NFTs are booming. Amid all the buzz, hype, and concerns, we take a step back to look at the core reasons to be excited about NFTs.
- A non-fungible token (NFT) is the tokenized representation on a blockchain of a unique item and the ownership rights to it — be that digital artwork, a financial instrument, a property deed, or a physical item such as a luxury watch. An NFT allows the item it represents to be bought, sold, or have its provenance (ownership history) and authenticity verified on a public blockchain network.
- Creators are keen to engage with this new technology for sharing and monetizing their work through the use of NFTs, as the technology encompasses a broad range of digital and real-world implementations.
- For crypto evangelists, NFTs represent an easy-to-understand use case for blockchain technology, a new milestone in mainstream crypto adoption.
- As with physical collectibles, fans and enthusiasts are excited to connect with their favorite creators through an NFT, following in the footsteps of the CryptoKitties boom of 2017. Others see NFTs as an opportunity for short- or long-term financial speculation.
- NFTs promise to be fundamental building blocks of the “metaverse” that is emerging as the quasi successor to the mobile internet, where individuals interact in interoperable 3D virtual worlds.
NFTs are a disruptive technology that could open up new and valuable revenue streams for IP owners, and shake up a number of industries by disintermediating incumbent gatekeepers. Owners of marketplaces for NFTs will be the direct beneficiaries of this disruptive technology — but non-crypto corporations such as videogames and media-streaming companies, while faced with challenges from NFTs, could also seize the opportunities the technology presents.
A recent report by Citi says that the music and video gaming industries, and more widely the owners and creators of content, will be among the early beneficiaries of NFT disruption. Companies associated with “walled garden” ecosystems such as streaming services and video game retailers may be the most subject to disruption.
The potential of NFTs to play a pivotal role in helping create new profit centers in a broad spectrum of industries has venture funds eyeing the sector.
In February 2022, news emerged that pioneering NFT start-up Yuga Labs — the company behind the wildly successful Bored Ape Yacht Club collection — was about to receive a multi-billion dollar valuation. The Financial Times reported that the start-up is in talks with Andreessen Horowitz to secure financing that would value the company at up to $5 billion.
What are NFTs?
Cryptocurrencies — digital assets taking the form of tokens or coins — are an elemental aspect of blockchain technology. Cryptocurrencies are fungible, meaning all units of a given cryptocurrency are of the same type and are not unique. Each unit is interchangeable and indistinguishable from another unit of the same cryptocurrency. One bitcoin is worth one bitcoin, and is indistinguishable in form from one unit or fraction to another.
NFTs, on the other hand, are tokenized representations on a blockchain of non-fungible items with associated assigned ownership rights. A non-fungible item is unique, and therefore does not have the property of being interchangeable on the basis of its “sameness” with any other item. Collectibles, antiques, homes, and fine art are all examples of non-fungible items, as their value resides in unique attributes that may ultimately depend on the eye of the beholder.
An NFT is not the underlying non-fungible item itself; it is a tokenization of the item and its assigned ownership rights. With an NFT, the ownership of the item is managed on a blockchain and is tracked on the blockchain’s ledger, in the same way as the ownership of other cryptocurrency. Almost anything can be represented as an NFT, but much of the focus of current NFT technology is on its representation of art.
How an NFT works
- Establish the NFT’s smart contract Ownership of an NFT is usually managed by a smart contract, which allows the item to be exchanged on a blockchain network and stored in a cryptocurrency wallet, much like fungible cryptocurrencies can be exchanged and stored. The smart contract creates the rules of ownership and exchange, including the possibility of a percentage of the proceeds from the NFT sale being retained by the creator in perpetuity (similar to music royalties). Because an NFT is programmable it provides a flexible and extensible format for designing and managing intellectual property rights and passive income streams.
- Mint the NFT The token representing the non-fungible item is issued on a blockchain via a smart contract, a process referred to as “minting” an NFT. Most creators — particularly those less familiar with blockchain technology — use a platform such as OpenSea, Rarible, SuperRare, or one of many more. These platforms allow creators to mint NFTs without needing the technical expertise required to manage smart contract code deployment.
- Sell the NFT Most creators sell their NFTs via the platform on which they were minted. As the unchangeable record of the NFT’s origination and ownership is recorded on a public blockchain, the authenticity and originality of the non-fungible item can easily be traced.
Most NFTs exist on the Ethereum blockchain, a popular blockchain currently transitioning from a proof-of-work (PoW) consensus mechanism to proof of stake (PoS). Other protocols gaining traction for NFTs include Flow and other PoS networks, Polkadot, Kusama, NEAR, Cardano, and Solana.
Purchasing a digital art NFT
The purchaser of a digital art NFT usually receives the digital piece of artwork represented as a token in a digital wallet. The purchaser is now considered the owner and has custody of the piece on the blockchain, as defined by the contract used to purchase it, and control or ownership of the public address at which the NFT “lives” (contract address).
In most cases, the “token” element of the NFT points to an internet gateway run by the platform the NFT was minted on, containing a JSON metadata file that defines the token and provides a name and description of the asset the NFT represents, as well as information such as a pointer to where an image file is stored. What the purchaser receives is a blockchain-based hash; the art itself does not reside on the blockchain.
As the unchangeable record of the NFT’s origination and ownership is recorded on a public blockchain, the provenance and authenticity of the non-fungible item can easily be traced. Unlike most pieces of digital art, someone can own an NFT digital art piece instead of just looking at it. Like most works of traditional fine art, the piece may be viewed by many people but only the purchaser holds its custody.
As NFT platform SuperRare wrote on the value of digital art NFTs:
“Yes, anyone can download and view the image for free, but they don’t own it and they can’t gain any value from it without owning the NFT as well. As a collector you want as many people as possible to be downloading and enjoying the artworks that only you probably own because this is how the artwork gains value. Imagine if one million people around the world were featuring an artwork that only you owned on digital frames in their houses. THAT is a piece of art that has real value. Hackatao, one of SuperRare’s most successful artist duos, said it best — ‘Everybody sees it, only one owns it’.”
How consumers interact with NFT marketplaces
An NFT is essentially a receipt, not the actual asset (such as a digital image, piece of music or video clip). It proves ownership of an asset.
- A visitor to an online gallery such as OpenSea, Rarible or SuperRare will see artworks listed for sale.
- To buy an NFT the user must connect a digital asset wallet (such as Coinbase Wallet) to the website (Metamask is a popular choice and Coinbase are building a Chrome browser extension for this purpose) and initiate a transaction to purchase the artwork.
- The network processes the transaction.
- The marketplace user has now bought the artwork and received the NFT.
Here’s a step-by-step breakdown of what actually happened and how it is recorded on the blockchain:
- The blockchain upon which the NFT marketplace is built transfers payment from a buyer’s wallet to the artist’s wallet.
- The public address on the blockchain where the NFT resides in the form of a cryptographic hash, changes from the artist’s to the public address secured in the buyer’s wallet. An address is a unique string of alphanumeric characters.
- The blockchain transfers the NFT (that the artist minted when they posted the artwork for sale on the website) to the buyer’s wallet.
- The blockchain adds a transaction record to its ledger stating that the buyer engaged with the website’s smart contract in order to send a payment from their cryptocurrency wallet to the artist’s cryptocurrency wallet, and received an NFT in return that is now stored in the buyer’s wallet.
When a buyer completes this transaction, the rights to the artwork are not determined by the NFT or the blockchain. Instead, they are determined by an agreement between the user/NFT buyer, the website and the artist. It is the agreement that defines the terms of the purchase.
However, some of the business logic that flows from the rights agreement will be codified in the smart contract, such as automating royalty payments to the artist from future sales.
Owning an NBA Top Shot NFT for a video clip of a favorite basketball player, for example, does not give you exclusive rights to the video — those rights still reside with the NBA.
Similarly, the superrare.com Terms of Service Agreement include some provisions about a buyer’s rights to the artwork, including a term that if and when the buyer sells the NFT (by transferring the NFT to a new owner), the artist receives 10% of that sale.
Here too, the underlying digital asset (such as that which has been bought) is not stored in the NFT. The NFT and the asset are separate. So the NFT will be stored in a digital asset wallet, but the artwork or other asset will be stored elsewhere — probably on a server belonging to or rented by the marketplace where the NFT was bought.
Creators are excited about a new medium and market
NFTs provide a new medium for creators to share and monetize their work. They comprise a broad range of digital implementations, including images, GIFs, audio/visual implementations, and even physical items, virtual interactions, or in-person experiences.
Digital art and NFTs
The creative possibilities for NFT-based art are endless. Take, for example, Crossroad by Beeple (artist Mike Winkelmann), which trended recently following its record-breaking resale for $6.6 million (a sale price eclipsed shortly thereafter by the auction of a different NFT by Beeple — Everydays: The First 5000 Days — at Christie’s for $69 million). Aside from its sale price, Crossroad made an innovative use of the medium: the artwork was programmed to change based on the result of the 2020 presidential election. As sold, it pictured former President Trump’s body on the ground covered in graffiti. Had the election gone differently, the artwork would have instead shown a portrait of a muscular Trump rising out of the White House in flames.
Videogaming is a site of interest for NFTs and is also an outlet for artistic endeavor. In-game NFTs, such as character skins, weapons, or accessories, offer another unique NFT-based medium for artists — particularly those with backgrounds in game art and animation. In-game NFTs can be traded on third-party marketplaces, allowing players to show their individuality and realize value in the gamespace. Gaming NFTs also allow artists not affiliated with major game developers to create usable art and earn revenue for their work.
Physical items and experiences get the NFT treatment too. Coinbase Cloud Protocol Engineer Trinity Montoya reflected on the ongoing experimentation with the technology in an interview on NFTs as an artistic application of blockchain:
“Limited edition NFTs that represent ownership of physical objects are pretty neat. Unisocks, the SaintFame Genesis shirt, and CryptoPunk prints with attached, sealed paper wallets all come to mind… CryptoJingles, though short-lived, were tokenized sounds that you could mix and match to create NFT songs. To my mind, this opened the door for people to explore what other non-obvious things could be represented by NFTs.”
NFTs lend themselves to limited-edition non-fungible items, which have driven some of the higher-profile recent sales of NFTs. Thus NFTs enable digital art — which in many ways is infinitely available — to be considered scarce, similarly to traditional art.
Artists can therefore take advantage of the very human attraction to rarity to turn a higher profit. Because each NFT token is unique, NFTs have greater similarity to, say, an autographed item than they do to a “physical” copy of a digital product. In cases where multiple NFTs are minted for the same non-fungible item, they are more akin to a numbered print than a standard print.
Music artists and NFTs
To get paid for digital creations, recording artists have had to entrust large corporations or other centralized entities (such as non-profit rights protection societies) to manage the ownership rights for them. So instead of selling music directly to their audience, artists depend on a record company for production and distribution.
That ultimately means allowing streaming services such as Apple Music and Spotify to sell the music. Record companies and streaming services take most of the proceeds, leaving artists with royalties of 10% to 25% of the sale amount, according to ASCAP. Similarly, filmmakers who want to share work online must entrust it to YouTube or a streaming platform like Netflix.
Digital image ownership was difficult to assign and verify, so it was not considered valuable enough to form the basis for creating profitable storage and distribution platforms. That meant there was no reliable marketplace to buy and sell digital images online. As the images were too easy to steal, they were treated as worthless.
This remained the case until NFTs were invented. As they became more popular, artists who had found it hard to sell their work discovered they could now realize its value by using NFTs as a virtual certificate of authenticity.
Where does the metaverse fit in?
The metaverse first entered the language in a 1992 science-fiction novel by Neal Stephenson called Snow Crash, in which human beings inhabit an online 3D virtual world, accessed via virtual-reality goggles, as a refuge from the dystopia of the real world.
When the parent company of Facebook was created and named Meta Platforms, it brought even more attention to this new computing paradigm.
Matthew Ball, managing partner of EpyllionCo, which operates an early-stage venture fund and advisory arm, and a former Head of Strategy for Amazon Studios, defines the metaverse as “a massively scaled and interoperable network of real-time rendered 3D virtual worlds which can be experienced synchronously and persistently by an effectively unlimited number of users with an individual sense of presence, and with continuity of data, such as identity, history, entitlements, objects, communications, and payments.”
If we distill the essence of the metaverse from this definition we have seven main features, all of which lend themselves to NFT application:
- Massively scaled
- Interoperable, real-time 3-D virtual world
- Experienced synchronously
- Experienced persistently
- Unlimited number of users
- Individual sense of presence
- Continuity of data
NFTs can play a key role in tracking items and assets in a massively scaled world (1 and 2); where events are synchronized and always have a state of liveness, making NFTs ideal vessels for storing this information as it relates to unique entities across time (3 and 4); assigning immutable and verifiable uniqueness to each user (5 and 6); and assisting in the maintenance of data continuity (7) as it relates to a user or unique in-world item.
The proof of NFTs’ applicability to the metaverse may already be apparent in the success of online virtual world Decentraland and the play-to-earn phenomenon in videogaming, as witnessed in the success of Axie Infinity. Other projects, such as NFT gaming pioneer Enjin and another gaming-focused project The Sandbox, are also gaining traction.
NFT sales are booming. According to NFT market tracker NonFungible.com, 2021 total full-year completed sales amounted to $15.37 billion..
But not only individual collectors are buying. On August 23, 2021 Visa announced it purchased an NFT from the CryptoPunk collection with Ethereum — valued at $150,000 at the time of the sale.
Explaining the payment network's foray into the sector, Cuy Sheffield, Visa’s head of crypto, said, “We think NFTs will play an important role in the future of retail, social media, entertainment, and commerce.”
Sheffield noted Visa wanted “a first-hand understanding [to] help our clients and partners participate”."
Many artists increasingly struggle to sell their work digitally, given the challenges of marketing their work in a world that expects digital content to be free. NFTs create an opportunity for a new marketplace in which all kinds of creators can reach potential customers, a dedicated forum in which to sell digital work that many felt was previously lacking within the art market.
As artist-manager Andrew Gertler said in an interview with NBC news:
"This [NFT boom] opens up a whole new world not just for the musicians that have suffered from revenue loss in the pandemic but also their collaborators… I know concert tour visual artists who were out of work and turned to NFTs to make a living. It's really incredible to see a new income stream for so many creators."
Nevertheless, for many creators, the prospect of selling NFTs also presents an opportunity to “cut out the middleman” and retain more of the revenue from the sale of their work.
In one unique case, professional tennis player Oleksandra Oliynykova minted an NFT that gave the purchaser the right to put temporary tattoos on her arms. This arrangement enabled her to earn sponsorship income outside of the traditional system that generally only pays the top 30-60 women in the league. It is also an interesting workaround to the Association of Tennis Professionals’ rule that extra sponsor logos can be physically cut off uniforms during matches.
For creators, perhaps the most important benefit of the smart contract functionality of many NFTs is that it allows them to earn revenue on secondary sales and royalties. NFT platforms such as Zora enable artists to set a “creator share” when minting their NFT, so that a percentage is automatically paid to the artist for all future sales.
With Zora, the creator share is paid out automatically via smart contract to the Ethereum address used to mint the NFT, meaning the artist does not have to track down future royalty payments as long as they maintain custody of their original address. This set-up to an extent helps to address concerns that if NFT marketplaces go offline or fail as businesses, the NFT could become inaccessible. However, this is perhaps more of an issue at the blockchain level, where there’s a broader risk of network value disappearing if a network collapses.
How the NFT sector is becoming more investible
For crypto evangelists, NFTs represent an evolution in mainstream understanding of blockchain technology. Many consumers are being introduced to the crypto ecosystem for the first time by interacting with NFTs. The breakthroughs in collectibles and the art world are the first examples at scale of mass adoption of a blockchain technology beyond the worlds of trading on crypto exchanges. The advent of the metaverse promises to act as a multiplier effect.
While the users on CryptoKitties peaked at 250,000 in 2018, just one NFT release on NBA Top Shot in February 2021 had more than 200,000 users waiting in the digital queue, each vying for a chance to purchase one of the 10,000 “premium packs” being released.
A majority of NFT platforms require buyers to perform some crypto-native tasks, such as using a digital wallet, purchasing crypto on an exchange, and sending crypto to and from addresses.
While some platforms such as music-focused Audius abstract away the visible elements of blockchain tech for their users, many believe that requiring users to complete basic crypto tasks serves as a good way to get consumers more comfortable with navigating crypto tools.
Crypto enthusiasts see the broad range of potential, big-idea uses for NFTs — expanding the potential audience way beyond niche collectors — as a further bullish sign for the mainstream adoption of blockchain technology.
Some see the recent NFT sale of a virtual home for $500,000 USD as a harbinger for the potential to conduct real estate transactions and manage deeds via smart contracts and NFTs. Here we may see an example emerge of how the worlds of DeFi (decentralized finance) and NFTs could mesh together. Others point to headlines explaining and promoting NFTs, such as the minting of a New York Times column as an NFT, as a sign of mainstream adoption of the technology.
Accessible exclusivity and curation and the value of ‘flexing’
Though high-grossing sales of celebrity works have dominated the headlines throughout the recent NFT boom (although by November 2021 many of those prices were coming off the boil), average retail collectors can snag an NFT in almost any price range.
New projects are emerging to allow for collective, fractionalized ownership of NFTs — for example, retail collectors buying small pieces of renowned artworks or building wealth via shared ownership of more valuable assets. The result is that NFT ownership is accessible to nearly any budget.
The phenomenon of social media “flexing” is helping to underpin NFT valuations. Flexing can be defined as showing off through ownership of a sort-after or exclusive item and using this proof of ownership to gain popularity or to appear “cool”. NFTs, it could be argued, are the perfect vehicle in the digital age for verifying bragging rights on social media.
Collecting as a hobby has been documented as far back as 3,000BCE, and its appeal remains strong. Top-traded autographs increased by 10% annually, for example, and even the volume of baseball trading card sales ison the rise. Sneaker trading, a booming trend expected to reach $6 billion in resale value by 2025, is a particularly compelling use of NFTs, given the complexity of verifying authenticity in digital, peer-to-peer marketplaces.
Just as with physical collectibles, fans and enthusiasts are excited to be able to connect with their favorite public individuals through an NFT, whether it’s owning the clip of their favorite NBA player dunking on his opponent or the rights to front row seats for life whenever their favorite band performs. NFT art also provides a new and often affordable opportunity for friends and fans to financially support their favorite digital creators.
NFTs are also finding value in providing their owners with access to a community. For instance, fans of a celebrity can purchase a NFT that gives its owner communication rights with that celebrity over mediums such as Discord server chatrooms. Or an NFT could provide access to a Telegram group chat populated by like-minded people.
What about the environmental cost of NFT minting?
All technological platforms require some energy expenditure to operate, but the concern about proof of work (PoW) blockchains’ high energy expenditure has many questioning whether NFTs — and the excitement they generate — are worth the energy used by their underlying technologies.
It’s hard to evaluate the environmental impact of NFT minting. The blockchains that NFTs are minted on would continue to operate and consume energy if NFTs — representing a small portion of a chain’s overall energy expenditure — did not exist. Other factors to consider include the comparative environmental impact of traditional distribution methods for non-fungible items, such as shipping CDs, mailing prints, or shipping artwork internationally.
As Justine Calma wrote in her piece for The Verge on the climate controversy surrounding NFTs: “Figuring out the culpability of NFTs is a little like calculating your share of emissions from a commercial plane flight, according to Joseph Pallant, founder of the nonprofit Blockchain for Climate Foundation. If you’re on the plane, you’re obviously responsible for a portion of its emissions. But if you hadn’t bought the ticket, the plane probably would have taken off with other passengers and polluted the same amount anyway.”
Ethereum, the blockchain most commonly used for NFT minting, currently operates using PoW validation, a traditional method of securing a blockchain that is critiqued for its high energy expenditure. Proponents argue that Ethereum uses less than 10% of the annual energy consumed by YouTube, while critics point out that Ethereum uses as much energy annually as the nation of Panama.
But Ethereum is in the process of transitioning to use Proof of Stake (PoS) validation, which is expected to cut Ethereum’s energy usage by 99%, in a migration process dubbed eth2.
Those who don’t want to wait until eth2 is live for more energy-efficient NFTs can mint or buy NFTs on PoS networks now. NFT minting and distribution platforms that operate solely on PoS networks already exist. Some options include KodaDot on Polkadot, Viv3 on Flow (a protocol that is also used by one of the largest NFT platforms, NBA Top Shot), hic et nunc on Tezos, Paras on NEAR, and Solible on Solana.
An abridged timeline of NFTs
2013: Colored Coins developed
Developed on Bitcoin, Colored Coins were a method of managing real-world assets via Bitcoin metadata. Though at their core Colored Coins were fungible tokens, users’ attempts to repurpose them to represent real-world, non-fungible items was validation of market demand for non-fungibility on a blockchain.
Colored Coins are considered to have laid the experimental groundwork for NFTs as the first exploration into representing the ownership of real-world objects on a blockchain.
2014: First NFT minted
Quantum is widely considered to be the first example of minting and selling an NFT.
Digital artist Kevin McCoy and technologist Anil Dash minted Quantum as part of an experimental presentation at the Seven on Seven event in NYC. Their project, titled “monetized graphics,” was described by Dash as a “blockchain-backed means of asserting ownership over an original digital work.”
2017: CryptoPunks launched
CryptoPunks, the first major collection of smart contract-based NFTs, was released by Larva Labs on Ethereum. A collection of 10,000 limited, unique pieces of digital art, each was originally offered free of charge and could be claimed by anyone with an Ethereum wallet. Once all 10,000 were claimed, the punks were only available via resale in the public Larva Labs marketplace.
Resales of CryptoPunks remain popular today; the average resale price over the last year was 15.63 ETH (~$30,166.37 USD), though prices vary widely depending on the rarity of a punk’s attributes.
2017: CryptoKitties launched
CryptoKitties is widely considered the start of the first mainstream NFT boom. Launched by Dapper Labs, this Ethereum-based game centered around breeding collectable cats, each an NFT. A smart contract-executed breeding algorithm decides each cat’s attributes (“cattributes”) with predetermined randomness and varying rarity.
- Dapper Labs developed a Dutch auction smart contract as the price discovery tool for their marketplace, laying some of the key technical groundwork for NFT marketplaces to come.
- Users could “breed” the cats to be sold on a secondary market, using the game’s breeding and training mechanics to flip cats for profit. This created a speculative market and proved the ability for NFTs to be used as collectibles.
- The CryptoKitties boom broke new territory, shifting the concept of NFTs away from being collectors’ items towards being a method of supporting creators, in-game functions, or representations of physical objects. This opened them to price speculation.
2018-2019: Developing maturity
Following the crash in crypto asset prices at the end of 2017, NFT speculation died down, as did the hype. Nonetheless, development teams continued to work on new NFT platforms and solutions.
Experimental projects ranging from NFT representations of physical items, such as fashion accessories, to rights and royalties for musical releases and NFT event tickets have been enabled in large part by the continued development of easy-to-use NFT platforms such as OpenSea, SuperRare, Niftygateway, CNFT, Solanart and many more.
2020: NBA Top Shot
Mainstream interest re-emerged with the NBA’s NFT product NBA Top Shot. Developed by Dapper Labs of CryptoKitties fame, the NBA-licensed and league-promoted collectible items reportedly reached over $230 million in gross sales in early 2021.
2021: The new NFT boom
Interest is exploding following 2020’s boom in cryptocurrency traction. Artists have seen massive success as mainstream adoption of NFTs expands.
The spike in popularity has led to an unprecedented blossoming in media coverage of NFTs (see Google Trends chart below) — along with a spate of social media mentions expressing concerns about their underlying technology.
NFTs set for use-case expansion and long-term adoption
Since the advent of CryptoKitties in 2017, NFTs have certainly become an opportunity for short- or long-term financial speculation, but there is real fundamental value in this disruptive technology.
The realm of collecting and re-selling items via NFTs is expected to grow in new and unexpected ways. NFTs are making their relevance felt in both the digital and non-digital arenas. In the latter respect, one such example is the development of platforms focused on minting real-world luxury items as NFTs. In 2019, luxury watch house Vacheron Constantin announced it would be launching a solution to combat counterfeiting and ensure traceability by tracking its watches’ authenticity on the blockchain. Shortly afterwards, NFT-focused blockchain company VIDT said it would be kicking off its NFT operations by minting an NFT of a rare vintage Rolex popular among collectors.
It’s clear the wide-ranging uses of NFTs and who has access to them — regardless of location, wealth, or niche interest — set them up to be a long-term player in the market of collectors, fans, and enthusiasts.
For institutional investors this disruptive technology is already creating investable opportunities, both in non-crypto companies seen as best positioned to leverage NFTs to enhance or build new revenue streams, and in crypto-first companies focused on directly developing the NFT ecosystem through, for instance, NFT marketplaces and protocols.