Unless you have been living under a rock, you must have heard of NFTs. Yeah, those silly ape pictures that were the talk of the town some time back. While NFTs seem like a recent trend, they have actually been around for nearly a decade. In 2014, Kevin McCoy create the first NFT called ‘Quantum’ and sold it to his collaborator Anil Dash for $4.
But while you may associate NFTs with bored ape pictures, the groundwork for it was laid by cats. In 2017, CryptoKitties started gaining popularity and it is estimated that fans have spent more than $32 million on these cartoon cat images. NFTs were the talk of the town from 2020-21 as the NFT market tripled to over $250 million in 2020. It started losing momentum in 2022 as the Wall Street Journal reported that daily NFT sales had declined by 92% since September 2021.
Amidst all this talk of kittens and apes and millions of dollars, you may have multiple questions such as what exactly is an NFT? How are they created? Why do people buy NFTs? Are they even legal? Let’s try to answer these questions in the following sections.
Meaning of NFTs
NFT means Non-Fungible Token. But before talking about NFTs, let us first understand the meaning of “fungible” and “non-fungible”. When an asset is fungible, it means that individual units of an asset are of equal value. As such, different units belonging to that asset class are interchangeable.
Money is the best example of a fungible item. A $1 bill is equal in value to another $1 bill. They can, therefore, be easily exchanged. Cryptocurrencies like Bitcoin are also fungible. One BTC is interchangeable with another BTC.
Non-fungibility, as the term implies, is the opposite of fungibility. A non-fungible asset is one that has some unique properties and is, therefore, not exchangeable with another asset of the same type. Take furniture for example. You cannot exactly exchange your sofa for another one even if they are of the same type.
Non-Fungible Tokens or NFTs are hence, digital tokens created with blockchain technology. They are non-fungible which means they have some unique identifiers and cannot be readily copied or divided. NFTs function as a record of ownership and authenticity. While they are not interchangeable, they can be bought or traded like stocks or collectible items.
In this sense, they are digital assets utilizing blockchain technology to represent the authenticity of items like artwork, music, games, sports memorabilia, and other collectibles.
How do NFTs Work?
NFTs are created on blockchains which are publicly accessible open ledgers. Cryptocurrencies like Bitcoin utilize the same technology. However, NFTs have unique identification codes that make each NFT one-of-a-kind and non-fungible. Note that due to technical limitations, the actual image is not stored on the blockchain.
What is done is that the web address or the link of the artwork is stored in the blockchain. It is simply used to reference the artwork elsewhere. Therefore, when you buy an NFT, it does not necessarily mean that you get ownership of the image itself. You buy the link that references the artwork in question.
Most NFTs are built on the Ethereum blockchain with the ERC-721 standard though there are other chains that support NFTs. They are created using a process called minting where users upload the media file on an NFT platform. Users specify the properties of the NFT including adding some unique properties or unlockable content. The NFT will then be put up for sale and once that is done, the metadata underlying the NFT cannot be changed.
Use Cases of NFTs
Ownership of Digital Assets
Establishing ownership of digital assets such as an art piece, a song or a video file is what NFTs are generally known for. They can help authenticate the originality of a digital asset. This enables creators in a digital economy to be adequately compensated for their efforts.
Cryptokitties is the best example of this. The online game has made more than $32 million by selling tradable cat NFTs. Similarly, NFTs representing rare in-game items could be issued by game developers which could be bought or further traded by users.
While you wouldn’t necessarily associate NFTs with the real estate business, the latter actually has a lot of potential for integrating NFTs into the working of the industry. The value of a property can be easily tracked and land deeds transferred in a jiffy with the help of NFTs.
Tokens that give access to certain types of content or products or services can be useful for content creators. They can monetize their work in a way that they receive benefits in proportion to their efforts.
Storing Medical Records
Since NFTs are stored in a blockchain-based open ledger, they can aid in confidentially storing an individual’s medical records. Since NFT transactions have to be validated on multiple nodes, this ensures that tampering with NFT-based medical records would be extremely difficult.
Complementary to Ownership of Physical Assets
Similar to digital assets, NFTs can be used to establish and authenticate the ownership of physical assets as well. It is sort of a digital proof of ownership of an asset-backed by smart contract technology.
NFTs can be used to keep tamper-proof records of attendance, grades, and other academic credentials. They can be used to keep immutable records of academic performance and the same can be validated with the help of smart contracts.
What is an NFT Marketplace?
An NFT marketplace, as the name implies, is a place where users can buy, sell, mint, trade, and auction NFTs. They feature multiple collections of NFTs that users can buy or sell. Generally, NFT marketplaces are placed into three categories:
Open NFT Marketplaces
Here, anyone can buy, sell, or mint NFTs. The creator can mint the tokens themselves or the platform may mint them on their behalf.
Closed NFT Marketplaces
There are generally some restrictions placed on trading on closed marketplaces. Creators have to specifically apply to host their collection on the platform and the tokens are almost always minted by the marketplace on the creators’ behalf.
Proprietary NFT Marketplaces
Such marketplaces host NFTs that have been trademarked by the operating company. As such, these are exclusive NFTs that cannot be found on any other platform.
NFT Marketplaces are also categorized as universal or art-oriented marketplaces and niche marketplaces. Universal marketplaces host a wide variety of NFT collections though they are generally dominated by the digital art category.
Niche marketplaces deal in tokens related to a specific category or sphere. NBA Top Shot is an example of a niche NFT marketplace where traders can buy, sell or trade video clips of memorable NBA moments.
Some examples of popular NFT marketplaces are:
OpenSea is the largest and oldest NFT marketplace. Founded by Devin Finzer and Alex Atallah, it hosts tokens related to art, photography, music, and much more. Primarily using Ethereum, Solana, and USDC as core cryptocurrencies, OpenSea does not support the use of fiat currencies.
However, it is a beginner-friendly platform with several collections of NFTs to hold the users’ interest.
NBA Top Shot
NBA Top Shot is a rather niche platform where customers can get video highlights of their favorite NBA or WNBA team and players. It also has an active community surrounding it and hosts a number of challenges where collectors can win exclusive prizes.
Rarible hosts aggregated NFTs from 5 different chains. It charges a 1% transaction fee on both the buyer and seller sides. While a credit card can be used to buy NFTs on Rarible, auctions are still crypto-exclusive.
Nifty Gateway is an NFT marketplace owned by the Winklevoss twins of Gemini fame. It hosts a great variety of art NFTs and supports multiple payment options such as debit cards, credit cards, Gemini balance, and prepaid ETH. As a bonus, there is no gas fee to be paid on Nifty Gateway.
Axie Infinity is a blockchain gaming platform and it has its own NFT marketplace where users can exchange in-game assets. Therefore, it is a niche marketplace where players only get gaming items such as Axies, runes, and charms.
How to Buy NFT
After this discussion about the uses of NFTs and NFT marketplaces, the question that arises is- how do you go about buying NFTs? Is it like buying cryptocurrencies on an exchange? Well, sort of. Let us discuss the detailed steps to get a clearer picture of the process.
Get a Crypto Wallet
First of all, you need a crypto wallet where you would store the keys to your NFTs. You can choose between a hot(online) or cold(offline) wallet at your convenience through cold wallets are generally more secure than hot wallets. Some popular wallets for NFTs are Metamask, Coinbase Wallet, and Phantom.
Next, you need funds to buy your NFTs. While some marketplaces accept debit or credit cards, others only allow payments with cryptocurrencies. Plus, since most NFTs are built on the Ethereum blockchain, it is better to fund your wallet with some ETH.
Connect your Wallet to a Marketplace
Go to the marketplace you want to buy NFTs from and connect your crypto wallet to it. You can now explore the marketplace and the NFT collections it offers to customers.
Buy the NFT
Confirm the price of the token you want to purchase and click on Buy Now. The transaction fee differs from platform to platform and you may also have to pay Ethereum gas fee depending on the marketplace.
Once the transaction is confirmed, the NFT will be transferred to your wallet. Remember that unless your contract specifies ownership rights, what you get is the token ID to the NFT you bought and not the rights to the original image itself.
Most Valuable NFTs
It may seem surprising but there are NFTs that have been sold for millions of dollars. The Cryptopunk collection has several NFTs in the list of the most expensive NFTs ever sold.
In 2021, The Merge create by an artist known as Pak was sold on Nifty Gateway for $91.8 million. It was sold in units called “mass” and was bought by over 28,000 collectors. A unique thing about The Merge is that it has a built-in scarcity mechanism that ensures that the token supply decreases with time.
Everydays: The First 5000 Days
Beeple’s The First 5000 Days is a collage of 5000 images created by Beeple over the course of his career. It was sold at the Christies in 2021 for $69.3 million and is the most expensive NFT bought by a single individual.
This real-time timer which counts the days Wikileaks founder Julian Assange has spent in imprisonment was sold for $52.8 million. It was created by The Merge’s artist Pak and the proceeds would be used for Assange’s legal bills.
Beeple is a respected artist whose 3D sculpture called HUMAN ONE which shows an astronaut traveling through various locations was sold for $28.9 million at Christie’s.
The concept of CryptoPunk was introduced by Larva Labs in 2017. Since then, it has gone on to become one of the most popular NFT collections. CryptoPunk #5822 is one of the rarest tokens of the series and was sold for $23.7 million.
Alien CryptoPunk #7523
This Alien CryptoPunk token is one of the rarest CryptoPunk tokens minted by Larva Labs. It comes with some exclusive accessories such as earrings and knitted caps and was sold for $11.75 million.
Crypto exchange Tron’s founder Justin Sun bought TPunk #3442 for $10.5 million in August 2021.
This NFT of an ape wearing a blue bandana was owned by a person known by their alias ‘Pink 4156’. They sold it for $10.26 million in December 2021.
This token in the CryptoPunk collection features an ape wearing a cowboy hat. It was bought by Compound DeFi protocol’s founder Robert Leshner for $7.7 million in 2022.
One of the nine ‘Alien’ CryptoPunks, CryptoPunk #3100 was sold for $7.57 million in March 2021.
NFT vs. Cryptocurrency
NFTs and cryptocurrencies both are created using blockchain technology. You can buy NFTs as well as other cryptocurrencies with crypto coins. But then, how are they different? Aren’t they both just digital tokens? Well, they are but there are some major things that differentiate NFTs from cryptocurrencies.
The crucial thing that differentiates NFTs from cryptocurrencies is fungibility. Cryptocurrencies are fungible. This means that crypto coins belonging to the same category or blockchain are of equal value. The value of one BTC will always be equal to another BTC.
Cryptocurrencies can, therefore, be exchanged for each other. You can interchange one BTC with another BTC without any loss or gain to either party because the two BTC coins have the same value.
NFTs are Non-Fungible Tokens. Each NFT is unique. They cannot be readily divided or substituted for each other. As such, you cannot just exchange one NFT for another as you would do with paper money.
Further, NFTs are primarily meant to function as proof of ownership and validate the authenticity of a digital asset. Cryptocurrencies, though they have become speculative instruments, were meant to be used as a means of exchange or an alternate form of payment.
There are businesses that accept payment in form of cryptocurrencies but you cannot use NFTs to make payments. They simply represent the authenticity and originality of items like digital art, videos, and music files.
Why do People Buy NFTs?
There are NFTs that have been sold for millions of dollars. At this point, you might be wondering why people buy NFTs. Why are some people willing to part with their money for these digital tokens?
The biggest thing that perhaps explains the appeal of NFTs is their scarcity. Each NFT is unique or one-of-a-kind which drives up its value. The rarity makes people interested in owning that piece. The Bored Ape collection or the CryptoPunk collection where each NFT in the collection has something unique about it is responsible for their popularity.
It is easier to understand the interest in NFTs if you think about it in terms of investing in art. Collectors used to invest their money in owning physical art pieces and now they invest their money in art NFTs hoping to make a profit by selling them when their value goes up.
Some people also see purchasing NFTs as a way of supporting their favorite artists. Buying NFTs put up by digital artists, musicians, and other creators can be seen as a way of adequately compensating these content creators for the labor and efforts they put into creating the final product.
NFTs can also function as collectibles. Similar to how people buy trading cards whose price can go up to more than a million dollars, sports companies, and artists are releasing NFTs as collectibles. A good example would be the NFTs of classic comic books released by Marvel.
Gaming has emerged as another sector where NFTs have been becoming popular. Some games might require the purchase of their NFTs to play. For example, you need three Axie NFTs before you can start playing Axie Infinity. In-game utilities such as character skins or charms or trading cards may also be released as NFTs.
Concerns about NFTs
Art NFTs do not store the artwork itself on the blockchain due to the large size of such files. They just store the web address that references the artwork somewhere else. This essentially means that you pay not for the art piece itself but simply for a link that points to the former.
Such links are prone to link rot and the artwork can be easily lost when the domain name expires.
You cannot enforce legal intellectual property rights for an NFT on a blockchain. Such images are publicly accessible and anyone can thus, download or copy the image included in an NFT.
NFTs were touted as something that would help artists reap the profits of their labor but turns out, scammers have started creating NFTs of artwork without the permission of the original artists and selling them for hefty profits. A major incident was when a fake Banksy NFT was sold for £244k in 2021.
Similar to cryptocurrencies, NFT transactions involve very high energy usage in the form of computational power. The proof-of-work consensus protocol used for validating transactions is extremely energy intensive and participating in the NFT market is hence, seen as environmentally unethical.
Ethereum’s shift to a proof-of-stake consensus mechanism may bring down the energy usage for NFT transactions but there is no conclusive evidence till now.
NFTs have been accused to be pyramid schemes where early buyers of overhyped digital images benefit at the cost of the late buyers. The value of NFTs depends on the hype created around them and the whole ecosystem can collapse like a house of cards.
“Rug Pull” Schemes
NFTs have become infamous for “rug pull” or pump and dump schemes where NFT creators hype up a project increasing its value and then abandon the project while pocketing the investor funds. The people who bought the NFTs lose their money and are left with worthless tokens in their possession.
The Bottom Line
NFTs are a step ahead in the concept of digital tokens introduced by cryptocurrencies. They promise to revolutionize the world of digital art and collectibles. It is claimed that NFTs would help creators in being properly compensated for their labor.
NFTs rose in popularity during 2020-21 and many artists and even companies such as Marvel jumped on the NFT bandwagon. While their value declined in 2022, NFTs still have a dedicated fanbase surrounding them.
Whether NFTs are some revolutionary Web3 innovation or not remains to be seen. There are certain issues with them that need to be addressed for them to become viable in the long term.