What are NFTs: everything you need to know about non-fungible tokens

You may have heard that the latest trend in the cryptocurrency world is buying and selling NFTs – sometimes for millions of dollars. But what does NFT stand for and what is behind all the excitement?

The non-fungible token (NFT) gained traction in 2020, drawing attention from the mainstream media and extending interest beyond blockchain technology enthusiasts to investors and consumers.

The acronym NFT stands for non-fungible token. NFTs are giving content creators a new level of control over their work, particularly in the worlds of digital art and collectibles. As assets that carry value, NFTs can also be used in the growing decentralised finance (DeFi) space, bringing together two aspects of the blockchain ecosystem that are exploding in popularity.

This guide tells you everything you need to know about NFTs – what they are, how they work, how to buy and sell them and the risks involved.

What are NFTs?

So, what is an NFT? Simply put, it is a type of cryptocurrency token that runs on smart contracts on a blockchain. This is typically the Ethereum blockchain, although other blockchains can run versions of NFTs. The concept originated in 2015, and the first NFT projects launched in the ERC 20 standard in 2017, with more standards appearing over the following two years. NFTs are now being developed on the ERC-721 protocol on the Ethereum blockchain, as ERC-721 tokens are unique while ERC 20 tokens are identical.

How do NFTs work?

NFTs differ from cryptocurrencies such as Bitcoin (BTC), Ether (ETH) or Cardano (ADA) that act as digital coins. NFTs are tokens that represent digital or physical assets – for example, a piece of art, music, or even potentially real estate – and contain additional information that a coin would not carry. NFTs can be used to authenticate works of art and other collectibles.

What does NFT mean? A token is a unit of currency. A non-fungible token is one that cannot be exchanged for something else. For example, a banknote is fungible in that it can be exchanged for other banknotes carrying the same value, however a plane ticket is non-fungible as it carries unique information and cannot be used in place of another passenger’s ticket. In the same way, an NFT is a unique token that can be used to distribute and verify ownership via the blockchain.

How are NFTs used?

Now, what are NFTs used for? NFTs are being used as a means to sell exclusive items online and have the potential to be used to verify anything that would have value in proving ownership, including:

Even tweets can be sold as NFTs. For example, Twitter co-founder Jack Dorsey auctioned his first tweet in March 2021 for millions of dollars, converting the proceeds to Bitcoin and donating them to charity.

Although digital items can be one of a kind, there is also value in items that might have multiple copies but retain value for collectors, such as sports trading cards.

What are some examples of NFTs?

High-profile NFT sales and projects launched by well-known celebrities and brands have highlighted the potential uses of the technology. Here are some recent NFT examples:

• Actor William Shatner sold 10,000 packs of memorabilia with a total of 125,000 digital photograph NFTs on the World Asset eXchange (WAX Blockchain) in just nine minutes in July 2020. The NFT format allows users to buy and sell the trading cards knowing that they are certified as authentic and carry the full trading history and ownership records. The packs contained shards that could be combined to create new collectibles. In addition, 25 cards could be redeemed for an autographed headshot and one card could be redeemed for an autographed action figure.

• Sportswear company Nike patented an NFT project in December 2019, a system called CryptoKicks that it would use to issue NFTs for footwear. CryptoKick tokens would be used to link physical shoes with digital versions with a range of applications, including verifying their authenticity, trading them on digital marketplaces, using them in video gaming and other virtual environments, and notifying customers when virtual shoe designs are manufactured. The digital shoes could change in appearance and value based on changes to the physical shoes, such as age and use, which would affect their value.

What are the most expensive NFTs ever sold? In February 2021, Crossroads, an animation by digital artist Mike Winkelmann, who is known as Beeple, was resold for $6.6m on an NFT platform called Nifty Gateway. That far surpassed the previous record for a single NFT of $1.55m and was 100 times the $66,666.60 the work originally sold for in November 2020.

At a similar value, music artist Grimes held a $6m NFT artwork auction in February 2021, selling 10 works in less than 20 minutes on Nifty Gateway. The WarNymph Collection includes videos, images and music. A one-off, 50-second video sold for $389,000, while 700 copies of two videos were sold for $7,500 each.

Also in February, the auction for the world's first tokenised album was held. In less than 24 hours, 3LAU, a famous American electronic music producer, sold 33 unique NFTs for a grand total of $11.7m.

NFTs and DeFi

NFTs have great potential to be used in the world of rapidly evolving decentralised finance (DeFi). For example, they can be used to put up fine art, real estate or other valuable assets as collateral for loans or as financial contracts for insurance, stock options or bonds that can be traded as products on secondary markets. They can also be used as governance tokens for NFT marketplaces.

While NFTs have been possible for a few years, it is likely the growth of DeFi that is making them more attractive as digital assets with a range of applications.

Why are NFTs important?

How is the hype around NFTs explained? As a digital record of a real-world asset, NFTs can be used to obtain and exchange ownership of physical assets in a digital marketplace. That has the potential to drive the NFT revolution in the buying and selling of rare and valuable items.

So, what’s the point of NFTs?

When an NFT is “minted”, on the blockchain and the associated content uploaded, the owner has proof that they are the sole holder of the token, establishing the scarcity of the asset.

The adoption of NFTs could turn around the fortunes of the music industry, which has struggled with monetising content in the age of streaming and declining physical sales. Companies such as digital rights management platform RAIR see the potential for musicians to use NFTs to license and distribute their own content. The use of smart contracts on the blockchain would allow artists to earn royalties every time their work is resold.

It is worth noting that transferring ownership of an NFT does not transfer a trademark or copyright to the holder. And the creator can upload multiple versions of a piece of work, each with their own NFTs, so it does not only have to be one of a kind to be distributed in this way.

There is also huge potential for the use of NFTs in gaming – where they could form the basis of in-game economies. Players could use NFTs to claim ownership of items that are rare or difficult to win, as rewards for meeting challenges or participating in special events, to convert points into currencies for real-world transfer, and so on. And creators could use NFTs to monetise their work directly from players.

NFTs are attractive for investors because, as with any other asset that carries value, they can be bought and sold for a profit on an NFT market if the value rises. Institutional funds are getting in on the opportunity, with cryptocurrency investment firms buying digital collectibles to create value for their clients.

NFTs are just beginning to take off and there is potential for widespread growth throughout the digital economy. Their popularity exploded in late 2020, as cryptocurrency prices rocketed to new highs.

Analysis by NonFungible.com shows that the total volume of NFTs traded in 2020, including sales and in-game financial transactions, soared by 299 per cent to $250.8m from $62.9m in 2019. The number of active wallets almost doubled to 222,179, from 112.731 in the previous year.

Sales are expected to accelerate as more artists and brands use NFTs to bypass traditional routes to market and monetise their products directly from buyers.

How are NFTs created?

Are you curious about how to make and sell NFTs? The process of creating an NFT is known as “minting” – a reference to the way a physical coin is minted by a manufacturer. NFTs are minted through an NFT marketplace, where a creator uploads a digital file and assigns characteristics, such as whether it is a one-off, has multiple copies or is part of a collection.

Once the NFT is created, the owner can sell it on the marketplace in an auction.

While most NFTs so far run on the Ethereum blockchain, other blockchains such as WAX have the capability to mint digital tokens to which creators can attach files.

Now that you understand more about them, do you want to know how to buy NFTs?

How do you buy and sell NFTs?

If you are considering their potential as a speculative asset, you may be wondering how you can buy and sell NFTs. NFTs are traded in cryptocurrencies, so you first need to buy cryptocurrency and hold it in a wallet. You then need to sign up for an NFT marketplace, such as Nifty Gateway, OpenSea or Rarible.

Sales typically take the form of auctions with a starting NFT price, so if you enter a winning bid you will take ownership of the NFT. If the value subsequently rises, you can set up your own auction on a marketplace to sell it for a profit.

While buying an NFT does not transfer the copyright for the work, it does confer basic usage rights like posting an image online.

What are the risks of buying and selling NFTs?

Like any new asset that is in the early stages of development and adoption, NFTs carry some risk as are a long way from mass acceptance. If an investor opts to buy an NFT and interest in trading them subsequently stalls or even wanes, prices will fall and the buyer could be stuck with large losses.

NFTs are not exempt from fraud. NFTs claiming to be the works of well-known artists have been sold for hundreds of thousands of dollars but have been revealed to be fake. And in the same way that cryptocurrencies can be stolen, NFTs can potentially be subject to theft depending on how they are stored.

Another risk to consider is that digital content is not entirely free from deterioration in quality, file formats becoming obsolete, websites going offline temporarily or even permanently, or the loss of wallet passwords.

For creators, minting NFTs to sell content does not guarantee legal rights to ownership of their work, providing less protection from theft than they may expect. While NFTs and the marketplaces that sell them are decentralised, there can still be hurdles to gaining entry and exposure for their work. Many of the platforms are invitation only, in the same way as art galleries and other physical venues select artists to represent.

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