From the Bored Ape Yacht Club to CryptoPunks, NFTs are one of the hottest trends in crypto. But what’s an NFT?

NFTs stand for non-fungible tokens. It is a term used to describe a digital asset that’s unique. From a linguistic perspective, the word ‘token’ implies a unique utility or quality, while ‘non-fungible’ means it cannot be replaced with an asset of the same type.

For example, cryptocurrencies like Bitcoin (BTC) are fungible, because they can be replaced by other identical units. Each NFT, on the other hand, has a bespoke identity on the blockchain they live on. (A blockchain is an encrypted list of items and transactions related to those items that can’t be tampered with but can be viewed by anyone.)

In this article, we explore and explain how NFTs work, current use cases for NFTs, and potential future utility in non-fungible tokens. 

What does blockchain mean?

To understand what NFTs are and how they work, you need to get a simple grasp of what a ‘blockchain’ is. A blockchain is a distributed ledger that consists of an interconnected chain of data. 

Blockchains serve the purpose of data transfer and validation. Data holds value in various forms like fungible assets (e.g. cryptocurrencies) and NFTs. When these assets change ownership, transactions are validated in batches/groups called ‘blocks’ which are linked together chronologically by chains.

The value of an NFT can be entirely speculative or trend-driven, hence the recurring news on various digital artworks selling for millions of dollars worth of crypto. We can call these blockbusting NFTs ‘on-market’ NFTs. By way of comparison, an off-market NFT has practical value, like a tokenised identity card, and is driven by the created demand for convenience. 

ℹ️ Interesting fact: ‘Generative NFTs’, also called breedable NFTs, can literally spawn new NFTs. This allows owners to operate NFT farms or even lease out NFTs for others to breed. 

Anatomy of an NFT

Aside from its audio and/or visual characteristics, an NFT is defined by the data entered during its creation and release to the blockchain. According to the ERC-721 token standard on which NFTs operate, there are two key sets of data to be defined:

  • Unique ID: This first first bit of data is compulsory, since it sets the NFT apart from all others. For example, if there are 50 issues of the same visually identical digital prints released, the unique ID is all that sets them apart. In the ERC-721 token standard, this is called uint256. 
  • Authorisation: There are three groups that can authorise an NFT transaction — we cover these later in the article. 
  • Optional Metadata: This includes anything like a written description of the NFT. It is used to describe the token’s properties in writing. 

How NFTs are stored and moved

Technicalities aside, NFTs are moved around like any other asset. There is a set of predefined conditions that partially determine how and where each NFT will go on the blockchain. 

The first thing to know about NFT transactions is ownership. Blockchain participants can authorise a transaction if they:

1. Are the owner of the NFT;

2. Hold access to an approved address of the NFT;

3. Can act on behalf of the NFT’s owner (eg, an authorised operator). 

Ownership and authority are defined in the smart contract when the NFT is launched, as are transfer mechanisms. 

Transfer mechanisms are bits of code that define whether a transfer is considered safe or risky. As per the ERC-721 standard, there are two transfer mechanisms – these are TransferFrom and SafeTransferFrom.

Thanks to these mechanisms, NFTs have a set of conditional approval functions that may approve or deny a transaction, depending on how the smart contract is set up. The outcome is based on ownership/authority data and prior transfer history. 

An example of how NFTs work

To summarise what we’ve learned, let’s compare the event of two tech-savvy millennials trading an NFT basketball season pass to two cavemen trading a stone spearhead.

Both the NFT season pass and the stone spearhead hold ambiguous values unless defined to accuracy. The origin and history of the NFT pass may seem irrelevant unless included as metadata, while the caveman wanting to buy the stone spearhead doesn’t know whether the seller found the spearhead or crafted it himself. These can bring a sentimental shift in value for both buyer and seller, regardless of whether the base supply needs are met. 

If the NFT basketball pass is the first issue by LeBron James, and the stone spearhead is a tribal heritage passed on through three generations, both increase in value.

As for the transaction, both parties agree on a set of conditions to be met. Due to smart contracts, an NFT transaction eliminates direct person-to-person interaction – that’s a key difference between our example cases. 

The future of NFTs

Given the current technical specifications of what an NFT consists of and how it works, many ideas are already in development. Entrepreneurs with a decent grasp on mechanics may see the most opportune fields for NFTs to prosper in, to be around privacy and security. 

With the advance and sophistication of tokenisation, we could quickly see NFTs in the form of:

  • Identification documents
  • Certificates
  • Memberships/passes
  • CVs
  • Metaverse items that can be used anywhere 

And these are only a few of the vast possibilities for NFTs. The current uproar around NFTs as a consumer-facing ‘fun’ tech is likely temporary but serves as a means to familiarise people with yet another digital landscape.

NFTs will inevitably face more publicity in the coming months and years in light of the technology’s huge potential to enrich the privacy and security industry. As we, the general public, build a better understanding of NFTs, there could also be ethics-driven conversations about the moral aspect of entrusting machine algorithms with the control of digitally tokenised tangible and intangible goods.

NFT marketplaces

If you want to see live examples of NFTs, check out these marketplaces:

Summary

NFTs hold a lot of promise and potential, but like any new tech, one should research well and obey the age-old axiom of caveat emptor before spending money on them at this early stage.