What Is an NFT; Should I Care About It?
The NFT craze has taken over the internet with popular NFTs soaring to absurd prices. But what are NFTs all about?
May 27, 2022
This article is provided for informational purposes only and should not be construed as legal or investment advice. Always consult with a professional financial or investment adviser before making investment decisions.
Cryptocurrency has exploded from niche to mainstream in the last few years. And as crypto itself took off, so did crypto-based projects and assets, such as NFTs.
But what is an NFT, exactly? It stands for non-fungible token. This guide will go over everything you need to know about NFTs and provide a birds-eye view of what’s driving the NFT craze today.
What is an NFT?
NFT stands for non-fungible token. An NFT is essentially a unique piece of data that exists on the blockchain.
“Non-fungible” means unique and non-exchangeable. To understand this, it’s helpful to look at the opposite — “fungible” assets.
A US dollar is a fungible asset. It’s worth $1 USD and could be exchanged for another dollar bill, deposited into a bank account or used to buy goods or services. It has value, but it’s not unique. Bitcoins or Ethereum tokens are also examples of fungible assets.
An original painting is an example of a non-fungible asset. It can’t simply be exchanged for another painting of equal value or beauty — it’s unique. It could have a very high value or no value at all — that value is defined by what other people are willing to pay for it, rather than by any underlying intrinsic value.
So, an NFT is a token that’s non-fungible, meaning verifiably unique. There’s only one of each NFT, and each is identified by unique ID tags and other details.
Most NFTs currently represent digital artwork. Many popular NFTs are part of a series, including brands like the Bored Ape Yacht Club, CryptoPunks and The Sandbox.
However, NFTs could technically represent many different things — the deed to a house, the copyright to a patent or even the digital ownership record of an original song.
How do NFTs work?
Most NFTs operate on the Ethereum blockchain.
The Ethereum blockchain is the technology that powers Ethereum (ETH), one of the most common cryptocurrencies. The blockchain is essentially a public record or ledger, which lists every transaction that occurs involving Ethereum.
NFTs “live” on this blockchain. Each has a unique identification tag used to verify the authenticity of the NFT. This record is publicly available on the Ethereum blockchain.
An EFT can only have one owner at a time — and this information is also listed on the blockchain. If an EFT is sold to another person, the transaction will be public record and the asset (and proof of ownership of that asset) will then transfer to the new owner.
What is the point of NFTs?
NFTs can represent proof of ownership of a digital item. The proof is publicly available and verifiable by the blockchain.
Since NFTs are currently often used for digital artwork, the craze mostly involves artists selling NFTs of their digital art — often for hefty sums of money.
At this point, the NFT craze is mostly driven by speculation. The prices of NFTs have been increasing dramatically, so investors and speculators keep buying.
NFTs also present a way to support your favorite artists and creators. Anyone can mint and sell an NFT — it’s just a matter of whether people think that NFT has value or not.
In the future, however, NFTs could be used for other activities that require proof of ownership and authenticity. The deed to a house — or the paperwork proving ownership of a business — could both be made into an NFT, for example.
Proponents of NFTs argue that non-fungible tokens can potentially help to solve or address many different problems; they could cut down on bureaucracy and paperwork, or speed up the process of buying and selling assets.
Remember, theoretically, an NFT could be designed to represent digital proof of ownership of almost any asset. NFT technology could possibly be involved in the future when we buy a used car, put down an offer on a house, or even purchase something like a concert ticket.
The potential of NFT smart contracts
Another interesting utilization of NFTs involves the use of smart contracts. Put simply, smart contracts allow the option of creating advanced contracts and protocols that can execute automatically when certain conditions are met.
For example, an artist could set up an NFT that provides them with ongoing royalties each time it’s sold. They might sell their original NFT for $1,000 and use a smart contract to attach a 5% royalty whenever that NFT is resold. In this case, if the NFT later sells for $2,000, the original artist would automatically receive a $100 payment for royalties.
Importantly, smart contracts don’t require an intermediary or “middleman.” Once set up, everything’s automatic. It’s simple enough to see that this technology could be very useful for royalties, managing distribution rights and more.
How are NFTs bought and sold?
Non-fungible tokens are traded in NFT marketplaces. Examples include OpenSea and Rarible.
These marketplaces are structured somewhat like classified ads. NFT owners (which could be the original creator, or someone reselling the NFT) can list their NFTs, along with an asking price. Other marketplaces exist as auctions, similar to how eBay works.
Most NFTs exist on the Ethereum blockchain and are typically sold for Ether (ETH), the native token of the Ethereum cryptocurrency. That means that you need to own ETH before you can buy an NFT.
Individuals can buy ETH on a cryptocurrency exchange, such as Gemini or Coinbase. They can then use this ETH to purchase an NFT on a third-party NFT marketplace.
For NFTs that exist on other blockchains, those assets are typically bought and sold using the native token of that blockchain. For example, NFTs on the Solana blockchain are sold in SOL, the native Solana cryptocurrency token.
Need a refresher on crypto basics? Check out this crypto 101 guide.
Non-fungible tokens are pieces of digital data, existing on the blockchain, that represent verifiable ownership of a certain unique asset or digital file.
The NFT craze has driven prices sky high. Nobody knows whether this trend will continue. And indeed, it’s unclear whether NFTs are just a trend or if they may transform various aspects of our financial and legal systems. Time will tell.
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