What is a Non-Fungible Token (NFT)? and How do NFT’s Work

While the concept of non-fungible tokens (NFTs) can be traced back to 2012, it’s only recently that they’ve garnered sustained attention from the mainstream media.

This has occurred as they’ve skyrocketed in popularity of late, with several high-profile sales having taken place through February and March this year. An original Banksy was recently burnt and destroyed as part of a viral live-streamed video before being sold via an NFT that represented the work for $380,000.

In February, a classic LeBron James clip was sold in NFT form for $99,000, while a looping video clip iteration also changed hands for $26,128 around the same time.

This represents just the tip of the iceberg for NFTs, which have evolved considerably since their inception nine years ago. But what exactly is an NFT, and what are its most prominent use cases?

A Brief History of Non-Fungible Tokens

At its core, an NFT is simply a unique and non-interchangeable digital asset whose ownership is recorded on a blockchain. The word ‘fungible’ means interchangeable, so assets categorized as NFTs simply cannot be exchanged as like-for-like entities on any particular network.

What’s interesting is that virtually any piece of digital content can be minted into an NFT, from iconic Banksy artwork to songs and famous tweets. The scope and potential use cases for NFTs remain virtually endless. To this end, Twitter founder Jack Dorset recently put his first-ever tweet (from March 21st, 2006) up for auction in the form of an NFT. Bidding has already reached $2.5 million at the time of writing.

We’ll further detail how NFTs work later in the piece, but arguably the first iteration of this technology existed in the form of colored coins. Colored coins were first discussed in a 2012 blog post written by Yoni Assia, with these entities consisting of small denominations of a single Bitcoin (BTC) token. Colored coins subsequently represented several assets across various use cases, including property, coupons, and company shares. Despite their complex nature, they represented a huge evolution in Bitcoin’s capabilities, while they also laid the foundation for the modern NFTs that we see replicated today. This partly inspired the launch of Counterparty in 2014, which was formed as a peer-to-peer financial platform and distributed an open-source protocol developed on top of the original Bitcoin blockchain. This allowed for asset creation within a decentralized exchange, while it also housed the first-ever game (Spells of Genesis) to issue in-game assets onto a blockchain in April 2015.

Similar projects followed as the concept of NFTs grew in popularity, although it wasn’t until October 2017 that it began to hit the mainstream. At this time, ‘CryptoKitties’ was launched on Ethereum’s blockchain network, with this described as a blockchain-based virtual game that enabled players to adopt, raise, and trade virtual cats in the form of NFTs.

Coinciding with Bitcoin and the crypto market’s infamous bull run of 2017, the launch of this unique project hit the headlines, even featuring on mainstream news sites such as CNN. This was largely due to the relatively high profits available through trading. Simultaneously, the immense success and popularity of the game caused many to realize the full potential of leveraging NFTs.

Before this years’ explosion of non-fungible token sales, 2018 and 2019 also saw considerable exponential growth within the NFT ecosystem. During this time, more than 100 high-profile projects were initiated. However, it’s fair to say that the trade volumes for NFTs and similar assets remained small about alternative cryptomarket niches.

Still, the market for selling NFTs as a digital representation of iconic artwork has exploded of late, with YouTube personality Logan Paul making more than $5 million selling such assets over two days as recently as February 2021.

Overall, it’s thought that musicians have now sold more than $4 million in NFTs throughout the global industry, with this number likely to increase exponentially in the near, medium, and long-term. We’ll explain why this may be the case a little later on.

How Do Non-Fungible Tokens Work?

As we’ve already touched on, digital content and records can be ‘minted’ into NFTs, with this referring to the process of creating a unique file that exists on a particular blockchain.

In this process, the blockchain acts as a decentralized ledger that records and tracks each NFT while simultaneously displaying the associated transaction history. This data is subsequently coded to have a unique ID and other forms of metadata that no other NFT can replicate, creating a unique and immutable digital record that third parties cannot manipulate.

The software programs used to code non-fungible tokens are referred to as smart contracts, which are central to contemporary blockchains’ appeal and can govern fundamental aspects such as the transfer and ownership of established NFTs. Like the vast majority of software and blockchain applications, NFTs can also be programmed far beyond ownership and transferability concepts. This allows individuals to access far greater functionality, including the capacity to link a particular NFT to an alternative type of digital asset.

Thanks to this transparent, immutable, and ultimately scalable process, NFTs are afforded scarce and originality attributes. This makes them particularly attractive when paired with digital media, while it also allows unique assets (such as Banksy artwork) to be replicated by NFTs without losing their inherent value. In this instance, a human asset is simply transferred into a digital one, with the value subsequently moved seamlessly onto the remaining NFT.

Why Non-Fungible Tokens are all the hype today

Given that the history of NFTs can be traced back to 2012, the question that remains is why non-fungible tokens are all the hype today?

The first observation is that the diverse realms of gaming, art, and music have become increasingly digitized in recent times, both in terms of development and distribution. As a result, they’re increasingly compatible with the technology underpinning NFTs, creating an easy-to-understand and more appealing proposition for investors and artists.

From the sole perspective of artists, of course, the proliferation of NFTs provides a unique opportunity for them to sell their content in a completely novel and unique way. As a result, they can arguably sell even mediocre content at a price premium while simultaneously accessing free and often viral marketing through social media and traditional news networks.

Remember, NFTs also boast a tangible sense of scarcity and a traceable real-world link, which automatically increases the asset’s value while creating a new and exciting outlet for speculative money. Similarly, NFTs allow for quick and secure transactions that leverage the unique advantages of blockchain technology, with this particularly appealing for those whose motivation is grounded in getting rich quickly without compromising on the viability of individual transactions.

Of course, the newest surge of NFT sales is seeing people pay tens of thousands for assets that would otherwise arguably be freely available on social media. Such assets can include memes and animated gifs, with one particular animated cat altered to include a dogecoin token recently selling online for $69,000.

In this case, the NFT assets don’t boast any inherent value or real scarcity, so their popularity is a little harder to explain. This is until you begin to understand how hype itself continues to drive the market for NFTs, with this generating a significant buzz that draws attention to the wider crypto marketplace and the unique technology that underpins it.

Non-Fungible Token Use Cases

As we’ve already seen, art and musical content have dominated the NFT niche, with aspects such as creation, copyright, and ownership highly important and lucrative within these spaces.

However, there are other prominent (albeit less obvious) use cases for non-fungible tokens, including the following:

The Gaming Industry

As digital games such as CryptoKitties highlight, there has always been an affinity between gaming and NFT technology.

Certainly, the gaming industry has spent much of the last decade creating virtual economies within an individual game’s ecosystem. This is underpinned by the type of freemium model that characterizes World of Warcraft (WoW) Fortnite.

In the case of blockchain-based titles, NFTs enable players to trade in-game collectibles securely and in real-time while also guaranteeing authenticity and allowing for fully verified transactions.

Interestingly, gaming-related NFTs work similarly to some cryptocurrency networks, particularly as users can participate in their governance and offer input into discussions on future development within a particular game’s ecosystem.

Sports

There are various transaction challenges faced by fans across a diverse array of sports, from the sale of historic memorabilia without provenance to counterfeit merchandise and tickets’ widespread deployment.

Make no mistake; using NFTs and blockchain technology can help eliminate these issues, as their immutable and transparent nature prevents counterfeit collectibles or tickets from being sold.

One iteration of this would see unique and tokenized game tickets issued directly on the blockchain network, providing a practical use case for NFTs while enabling buyers to protect themselves at all times. While each game ticket may be similar, every entity will be defined by unique identifiable information that connects it to the designated owner on the blockchain.

Going forward, it’s thought that sporting merchandise could ultimately be represented by NFTs, allowing the owner to register and verify official items as theirs.

Real Estate

Real estate represents a slightly different use case for non-fungible tokens, while it is also one of the most interesting types of projects in the marketplace. In this example, a single property is fractionated into multiple assets, subsequently purchased by investors on a blockchain-based exchange network. This allows for collaborative ownership of individual properties, while it also provides a seamless and simplified transaction process whether you’re buying or selling a house. Most importantly, this eliminates the need for a third-party intermediary, potentially lowering the cost of buying and selling homes in the process.

By deploying NFTs as a form of smart contract, sellers can also minimize the risk of conflict or legal disputes about land ownership or a particular estate.

ERC-721 vs. ERC-1155 vs. Non-Fungible Tokens Comparison

When titles such as Cryptokitties were first created on the Ethereum blockchain, developers sought out ways to enhance the standard of gaming through this medium. To this end, non-fungible tokens were developed using the ERC721 standard, which created a formal template that other participating developers agreed to follow from the outset.

However, we live in the age of third-generation blockchains, some of which offer similar functionality to Ethereum and have evolved the concept of decentralized gaming. As a result of this, Enjin has created a newer and approved Ethereum token standard, with this referred to as ERC1155.

But what are the differences between these standards?

Well, ERC-721 is limited to non-fungible tokens only, whereas the ERC1155 standard also makes allowances for fungible and interchangeable assets such as crypto tokens.

Currently, the ERC-721 standard only supports the transfer of a single token or asset at a time, while ERC1155 allows for much larger batch transfers that include numerous token IDs as part of a single transaction. Given that each Ethereum transaction takes between 15 and 30 seconds to complete attempting to transfer numerous ERC-721 tokens at once can be incredibly time-consuming.

When it comes to smart contracts, ERC-721 assets require a separate and unique contract for every token iteration. However, ERC-1155 tokens can be deployed in a single, smart contract for infinite token and asset types, affording users far greater flexibility and autonomy when creating agreements between parties.

The 10 Most Famous Non-Fungible Tokens (So Far!)

We’ll close with a list of the ten most famous and lucrative NFT transactions of all-time, highlighting the immense appeal and popularity of this asset class and how it exploded of late.

These include:

10. Nyan Cat by Chris, on Foundation ($590,000): This featured the popular piece of Internet folklore called the Nyan cat meme, which sold for $590,000 (or 300 ETH) in February 2021.

9. The Complete MF Collection by Beeple, on Nifty Gateway ($777,777.77): This unique NFT transaction combined blockchain-based art with an original, physical component and sold for a premium earlier this year.

8. Hairy by Steve Aoki, on Nifty Gateway ($888,888.88): Similarly, musician Steve Aoki collaborated with Antoni Tudisco to produce a combination of the former’s music and a blue-and-purple figure while sold for a huge and rather specific sum of money.

7. Not Forgotten, But Gone by WhlsBe, on Nifty Giveaway ($1 million): This 16-second video clip of a spinning, gold skeleton gummy bear was another sell recently on the Nifty Gateway platform and managed to reach the $1 million mark.

6. Auction Winner Picks Name by SSX3LAU, on Nifty Gateway ($1.33 million): This example saw electronic music artist 3LAU join the NFT party. This major sale allowed the winner of an auction to name the song played in his next music video.

5. CryptoPunk #6985, on Larva Labs ($1.54 million): This is the first CryptoPunk entry on our list, with this funky fedora one of the latest NFT sales to breach the coveted $1 million thresholds.

4. First Tweet by Jack Dorsey on Valuables ($2.5 million or more): The auction above of Twitter CEO Jack Dorsey’s first tweet closed on March 21st, with the final sale value sure to be $2.5 million or more when it’s finally confirmed.

3. Crossroad by Beeple, on Nifty Gateway ($6.66 million): This is the second digital collection listed by Beeple, with this netting an incredible $6.66 million on the secondary sale market on February 24th.

2. CryptoPunks #7804 and #3100 on Larva Labs ($7.6 million each): These two tradable CryptoPunk collectibles were sold on March 11th for a combined value of 4.2k Ethereum tokens, creating the second most valuable NFT transaction of all time.

1. “Everydays: The First 5,000 Days” by Beeple, at Christie’s ($69 million): Beeple also produced the highest-selling NFT to date, with the crypto artist raising a staggering $69 million for a piece auctioned at the iconic Christies. This was a compilation of Beeple’s first 5,000 pieces of work, and we’re not sure that the record will be topped any time soon!

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