Non-Fungible Tokens (NFTs)
A digital work of art by Beeple sold last week for 69.3 million USD, in an auction by Christie’s. Let’s find out more about what’s going on, and how it’s related to this image of digital kittens. Some of whom are almost 4 years old now, by the way.
I will share with you what non-fungibles tokens (NFTs) are. I’ll point you towards historical analogues, tell you more about why they are valuable, and sketch out various ideas, problems and thoughts around NFTs, and why they could be the future of value.
How will scarce, valuable digital assets be transacted, and more excitingly, generate value of their own? I propose that understanding NFTs and their current impact would be a good place to start.
Non-fungible: Most assets and things are non-fungible. They are not-exactly-the-same. Your phone, your engagement ring. They have a history (that is often relevant to their value). Sometimes they don’t carry that history with them, but they have that history nonetheless.
In comparison, fungible things are, for most intents and purposes, equivalent to one another. One US dollar is equivalent to another US dollar. A thousand dollars in 1 dollar coins, in theory, is equivalent to a thousand dollars sent via wire transfer (or PayLah!, or Venmo, or Paypal…).
A token, in this context, is an asset on a blockchain. You own a token if it’s associated with your wallet, or your identity online. More specifically, a non-fungible token says which wallet or address it currently belongs to, and a fungible token gives you a list of all addresses and their balances.
A token can be fungible (a bitcoin is the same as any other bitcoin, and a US dollar is the same as any other US dollar), or non-fungible (my 1999 First Edition Mint Charizard Holo ($25-$150K) card is not the same as your 2016 Charizard base-set reprint, okay?)
But what are they good for?
Representations, and proof, of digital ownership. Anyone who’s had skins, or rare gear, in a video game, knows this concept well, as I’ll explain later.
You own a bunch of things in the physical world. How do you know they’re yours? Perhaps you’ve etched your name into the side of your guitar. Or you have a sticker on your water bottle. More abstractly, you may have a Rolex, and a box and papers to ~prove that it’s authentic~.
But that’s a bit of a flimsy system, isn’t it?
When you have a digital asset on the blockchain, when you own something, everyone can see that you (or the account associated with you) own it.
Specifically, on the Ethereum implementation of a NFT, aka ERC-721, they can call a function, that gives you back the address, or the account number, of the owner.
function ownerOf(uint256 _tokenId) external view returns (address);
More importantly: you can transact them, without permission from anyone else (permissionlessness), and you can build more things on top of them. (interoperability).
An aside: Technically, they are implemented using a ERC-721 interface on the Ethereum blockchain, and ZRC-1 on the Zilliqa blockchain. Standards are important so that anyone developing code that uses NFTs can easily find the info they need to make cool stuff from those tokens. Oh yeah, and on a blockchain, they can do that, permissionlessly. (more on that later!)
What’s their history?
NFTs are not new. The most famous example: CryptoKitties, collectible digital cats that you could breed and sell. In 2017, there was insane hype around CryptoKitties and they sold for up to $172,000.
People have built apps around CryptoKitties, which include battling systems (CryptoCuddles), CryptoKItties price tracking software, and more.
CryptoKitties caused the Ethereum blockchain to become congested, which triggered a flurry of activity in the blockchain space: development of new blockchains that purport to solve the ‘scalability’ problem. So they were a landmark in their own right.
However, they’ve recently come back into the spotlight, with NBA Top Shots having headlines on NBC such as “$230 million spent trading video highlights.”
Why are they valuable?
Well, they are only as valuable as others would pay them for. In the same way that money is only valuable because other people believe that others would honor their money. Wealth is not money.
A koan: If you were stranded on an island, would you give up your debit card with the right to access your Wells Fargo / DBS bank account for a good batch of bananas? Why or why not?
But more to the point: NFTs are valuable for the same reason collectibles are valuable. Collectibles (with no obvious utility, by the way!) having monetary value is not new: Tulips, beanie babies, first edition Pokemon trading cards (55,000 for a layer of paper, or aforementioned 1999 First Edition Mint Charizard Holo) and Babe Ruth trading cards. The housing market. Shoes.
Those shoes sell for $65,000 as of 15th March 2021. They derive their value from scarcity: there are only 89 of them, and there will only ever be 89 of them. We call that limited edition.
The best part: with NFTs, you can PROVE that there are just a few of them, and you know which ones are real (and which ones are just sock sneakers).
There are websites that teach you how to identify Nike AIr MAG in just Five Quick Steps! NFTs can reduce that down to a function call.
The interesting part comes when an NFT carries with it a proof of when it was made, who it was made by, and where they’ve been.
NFTs extends this concept of collectibles into the digital realm. They have applications in gaming, digital art, and more. Now let’s get to the meat: why are they interesting?
Why are they interesting?
My thoughts that I’ve developed after almost 3 years in the space.
(1) NFTs allow interoperability.
This is the coolest part about NFTs, for me. One asset could appear in multiple digital worlds, and perhaps even give you rights in the physical world as well.
This is already practiced in closed ecosystems like Blizzard’s. Purchasing an item could give you a mount in World of Warcraft, and a pet in Diablo III, and a portrait in Starcraft II, et al…
You could go so much further. A thought: a limited edition mount that you really loved in World of Warcraft, when tokenized, could become a gun in Counter Strike: Global Offensive. Forty years from now, a kid who loved that gun in their youth could make a tribute and distribute a special gun to be claimed in their new game if you had that token. And that special gun would be its own NFT. Oh, and they don’t need permission from (hypothetical) Blizzard OR (hypothetical) Valve to build that. They just need to be able to see who owns those assets that they so love.
Another issue: those assets don’t belong to you. They’re tied to an account, which belongs to you, so long as you play by the rules, or so long as the game servers remain running. What if you get banned? Or the game stops being supported, or (touch wood) Blizzard stops operating? Then the representation of those assets disappear.
And if you don’t have the right to trade your items, do they REALLY belong to you? Steam does a somewhat more amiable job at this, allowing folks to trade ‘hats‘ (in-game items that are purely cosmetic, and give you no advantage whatsoever) — sometimes for up to 18,500 dollars.
Technically, selling your items is against the terms of use of many video games. But why should the sword that you spent 300 hours grinding for, not belong to you? What if you could have exactly the same gameplay, and you could legally sell your account, or assets, if you no longer wanted to play the game? (What I always wish I had everytime I quit WoW.)
You might claim: hey, there’s a reason why game companies don’t allow for this. But my claim is that companies who do consciously decide on whether they want to allow for assets to be transacted in such a way and provide at least the same level of gameplay will attract more people.
For example, concerns of pay-to-win (throwback to the failure of Diablo III’s Real Money Auction House) could be addressed by only allowing cosmetic items to be transacted at first.
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(2) NFTs allow trustless trade.
Trust is important in transacting. People pay a disproportionate amount for trust. Think about wills: say you want to will your house to me, over your children, because you like my writing. (If you want to do this, e-mail me please.)
What’s the best way to do that? Well, there’s an entire market for this: escrow, will execution services and lawyers. These require you placing trust in a third party, and paying significant amounts in fees as well.
Even with simple one-to-one transactions, you still have to trust the other party. Carousell, eBay and others can implement escrow payment, and reputation features on their platform in order to reduce the risk, but there’s still trust involved in the transaction.
For example, people are selling Shiny Mews on eBay for $1.00. You need to trust that they’ll send you the Mew, that the Mew won’t get you banned from battling online, etc. The latter could happen if the Mew was generated via an illegal process (hacking your device).
Now consider Axie Infinity. The most expensive Axie (like a Pokemon) ever sold was for 300 ETH. That’s about 550,000 USD in today’s value. This was done in an auction process and the transaction occured, just like that. No middleman required.
In comparison, there are no legal, easy and trust-less ways to trade Pokemon for money that I know of.
Which brings us to… provenance.
(3) NFTs provide provenance of an asset.
Provenance tells you where’d the asset come from, and whose hands has it passed through. Starbucks can (ostensibly) tell you where their beans came from, but can they prove it? How costly is that to verify?
But what if the stakes were higher? Consider the thorny issue of blood diamonds. If someone has to work school-age children in mines to get diamonds, do you really want to be supporting such a process so that you can give a rock to someone you want to spend your life with for slightly cheaper? The point being: it’d be nice to know where something came from.
Digitally, this might look something like not buying items ‘farmed’ by Chinese gold farmers. The point is, you have more information now, and with more information, you can act according to your own values.
You can trace back all transactions containing references to an NFT, and find out its origins. Not so easy to do with coffee beans. But for now, Starbucks, we’ll take your word for it. It’s a fair trade.
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(4) NFTs allow artists additional incentives to create art, by providing more avenues to capture value.
You could build a marketplace with transaction fees, where a portion of those fees can go to the original creator every time the NFT changes hands on that platform. In fact, this is what MightyJaxx, a collectibles and toy company, did with MightyVerse during Batch 1 of Tribe Accelerator.
They’ve managed to extend this out into the physical world, with a chip embedded into their physical collectible that allows quick verification of the origin of the item.
A purely digital work of art, sold for 69.3 million US dollars on Christie’s. With most services, 10% or more of the resale value goes to the minter, or creator, of the NFT. Wow.
In theory, you can initiate a transaction on the blockchain to transfer ownership. In practice, we use platforms like OpenSea and MightyVerse to facilitate this process, because we understand, on some level, the value of an asset is also tied to its provenance, and platforms like MightyVerse for their own products can come with all sorts of interesting features (like links to tidbits, interviews with the artist). Archival of information is its own reward.
(5) NFTs allow all sorts of other applications to be built on top of them.
You can even rent out your assets. Say you’re taking a vacation from World of Warcraft, but you want to let people use your cool mount, or battle pets. How about renting access to them for 3 months? That’s something you can do with NFTs. After three months, the NFT reverts back to you, and you can use your cool mount again.
What do you have to worry about? What are the risks?
Well, you could buy an NFT and it goes to 0: the buying interest has gone to nil. That’s just poor decision making though, like shorting GME. You can’t indict the system of stock markets for your faulty decisions.
There’s platform risk you’re taking as well: if the marketplace goes down, or if the blockchain you’re transacting on goes down or gets attacked. Luckily, there’s tons of smart people working on those problems, and if you’re keen on knowing more about that, you can start with technical whitepapers and research websites.
The Future of Value
Oh, and regarding the title: I hope we’ve answered the question of how will valuable, scarce assets might be transacted. NFTs look like a pretty good place to start.
And if you’re an artist that’s keen to create an NFT, or just keen to chat about NFTs, feel free to DM me on Twitter @ryanmyfoo.
Postscript
Consider this a provisional stab at the topic, and I’ll continue to refine as people engage me on this & carry on.
So how do I get some?
Try looking at OpenSea, Mintable and other marketplaces. Read up more about NFTs.
Problems related to NFTs
I was speaking with Professor Andrew Bailey and Lloyd, and one of the problems Professor Bailey raised was the physical-NFT problem.
Let’s say I had an NFT that allowed the owner to access a car. Say, a Tesla.
I could trade this NFT, and give access to the car to someone else, in exchange for money, or another NFT. This works well, and has worked in the MightyJaxx MightyVerse collectibles context, for example.
You might think: well, I could rent this car too. I’m out of town for a week, so I could let Bob rent it for a thousand dollars, and initiate a transaction that authorizes the renter to have access to the NFT (and thus, access to the car) for a week.
Bob rents it, and takes apart my leather seats, and my engine, and my wheels in his garage. He even takes my steering wheel. He leaves town.
I will never see the car again, but at least the NFT is back in my wallet, I guess?
This is a problem, to the best of my knowledge, yet unaddressed. It is difficult to connect the physical world and the digital world.
More NFT Resources
OpenSea’s guide to Non-Fungible Tokens.
Barrons: How Non-Fungible Tokens Are Transforming the Art World
Your CryptoKitty Isn’t Forever — Why DApps Aren’t as Decentralized as You Think – Thought-provoking article on CryptoKitties and their ‘centralized nature.’