What Are Nonfungible Tokens?
Nonfungible tokens are unique cryptographic tokens. They are digital watermarks that can be used to establish provenance and ownership of many types of assets, from tweets to artwork and real estate. The market for NFTs is still nascent. As physical assets increasingly become digitized, it is expected to multiply in the future.
Basics of NFTs
Physical money is fungible. It can be exchanged at parity: one unit of physical currency is always equal to another unit. This fungibility characteristic makes money an ideal medium for daily transactions.
As their name indicates, nonfungible tokens cannot be exchanged at parity with each other. Instead, they are used for unique artifacts with unequal valuations. For example, it is difficult to establish the price for a valuable painting. There are several questions that need to be answered before a price is fixed.
Some of them are:
- When were the paintings made?
- Are they counterfeits?
- Do they contain the artist’s signature?
The amount of research and effort required to price and conduct such transactions is significant. As a result, their frequency is fairly low as compared to those that involve physical currency.
Nonfungible tokens are ideal for business transactions that do not have the frequency or rapidity of daily transactions. In the example above, an NFT can be used to digitally encode attributes pertaining to paintings to speed up the transactions.
Nonfungible tokens simplify transactions by streamlining them in a number of ways.
First, the use of blockchain removes middlemen in transactions. For example, direct connections between artists and buyers eliminates agents from the sale process and makes artwork cheaper by removing associated cost overheads and commission fees. A similar approach can be used in the music industry. Musical acts can directly connect with their audiences and earn royalties for sale of their music.
Second, NFTs can make it easier to detect forgeries by establishing the origins for artwork on a tamper-resistant blockchain. Their use could potentially eliminate the market for forgeries.
Other diverse applications for NFTs have also been proposed.
In the coffee industry, NFTs can be used in the supply chain to track the provenance and passage of coffee beans, ensuring that the processes for raw trade and labor are in accordance with fair trade practices.
NFTs can also be used to fractionalize physical assets and create new markets. For example, real estate can be parceled out into different pieces and each piece can be sold at different prices.
The advantages of digital apportioning of physical real estate on a blockchain are:
- It can eliminate middlemen involved in the transaction.
- It can reduce overall costs.
- It can establish a chain of provenance.
In finance, experiments are being conducted to use NFTs for escrow in multiple transactions for a single firm. The current practice involves much paperwork and is complex. An escrow account, identified with a unique NFT, could simplify the process and help firms use funds for multiple transactions at the same time.
How do you create and sell NFTs?
Virtually any asset can be tokenized. Non-fungible tokens are created in online marketplaces or platforms run by companies. While most NFTs are created on Ethereum, a public blockchain, competing blockchains have also emerged. But the difference in blockchains is mostly related to technical design and does not affect the essential characteristics – ownership attributes and costs – of an NFT.
The steps to create an NFT are as follows:
- Choose the online marketplace or platform where you would like to create the NFT. Examples of NFT marketplaces are OpenSea, Rarible, and Nifty Gateway.
- Most NFT marketplaces do not charge for NFT creation. However, there might be some places where you have to pay transaction costs, called “gas”, in the blockchain’s native cryptocurrency from your crypto wallet. The costs change based on the amount of traffic flowing through the network. For example, the cost to create an NFT will be high, if there is a greater amount of traffic flowing through the network.
- NFTs can be sold in marketplaces in the following three ways:
- At a fixed price.
- By auctioning them off to the highest bidder.
- Bundling them with other items for a consolidated price.
A Brief History and Examples for NFTs
NFTs first became popular in 2017 through CryptoKitties, which are digital representations of cats with unique features. CryptoKitties behave much like their physical counterparts. They grow and reproduce. They respond to nurturing. And they can be exchanged. Not surprisingly, they quickly gained attention from cat enthusiasts who spent more than $20 million of ether in purchasing, feeding, and nurturing them to develop particular characteristics.
That spotlight on CryptoKitties helped popularize the concept of NFT. Another recent development – Twitter co-founder Jack Dorsey’s recently auction of his first tweet for $2.9 million – further pushed mainstream spotlight on them.
In the incipient market for NFTs, use cases are still being developed. An NFT JPG file by Beeple, a South Carolina-based artist, recently sold for $69 million at venerable auction house Christie’s. Back in November 2020, the same artist sold another NFT digital artwork called Crossroads for $666,666 at Nifty Gateway, an online NFT marketplace owned by the Winklevoss brothers.
The National Basketball Association (NBA) has also hopped onto the NFT bandwagon. In March 2021, it launched Top Shot, a crypto-collectible game that is similar to trading cards for baseball.
The use of technology on the site makes it possible to own and exchange digital artifacts like video clips and gifs, each one of them with a unique digital stamp by the NBA for identification purposes. They can be purchased in packs for as low as $9 or as sophisticated NFTs that feature different lighting and camera angles of historic shots for as much as $240,000.
Nonfungible Tokens FAQs
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.