFTs. The basics:
I’m by no means an expert myself, but I’ll do my best to explain what all of that means as clearly as possible - without too much rambling.
Okay, they’re Non-Fungible Tokens. What does that mean? Fungible means “being something (such as money or a commodity) of such a nature that one part or quantity may be replaced by another equal part or quantity in paying a debt or settling an account.” The word derives from the Latin word fungi, meaning “to perform.” In essence, to be fungible means to be able to perform the same function or hold the same value as something else of the same kind - in paying a debt or settling an account. A common example you’ll find is cash. You could swap my 10 AUD note for your 10 AUD note and expect to be able to pay for the same 10 AUD amount, or even swap my 10 AUD note for your two 5 AUD notes and still be able to purchase the same 10 AUD value. Similarly, one tonne of wheat should be just as valid as another tonne of wheat (provided both are of adequate crop) to satisfy a customer’s order for a tonne of wheat.
Therefore, to be non-fungible, an item does not have the same value as another of its type. An example of this might be a handmade custom guitar, such as Willie Nelson’s guitar Trigger or Bruce Springsteen’s Fender Esquire. By virtue of being the tools of such globally renowned musicians, no guitar will ever be worth exactly the same as these, even if you were to try and replicate the exact modifications and customisations that these guitars underwent. Since a lot of NFTs on the market are visual artworks/ images, another common analogy for understanding non-fungibility is to differentiate an original painting vs an art reproduction. You can get as close as possible to replicating the canvas, paints, strokes and finish of Monet’s Water Lilies, but it will never be worth as much as the original. But aren’t these NFTs just jpegs and so more or less digitally identical? For the most part, yes. We’ll touch on that later.
The Token portion of NFT suggests that they are not inherently ‘items’ or ‘valuables’ themselves, but rather tokens or symbolic representations of other things/ concepts. A rather outdated comparison would be purchasing tokens at game arcades. These tokens stand in place of fiat currency in the ecosystem of the arcade and are used as currency to play different games. Or if you were to see a show and check in your bag and coat in a cloak room, you’re likely to receive a ‘token’ indicating your ownership of the items tagged 24D on the rack. Much in the same way, NFTs mostly act as tokens representing something else of value.
So NFTs are non-fungible tokens, but where do they come from? Who makes them? One of the keys to understanding their existence is that they are built on blockchains, the bedrock of the recent cryptocurrency boom. Blockchains are ledgers or records which record data in blocks. The blocks are chained or linked together by referring to properties of previous blocks using cryptographic hashes (encrypted data). Blockchains are managed by a network of nodes: participants in a connected system who work together to maintain the state of the blockchain. Buzzwords you may hear around blockchains are ‘decentralised’ and ‘distributed’; in the network of participants that manage most blockchains, there is no key authority which can overrule all other nodes, and the work of managing the blockchain and its accuracy/ progress is spread between all of the nodes.
A popular blockchain analogy that I am fond of is The Island of Boulders (it may have a different name, but its origin is seeded in human history!). Consider an island of people with an abundant supply of incredibly large, immovable boulders. Each boulder has a name and as such everyone knows which boulder is which. These boulders are divided amongst the islanders, and the ownership of each boulder is recorded on a large monument in the middle of their town square. Throughout each day, islanders may decide to exchange or give away ownership of their boulders. They’re a fairly talkative, cooperative and close knit community, so whenever they agree to a transaction or change of ownership, others know: people might overhear the exchange, they tell their friends, so on and so forth. Each afternoon, the islanders gather at the monument to discuss changes in ownership of boulders. Now let’s suppose two islanders Alice and Bob (common names used in computer science owing to their initials) have agreed to a deal where Alice is exchanging her biggest boulder for Bob’s biggest boulder. Upon reaching agreement, Alice and Bob have told their friends and family, who have then spread the word. At the end of the day, relying on what they have heard, the islanders discuss and then agree that the boulder exchange between Alice and Bob has occurred. The new ownership of boulders is recorded on the monument for all to see. Should the islanders disagree strongly on the nature of the exchange, it will not be recorded on the monument and the monument shall remain unchanged. As the meeting adjourns, everyone writes down their own copy of the boulder ownerships recorded on the monument and takes it home with them.
This system is decentralised because there is no single key player or authority to overrule the monument. i.e. There is no mayor or governor who can deny a transaction has occurred or can stop the agreement of the people to change the monument. Similarly, it takes the majority of the community to agree on a transaction taking place. Should anyone lie about what transactions took place, the community, having correct information, can overrule that person. Additionally, should anyone try to tamper with the monument while everyone is asleep, it will become apparent to everyone else, as they have their own copy and can verify that an error has been made, returning the monument to its original state.
Of course, there are several flaws in this analogy, the major one being that generally blockchains are considered ‘trustless.’ Since nodes in a blockchain network are often (but not always) anonymous and spread over a public system, it’s impossible to know who everyone is and that they can be trusted to share the truth about the transactions they ‘hear about.’ It is impractical to gather everyone on a blockchain spread across millions of nodes on the internet to discuss and argue what transactions have occurred. That is why blockchains use Consensus Algorithms to reach high Byzantine Fault Tolerance. These are two terms which are important for the efficiency and security of blockchains but are themselves intricate topics, which should be discussed in a separate article. For the time being, you can understand blockchains by knowing that there are certain cryptographic means by which everyone in the system can agree on and update blocks in the blockchain. I highly encourage you to look into consensus algorithms which include concepts you may be familiar with such as ‘Proof-of-Work’ and ‘Proof-of-Stake,’ as well as the ‘Byzantine Generals Problem.’
Bitcoin, Ethereum, Dogecoin and the myriad of other cryptocurrencies in existence exist on their own blockchains. Their state is managed by networks of nodes around the globe, and NFTs exist as objects on different blockchains as well. At the time of publication, most NFTs are built on the Ethereum blockchain, although the offering of NFTs has extended well beyond Ethereum to its own metaverse of blockchains and ecosystems which support NFTs.
Digital assets are a vague and widespread category of assets, the limits of which are really up to your imagination. They can start as simple as pdfs, docs, jpegs, pngs - i.e. basic files that we use and exchange every day. They can get slightly more complex like mp4s, MOVs, WAVs and Vector Files. These are still single file types. They can be groups of files like folders. They can be applications and scripts. They can be websites. They can be currencies like Bitcoin. More or less anything that exists in a digital format can be a digital asset.
Of course, some digital assets have more readily available commercial value than others. This article is a digital asset with a copyright that I could sell, but it would take a little time to find its value and the appropriate buyer, then draw up a contract for its purchase. Commercial Digital Assets like cryptocurrencies, domain names and NFTs tend to have marketplaces where they are bought and sold, as well as Digital Wallets where they can be securely stored. And of course, assets which exist on a blockchain come with their own advantages and disadvantages. Again, this could be discussed at length, and will likely be explained further in a subsequent article.
Okay, so an NFT is a digital asset, so what? When I buy an NFT, what am I actually getting? As previously mentioned, digital assets take many forms. Similarly, NFTs are digital assets that ‘tokenise’ or represent the value of other digital assets. If we return to the example of me selling the rights to this article, if I tokenised the article, selling with it the original file, the right to publish it and ownership of the articles ideas, then there now exists an asset which can be much more easily traded and sold. The NFT holds all of the data pertinent to the contract of the sale, and then the sale is verified on a blockchain, for all to see. But there is a lot of abstractness and uncertainty with the purchase of an NFT. So here is a string of FAQs which may better explain the concept:
So I bought the NFT for this article - do I own the article? If I buy an NFT for an artwork, do I own the rights to the artwork?
Yes and no, sorry. I, as the creator of the NFT, can stipulate many different conditions around the underlying asset which determines the NFTs value. So I can create an NFT and agree that it will be the only genuine NFT created for the article; and I can agree that you now own copyright over the article, alongside all of the publishing rights and royalties etc. These terms will all be written into the NFT. But, if I so choose, I can create an NFT with no guarantee of exclusivity, giving you no rights to the publishing of the work and nothing but a digital certificate which I have signed saying that it is a genuine NFT which is linked to this article. Obviously the first NFT has more value than the second. You may have heard of different artworks selling as NFTs for hundreds of thousands of US Dollars to upwards of tens of millions of US Dollars. Most of these NFTs do not include copyright of the image. The NFTs are merely digital assets which reflect the value of the underlying artwork.
So, I can spend millions of dollars on art… which I could have found through a basic image search and then saved to my harddrive?
Yes. Most of these high profile sales feature image files which can easily be found online.
So why can they be worth so much?
Some people like to compare these art NFT sales to buying original prints vs art prints. Some physical artworks are created by using a matrix - a plate or block which is made by the artist - which transfers an impression to another surface for sale, in a process which is repeated several times over. The matrix will be destroyed to ensure no further prints, and each print is signed and numbered by the artist. These ‘limited edition’ original prints are more valuable than mass produced art prints because of their short supply, original status and the artist signature, even though the image and printing technique can be nearly identical. NFTs retain some of their perceived value from the limited supply of tokens and the signature of the artist attached to it. A further argument could be made that prints are close in nature but never exactly the same, whereas digital copies are bit for bit replicas, making them digital identical clones. True! Again their value is derived from the signature of the artist, and the limited number of tokens themselves.
I still don’t understand what I’m paying so much for.
Like many things in the world, you don’t always ‘get what you pay for.’ Fashion, art, music and collectibles are all realms where value is abstract and highly subjective. The same material and cut of white t-shirt can quadruple in value with simply a few dollars or less worth of ink to print a logo. You can pay money to see a performance of John Cage’s 4’33”, an avant-garde experimental piece of music which is four minutes and thirty three seconds of silence. You might pay more for a beat up, inoperable, dirty chevy than for a brand new sports car off the line just because Elvis used to drive it.
In life, we attach our own value to things. Sometimes it is an unexplainable and intangible value like certain memories that we cherish, connections and emotions we feel for family and friends. Other times it is value that might have to be quantified so that something can be bought. These values can sometimes be wrought by mere faith. You have faith in the opinion of a friend who seems to have a deep understanding of BBQs, so your perception of BBQ value can be tethered to her perception of BBQ value. Without tasting it you might buy a bottle of wine endorsed by your favourite artist or celebrity simply because you value their opinion and perspective, even if you feel it is ‘overpriced’. You might buy your groceries from a local grocer and pay more for what is equally fresh and tasty produce as what you would find in a supermarket because you value supporting your community. Likewise, you may purchase an NFT because you like the idea of owning this piece of digital history, or because you want to support an artist, or because it seems like something fun to collect.
But all of these things you described are physical objects or experiences. When I buy an NFT I don’t really get… anything?
In some ways, correct. The most important thing to remember when trying to assess the value of NFTs is that they are digital assets. 1s and 0s. Digital, abstract reflections of other digital things. You might invest in NFTs because you see value in them. You might invest in NFTs because you think other people might value them. But the more time you spend online and in the digital world, it can become easier to see why people value digital things. Years ago, it might have seemed ridiculous to pay thousands of dollars for a domain name. It might have seemed strange to spend so much time on things like Search Engine Optimisation and Marketing. But the more you navigate the internet, the more you can understand how a good domain name and a well built website can drastically affect your digital real estate, and as a corollary impact your business for better or worse. These concepts exist in purely digital realms.
Online video gaming is an industry worth billions, and is all digital. People can often spend just as much time wandering through these games as they do exploring the real world. Whether or not you agree that this is a good way to spend one’s time, it cannot be denied that the digital world possesses a power to manifest ideas and values that the physical world cannot, which is why so many people are drawn to it. And if you can come to accept that possibility, then you might start to see how digital assets like NFTs can be worth something, especially as the ecosystem around NFTs continues to grow.
To find out more, stay tuned for our next article which will discuss the value proposition of NFTs in a little more detail as we dive into popular use cases, big NFT markets, and who is actually ‘minting’ them.
