Non Fungible Tokens (NFTs)
If you haven't heard about NFTs, I promise you are going to hear about it very soon
What is fungibility?
You have a $1 bill and I have one as well. We can exchange our bills and none would be richer or poorer. That’s fungibility and it is one of the desired attributes for any form of currency or reserve assets.
So then what is non-fungibility?
There are certain things in our world that are unlike others even in their own class. For example, consider the series of paintings titled ‘Bedroom in Arles’ by Vincent van Gogh. There are 3 versions of the painting. Today, one hangs in the Van Gogh Museum in Amsterdam, the second in the Art Museum of Chicago, and the third in the Musée de Orsay in Paris.
All three are made by the same artist and have the exact same subject with few variations. But that does not make them the same. It is not the same as having 3 different $10 notes issued by the same Central Bank with different serial numbers. All 3 paintings will be valued differently by collectors based on which one was made first, which one was made during a tumultuous time in Van Gogh’s life etc. Each unique piece becomes non-fungible based on its physical, cultural, and historical attributes and that is non-fungibility.
So if you think about it, everyday things in our life are naturally non-fungible to some extent. We had to invent fungibility to support the mechanics of the financial world. The serial number on a currency note does not change its value. But an edition number on artwork will drastically sway its worth.
Owning Digital value
Property ownership of physical things is well understood even by people who don’t study law. But till now ownership of digital assets was not very clear or even possible in many cases, much less understood. Even if you did buy a digital item, it wasn’t easy to establish ownership or freely trade it across contextual domains. In most cases, you would need to sell a digital item in the same market, game, or platform where you bought it from. There was no interoperability or standardized way to represent a digital asset in order to facilitate platform-agnostic trading, verifying provenance, proving ownership and authenticity.
Enter Non-Fungible Tokens or NFTs
“Non-fungible tokens (NFTs) are unique, digital items with blockchain-managed ownership” - Open Sea NFT Bible
These are digital tokens created on a blockchain like Ethereum. Whenever a token changes hands, the transaction is permanently and irreversibly recorded on the blockchain. If you ever want to verify if a particular token was really created by the creator as the seller claims, all you need to do is look at the transaction history and you can verify its provenance. Imagine what that kind of power could do to the art market. But more on that later.
What is being NFTied?
Gaming collectibles were the pioneers in the NFT space. Game items were tokenized which made them freely tradeable outside the game.
Metaverse Real Estate is another digital asset that gained huge momentum. These are virtual worlds where you enter with your avatar, purchase a parcel of land, and build structures. Your avatar, its accessories, the piece of land, the stuff you build on it, every single thing becomes an NFT of its own and is registered on the blockchain.
Digital Art - Animators and 3D Artists for the longest time had to rely on freelance commissioned work by brands to make any money. Digital art was not considered a serious art form and there were no ‘Art Collectors’ in this space. When these artists started creating their NFTs, that changed very quickly.
Trading Cards- These are digital versions of Gamecards the likes of Pokemon, WWE, Baseball, etc. Like their real-world counterparts, some digital trading cards are more valuable and rare than others and NFTs offer a way to verify the scarcity. NBA TopShots allows you to own historical moments from Basketball games and they already have had secondary market sales of $31 million.
So how do you play this game?
Since NFTs are created or ‘minted’ on the blockchain you need to have access to a Crypto Wallet yourself or access to a custodial wallet. Once you have that, you need to decide how you want to fund a purchase. Many platforms only accept Cryptocurrencies. But then there are a few that have what is known as ‘Fiat on/off-ramp’ which means you can buy using a credit card and cash out your earnings to a USD bank account. I won’t get into the details of the trade-offs involved in using one way versus another in this post but know that there are benefits and risks in using both.
There are markets where you can buy and sell your tokens but since the tokens themselves are on the blockchain, nothing stops you from selling a token on a different platform.
OpenSea.io is a great place to start exploring the NFT world.
But why should you care?
Astronomical returns are driving the current NFT Goldrush. NFTs have been around since 2017, but 2020 was a coming-of-age year for NFTs where activity and value in each of the use cases that I have described above grew thousands of times. 2021 is expected to be the year when this goes mainstream.
As new collectors entered the market, the valuation of some art pieces grew by 10000x times. Take an example of ‘Politics is Bullshit’ by the now legendary artist Beeple which was sold back in October 2020 for $1 was last sold yesterday for $45000 on the secondary market.
And remember, this is not even a Single edition, there are 100 editions of this work out there. But that is exactly it. There will only ever be 100 editions.
Just take a look at the rise in cumulative Art sale volumes below.
But don’t just get starstruck by the money. This technology is here to stay and here to change the way we look at value. It is already driving a renaissance in the way artists and creators are monetizing their work.
Artists traditionally never benefitted when they became famous eventually and when their old artwork sold for huge amounts later between galleries and collectors. NFTs allow artists to earn residual income every time one of their work is sold in the secondary market.
And this is just one of the infinite use cases for leveraging NFTs to change the way we perceive, own, store, and exchange value. It recently started getting attention from celebrities who launched their own NFTs like Investor Mark Cuban, Actor Lindsey Lohan, Music artists Mike Shonda from Linkin Park, 3lau, Monstercat, and Soulja Boy.
Elon Musk’s wife Grimez is scheduled to drop her art collection soon and it is expected that it will give NFTs a huge boost.
What are the risks
Before entering this space, do your own research. As much as NFTs offer immutable provenance, nothing stops someone from creating a copy of an original work by someone else and minting a new token themselves. You need to learn ‘how’ to verify if a token really came from the Creator. There is a lot of fake goods out there.
Familiarize yourselves with a project. Many new NFT projects are being created every day. Not all of them are valuable. A major FOMO is driving the current bull run and it is very easy to fall prey to a pump and dump scheme.
If you are new to dealing with cryptocurrencies, you need to learn the terminologies and tools used.
Transaction fees on the Ethereum network are very high and you may end up paying a huge amount just to cancel a trade.
You may accidentally share your private key leading to you getting robbed. You may lose access to your device that is hosting a wallet and lose all your tokens. Please learn how to take proper backups or use custodial wallets if you are not sure.
And finally, the current valuations may not sustain. We are in a hype cycle and this is clearly a huge bull run. There will be a bear phase. So when you make a purchase, make sure you do your research, identify which NFTs will hold true value, and only then invest. NFTs from a lot of artists and projects will hold value in the long term. Others will become worthless.
@DCLBlogger does a great job of analyzing the current NFT hype cycle
Full disclosure, I own multiple pieces of NFT art myself.