What is a non-fungible token (NFT)?

What Is An NFT: How It Works, Characteristics, and Use Cases

Since the inception of blockchain technology, the world has pushed innovations to a limitless boundary with the key qualities of the technology: borderless, trustless, and digital scarcity. The most recent innovation is non-fungible tokens, also known as NFTs. Perhaps you must have heard how Jack Dorsey, former tweeter CEO sold his first tweet as an NFT for a whooping $2.9 Million. Are NFTs merely pictures of colorful apes on a yacht, are they as lucrative as the media suggests? This article explores what non-fungible tokens actually are, and how they work.

What are NFTs?

Non-Fungible Tokens (NFTs) are cryptographic tokens on the blockchain representing an asset's unique ownership. These assets are either full digital assets or tokenized versions of real-world assets. In essence, imagine creating a digital asset like bitcoin or Ethereum, but adding a unique identifier to each unit of the asset. Simply put: NFTs= Cryptographic token + Unique identifier. NFTs are digital assets that came into existence just recently, and unlike traditional digital assets, their use cases are far more valuable and exciting.

How NFTs Work

Since NFTs are a type of token, they require the blockchain to function. Each unit of NFTs is usually tied to a set of computer programs that exist on the blockchain known as smart contracts. These digital contracts make it possible for anyone to create and own NFTs without the need for a secondary intermediary. Blockchain technology is the best for creating, storing, and transferring NFTs. Its immutability makes it possible to keep a comprehensive list of all the activities regarding a piece of NFT.

The non-fungibility in NFT means that each piece of NFT is unique and does not hold the same value as another piece of NFT: therefore cannot be traded or exchanged with each other for the same value. The NFT market currently valued at $11.3 Billion, largely depends on the Ethereum blockchain for carrying out activities, this is because of Ethereum's chain secure network, data architecture, and smart contract technology. Other Blockchains contributing to NFT activities include Solana, Polkadot, Avalanche, Cardano, Binance Smart Chain, and Flow.

Key Characteristics of NFTs

NFTs are similar to traditional digital assets in a lot of ways, unlike the former which haven't changed over the years, NFTs are far more flexible and valuable. With NFTs, tokenizing real-world assets makes buying and selling much easier. They serve as a more efficient way of reducing fraud that exists with conventional digital assets. Here are a few unique characteristics NFTs possess.

  • Non-Interchangeability: An asset listed as an NFT is usually encrypted using a smart contract, that identifies it and differentiates it from all other assets. Thus, an NFT cannot, and will not be exchanged for directly with another NFT after being minted. For example, when a bored ape NFT has been minted, it cannot be interchanged for another bored ape NFT. 

  • Uniqueness: The way NFT works allows each piece to be unique in terms of attributes. They each have no identical match in shape, content, number, name, and address. Their smart code enabled by smart contracts allows them to be identified as unique objects in NFT marketplaces. Crypto kitties is a collection of over two million kitties, each having its unique qualities.

  • Authenticity: Since NFTs are part of the blockchain technology, and have similar characteristics to the tech. The data of each NFT is usually irreversible and unalterable once it has been minted. When a creator mints an NFT, they are assigned unique IDs such as token ID, wallet address, and a smart contract code. NFT authenticity protocols allow users to confirm the validity of an NFT.

  • Scarcity: The unique characteristic of NFT means that each NFT is scarce, and is the only one that exists on the blockchain. Scarcity is what drives the market value of NFTs. Creators of NFTs can release a one-of-one NFT collection, or a group of the collection has a similar theme. One-of-one NFTs usually are highly sorted, and possess a higher market value. 

  • Resaleability: After a creator mint and sells an NFT, that particular NFT can be continuously resold in the secondary market, creating additional income for the creator. NFT marketplaces allow creators to set a percentage royalty for each NFT they mint. Royalty payments are automated and supported by smart contracts. It allows payments to be transferred to the creator's wallet when that NFT is resold.

  • Collectability: Blockchain technology through NFTs allows objects to be collected in virtual mode, usually done to gain value. The value which could be economic or non-economic is determined by the creator and collectors of the NFTs. Anyone can partake in the NFT economy, after you set up a wallet and account in an NFT marketplace ( e.g OpenSea, Polkadot), you can buy and resell them.

Use Cases Of NFTs

NFTs currently are gaining ground in the digital art world, however, many other industries are integrating the technology of NFTs into running their businesses. Various types of assets can be transformed into digital goods and tokenized. These could range from virtual gaming assets, digital artworks, software licenses, and physical assets such as cars, luxury goods, and real estate. Some current use cases of NFTs include 

  • NFTs as a Virtual Asset: NFTs in the real sense are utilized as virtual assets which could mean the creation of a 1/1 unique piece of digital art on the blockchain. It may also translate to the creation of a crypto collectible art that users could hold for various reasons, such as utility or just the appreciation of the art form, for example, the Bored Ape Yacht Club (BAYC) is a collectible art that has certain utility for holders. Virtual assets could also be virtual games that serve a distinct purpose from traditional video games. An example video game is NFT Axie-infinity, where you collect convertible tokens by showing off your gaming skills.

  • NFTs as Hybrid Assets: These are a category of NFTs with a lasting copyright license to use the NFT for commercial purposes. This type of NFT allows holders license to explore the creative works of an NFT creator. For example, a musician can decide to sell rights to their music in form of NFTs. Holders of this NFT have legal rights to use their music for commercial purposes. Depending on the terms of the smart contract, holders of the NFT also stand an opportunity to have life-long earnings from the profits the record makes. These types of NFTs offer more utility and functionality for the holders. 

  • NFTs as Physical/Virtual Interfaces: This is an innovative approach that allows users to acquire the digital version of a good as well as the physical one. This creates a connecting bridge between a consumer's digital experience and their physical experience. 3D printing serves as the perfect medium for bridging the gap between the digital and physical worlds. 3D printing has been in existence long before NFTs became popular, it date as far back as 2013. Big companies are investing in these NFT interfaces, a popular one is Nike, which filed the trademark for 'virtual goods. Subsequently, they launched Nikeland. Rare goods, luxury items, and fashion items can be integrated.

  • NFTs as Metaverse Experience: The metaverse is a complex term that includes both virtual and augmented reality. It is described as the future of the internet, and many companies have hopped on the bandwagon. Including tech giant Facebook which recently rebranded to a close term called 'Meta'. NFTs are the essential token required for functioning in the metaverse experience. The Metaverse and NFTs are beginning to find common ground. Virtual real estate company Decentraland allows users to purchase plots of land in the form of NFTs, and these lands are represented in 3D. The intersection between Metaverse and NFTs is still a new concept.

Conclusion

Non-fungible tokens have the potential to disrupt global economies, and views on how we interact with one another on a societal and cultural level. NFTs are moving in the same direction as every other thing existing in the new web3.0 iteration of the internet, with the ability to democratize ownership, and grant creators rights to their intellectual properties. Its application is different from anything we have seen in the past with digital assets and has roots in all industries. As we move to this new age of the internet, where virtual and augmented realities form major means of communication, NFTs are proposed to be the core driving force of this innovation.

ByteBao is a leading Web3 law firm that helps clients comply with legal, ethical, and regulatory standards relevant to the blockchain-powered Web space.

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