What is Non-Fungible Tokens (NFT)? The Latest Premier Guide 2024

What Are Non-Fungible Tokens (NFT)?

Non-Fungible Tokens (NFT) are assets tokenized through blockchain technology. Tokens are created from unique identification codes generated through cryptographic functions from metadata. These tokens are stored on the blockchain, while the asset itself is stored elsewhere. The link between the token and the asset makes them unique.

NFTs can be traded and exchanged for money, cryptocurrencies, or other NFTs—depending entirely on the market and the value assigned by their owners. For example, you could draw a smiley face on a banana, take a photo (with metadata), and then tokenize it on the blockchain. Whoever holds the private key to that token possesses any rights you assign to that token.

Cryptocurrencies are also tokens; however, the main difference is that two cryptocurrencies from the same blockchain are interchangeable—they are fungible. Two NFTs from the same blockchain might look the same, but they are not interchangeable.

Key Points

• NFTs (Non-Fungible Tokens) are unique cryptographic tokens that exist on a blockchain and cannot be replicated.
• NFTs can represent digital or real-world items such as artworks and real estate.
• Tokenizing these tangible assets in the real world can improve the efficiency of buying, selling, and trading while reducing the potential for fraud.
• NFTs can represent personal identities, property rights, and more.
• Collectors and investors initially sought them after the public became more aware of NFTs, but their popularity has gradually waned.

The History of Non-Fungible Tokens (NFT)

NFTs were created long before they became popular in the mainstream. Reportedly, the first NFT sold was “Quantum,” designed and tokenized on a blockchain (Namecoin) by Kevin McKoy in 2014, then minted on Ethereum and sold in 2021.

NFTs are built according to the ERC-721 standard (Ethereum Request for Comments #721), which dictates how ownership is transferred, methods for confirming transactions, and how applications should handle the secure transfer (among other requirements). The ERC-1155 standard was approved six months after ERC-721, improving upon ERC-721 by bulk putting multiple non-fungible tokens into a single contract, thus reducing transaction costs.

How NFT Work

NFTs are created through a process called minting, where asset information is encrypted and recorded on the blockchain. At a higher level, the minting process requires creating a new block, validating NFT information by verifiers, and then closing that block. This minting process typically involves incorporating a smart contract that allocates ownership and manages the transfer of NFTs.

When tokens are minted, they are assigned a unique identifier directly linked to a blockchain address. Each token has an owner, and the ownership information (i.e., the address where the token was minted) is public. Even if 5,000 NFTs of the same item were minted (similar to a movie’s standard ticket), each token has a unique identifier that distinguishes it from the others.

Many blockchains can create NFTs, but their names may vary. For example, on the Bitcoin blockchain, they are called ordinals. Like Ethereum-based NFTs, Bitcoin ordinals can be bought, sold, and traded. The difference is Ethereum creates tokens for assets, whereas Ordinals are assigned to satoshis (the smallest Bitcoin denomination) serial numbers (called identifiers).

Blockchain and Fungibility

Like physical currency, cryptocurrencies are typically fungible from a financial standpoint, meaning they can be traded or exchanged. For example, the value of one Bitcoin is always equal to another Bitcoin in a given exchange, similar to the implicit transaction value of $1 for every dollar bill. This fungibility characteristic makes cryptocurrencies suitable as a secure medium of transaction in the digital economy.

Thus, NFTs change the crypto paradigm by making each token unique and non-fungible, making one type of non-fungible token impossible to be “equal” to another. They are digital representations of assets, likened to digital passports because each token contains a unique, non-transferable identity to distinguish it from other tokens. They are also extensible, meaning you can combine one NFT with another to create a third unique NFT—a process known as “breeding” in the crypto industry.

Examples of NFT

Perhaps the most famous use case for NFTs is Cryptokitties. Launched in November 2017, Cryptokitties are digital representations of cats on the Ethereum blockchain with unique identifiers. Each kitty is one-of-a-kind and has different price tags. They “breed” among themselves and create new offspring with other attributes and valuations compared to their “parents.”

Within just a few weeks of launch, Cryptokitties accumulated a fanbase that spent millions of Ether to purchase, feed, and breed them.

The early NFT market was mostly centered around digital art and collectibles, but it has now expanded into more areas. For example, the popular NFT marketplace OpenSea has several NFT categories:

• Photography: Photographers can tokenize their works and offer full or partial ownership. For instance, OpenSea user erubes1 has an “Ocean Intersection” collection containing beautiful ocean and surfing photos, with multiple sellers and owners.
• Sports: Digital art collections based on celebrities and sports figures.
• Trading Cards: Tokenized digital trading cards. Some are collectibles, while others can be traded in video games.
• Utility: NFTs that can represent membership or unlock benefits.
• Virtual Worlds: Virtual worlds NFTs grant you ownership of anything from virtual avatars wearable to digital property.
• Art: A broad category of NFTs, including everything from pixel art to abstract art.
• Collectibles: Bored Ape Yacht Club, Crypto Punks, and Pudgy Pandas are examples of NFTs in this category.
• Domain Names: NFTs representing ownership of your website domain names.
• Music: Artists can tokenize their music, granting buyers the rights the artist wishes them to have.

Benefits of NFT

Perhaps the most obvious benefit of NFTs is market efficiency. Tokenizing physical assets can streamline the sales process and eliminate intermediaries. NFTs representing digital or physical artworks on the blockchain can eliminate the need for agents and allow sellers to connect directly with their target audience (assuming the artist knows how to securely host their NFTs).

Investment

NFTs can also simplify investments. For example, consulting firm EY developed an NFT solution for one of its boutique wine investors—storing the wine in a secure environment and using NFTs to protect the provenance.

Real estate can also be tokenized—a property can be divided into multiple sections, each with different characteristics. For instance, one section might be by the lake, while another is near the forest. Based on their characteristics, each piece of land might be unique, have different prices, and be represented by NFTs. Real estate transactions are complex and bureaucratic affairs that can be simplified by merging the relevant metadata into unique NFTs only related to the respective section of the property.

NFTs can represent business ownership, just like stocks—in fact, stock ownership has already been tracked through ledgers containing information such as shareholder names, issue dates, certificate numbers, and the number of stocks. Blockchain is a distributed and secure ledger, so issuing NFTs to represent stocks serves the same purpose as issuing stocks. The main advantage of using NFTs and blockchain instead of a stock ledger is that smart contracts can automate ownership transfer—once an NFT share is sold, the blockchain can handle everything else.

Security

Non-fungible tokens are also incredibly useful in terms of identity security. For instance, anyone without the keys cannot access, steal, or use personal information stored on the immutable blockchain.

NFTs can also democratize investments by segmenting physical assets. Fragmented ownership made possible through tokenization can extend to many assets. For example, a painting does not always have one owner—tokenization allows multiple people to buy a part of it, transferring a portion of the physical painting’s ownership to them.

How to Buy NFT?

Many NFTs can only be purchased with the cryptocurrency supported by the exchange you are using. Therefore, you need a digital wallet and some cryptocurrency to make a purchase. For example, OpenSea accepts ETH, WETH, AVAX, USDC, and DAI. You can purchase NFTs through other online NFT marketplaces like Rarible and SuperRare.

Are NFTs Safe?

Non-fungible tokens use blockchain technology (like cryptocurrency), which is generally unhackable. However, the weak link in all blockchains is precisely your key to the NFT. Software that stores keys could be hacked, and the device you hold the keys on could be lost or destroyed, so the blockchain adage “not your keys, not your coins” applies to NFTs as well as cryptocurrency. As long as your keys are well protected, NFTs are safe.

What Does Non-Fungible Mean?

Fungibility describes the interchangeability of goods. For example, suppose you have three sticky notes with the same smiley face drawn on them. When you tag one of the notes, that note becomes distinguishable from the others—it is non-fungible. The other two notes are indistinguishable, so they can replace each other.

Bottom Line

Non-fungible tokens are an evolution of the cryptocurrency concept. The modern financial system is made up of complex transaction and loan systems for different asset types, from real estate to lending contracts to artworks. By implementing digital representations of assets, NFTs are a step towards reshaping this infrastructure.

Certainly, the idea of digital representations of physical assets is not new, nor is the use of unique identifiers. However, when these concepts are combined with the advantages of tamper-proof blockchains with smart contracts and automation, they become a powerful force for transformation.