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What are NFTs, and how do they work?

We demystify what non-fungible tokens are, how they work, and what their pros and cons are.

Non Fungible Tokens

If you’ve been keeping an eye on the tech news lately, you’ve probably heard of terms such as Bitcoin, blockchain, and more recently, NFTs. Stories of multi-million dollar auctions for the digital assets have attracted the attention of artists and collectors alike. But what are NFTs? And how do they work? 

Here, we explore the basics of non-fungible tokens, the technology behind them, and their uses in everyday life. We also look at some of the skills and knowledge you’ll need to get involved with them. 

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What are NFTs? Key terms explained 

First things first, let’s take a look at some of the key terms and definitions we’ll be using. To understand what NFTs are and how they work, we need to have some broader context: 

NFT

NFT stands for non-fungible token. That probably doesn’t mean a whole lot at this stage; the word ‘fungible’ isn’t a particularly common one. However, it essentially means that something is interchangeable. 

For example, in economics, money is a fungible asset. It has units and can be easily interchanged (such as swapping a £20 for two £10s) without losing or gaining value. Fungible assets also include things such as gold, cryptocurrency, and shares. 

As we explore in our cryptocurrency open step, a fungible asset is something that can be divvied up in a bunch of different ways, and there can be an unending supply of it. They can be used in a myriad of ways, such as for payments or to store value.  

A non-fungible asset, on the other hand, is a one-off; a painting, a house, or a trading card, for example. Although a painting, for example, can be copied or photographed, the original is still the original, and the replicas don’t have the same value. 

NFTs are units of data stored on a blockchain digital ledger. Each non-fungible token acts as a kind of certificate of authenticity, showing that a digital asset is unique and not interchangeable. An NFT can never be changed, never be adjusted, and never be stolen, thanks to the principles of cryptography that make the blockchain unique. 

Digital asset 

Put simply, a digital asset is anything that exists in a digital format and has a right to use (a right to copy, duplicate, reproduce, modify and otherwise use). So, for example, things such as documents, audio or visual content, images, and other similar digital data are all considered digital assets.

Blockchain 

We’ve got a full article on understanding blockchain, cryptocurrency and bitcoin. In that post, we highlighted that a blockchain is a type of database – a collection of electronically stored information or data. 

Unlike a regular database, a blockchain is a series of data ‘blocks’ that are linked together. This chain of blocks creates a shared digital ledger (collection of data) that records the activity and information within the chain. 

Each blockchain ledger is stored globally across thousands of different servers. This means that anyone on the network can see (and verify) everyone else’s entries. This peer-to-peer and distributed ledger technology, as it’s known, means that it’s nearly impossible to falsify or tamper with data within a block. 

So, to use IBM’s definition, blockchain is a shared, immutable (permanent and unalterable) ledger that facilitates the process of recording transactions and tracking assets. 

When we think about NFTs, they are created on a blockchain and can never be taken into a separate blockchain ecosystem. It will exist on that blockchain and prove the authenticity of the good that you’ve purchased. 

Non-fungible tokens vs cryptocurrency

It’s important to outline the distinction between cryptocurrency and non-fungible tokens. Although both are based on blockchain technology, the fundamental differences can help us to understand how NFTs work. 

The key difference goes back to cryptocurrency being fungible. You can exchange a Bitcoin for another Bitcoin, for example. However, you cannot do so for an NFT. A non-fungible token is tied to one particular digital asset and cannot be replaced. 

Why do NFTs have value? 

As we’ve mentioned already, a non-fungible token is essentially a certificate of ownership for a digital asset. The value comes from the collectibility of that asset, as well as its potential future sale value. NFTs can be sold and traded.   

Again, using art is a great example of the value of NFTs. In February 2021, digital artist Beeple sold the NFT for their Everydays – The First 5000 Days artwork for a staggering $69.3 million through Christie’s auction house. 

Examples of NFT sales

It’s not just NFT art that sells well. There have been several notable sales of NFTs in recent months, although this has given rise to the speculation that there is a market bubble at the moment (more on that later). 

Some examples of NFT sales include: 

  • The first Tweet. Jack Dorsey, the founder of Twitter, sold the NFT for his first Tweet for $2.9 million
  • The ‘Nyan Cat’ GIF. The NFT for the colourful GIF sold for 300 Ether (a cryptocurrency), worth around $561,000 at the time. 
  • The ‘Charlie Bit Me’ Video. The popular video of a baby biting his brother’s finger was viewed over 800 million times on YouTube. The NFT for the video sold for around £500,000. 

What can non-fungible tokens be used for? 

Many people question whether there are use cases for NFTs. However, although the concept is in its infancy, several potential uses have already emerged. We’ve picked out some of the most notable ones below: 

Tickets

One of the uses of NFTs discussed in our open step is that of event tickets. The argument is that if tickets are created using a non-fungible token, if you make an exchange of that ticket, there is a record of that exchange. 

As a result, there is no chance of someone scalping tickets, stealing tickets, or trying to use counterfeit tickets. This is because there is no chance of replacing the token on a blockchain associated with that ticket.

Fashion

A couple of major issues in the fashion industry could be addressed through the use of NFTs. To start with, having a digital record of authenticity helps with issues such as counterfeit goods. Luxury items could have an attached NFT that would show it’s genuine. 

Similarly, a non-fungible token could show crucial data about the origins of an item, such as the materials used, where they were sourced from, and how far the item has travelled. As issues around fashion and sustainability become more pressing, this could help people make more ethical decisions. 

Collectables 

We’ve kind of touched on this point already. People have always enjoyed collecting memorabilia, trinkets, and other similar items. NFTs provide a way of ensuring authenticity, a kind of digital signature or stamp of approval.  

Gaming

In our article exploring the video games industry, we explored the huge market value related to gaming. NFTs provide gamers with a way of owning unique in-game items. Whether for fun, authenticity or in a competitive nature, such tokens can power in-game ecosystems. 

How to create an NFT

If you’re a budding digital artist, you might be interested in creating NFTs for your work. Luckily, there are several platforms available that can help you get started. On the whole, the process is fairly simple, and the various platforms will guide you through the process.

However, there are a few things you’ll need to know before you’ll get started: 

  • NFTs are based on and supported by a particular blockchain. The most popular one for non-fungible tokens is currently the Ethereum blockchain. 
  • You’ll need to have a cryptocurrency wallet, complete with cryptocurrency. The most widely used one is currently ether (ETH).
  • You can create and sell your digital assets on an NFT marketplace. The OpenSea platform is a popular, Ethereum-based platform.   

The pros and cons of NFTs 

So, non-fungible tokens are clearly popular right now. But what are the positives and negatives of NFTs? We’ve outlined some potential pros and cons below: 

Pros of NFTs 

Some of the advantages of NFTs that are often stated include: 

  • They give artists ownership over digital assets. When content creators create a digital asset, an NFT gives them the chance to not only show authenticity but to then profit from their work. With things like memes that are widely circulated, this could mean a significant income stream for the creator. 
  • They’re unique and collectable. Many people enjoy the excitement that comes with collecting something that’s unique or rare. NFTs provide an extra layer of legitimacy to collectable content, particularly in the form of digital assets. 
  • They’re immutable. Because non-fungible tokens are blockchain-based, they can never be altered, erased, or replaced. Again, when proving the origin or authenticity of digital content, this is a valuable quality. 
  • They can include smart contracts. Smart contracts are another feature of blockchain technology that are quite intriguing. Essentially, they can store instructions that are executed when certain conditions are met. As such, an NFT with a smart contract could give artists a percentage of the profit when the NFT is sold in future. 

Cons of NFTs

Of course, as with every new technology, there are some potential downsides. The disadvantages of NFTs include: 

  • It’s a speculative market. The big question remains as to whether there’s any true value in NFTs. Are they a long-term investment? Or simply a passing fad? It’s hard to tell. Currently, the only value is based on the emotive quality of NFTs. 
  • Digital assets can be copied. Just because someone owns the NFT of a digital asset doesn’t mean that copies of it don’t exist. Art can be copied and pasted, GIFs reposted thousands of times, and videos posted on various websites. Just because you own the NFT doesn’t mean you control the asset – you simply have a token of authenticity. 
  • Environmental costs. A lot has been said about the environmental impacts of blockchain-based cryptocurrencies such as Ether and Bitcoin. It takes a lot of computing power to enter records onto a blockchain. There is a big question as to whether assets based on blockchain are sustainable. 
  • They can be stolen. Although the technology behind NFTs is relatively secure, many of the exchanges and platforms aren’t. As such, there have been several reports of stolen NFTs after cyber security breaches

Are non-fungible tokens the future? 

Hopefully, you now have an understanding of what NFTs are and how they work. We’ve seen that there are several potential applications for non-fungible tokens in the real world, but are they a technology of the future? 

It’s hard to say whether NFTs will be widely used over the years to come. Clearly, there is a huge interest in them at the moment, as well as several potential benefits. However, the technology is in its relative infancy, and there are numerous challenges to overcome. 

If you’re interested in learning more about NFTs, blockchain technology, and cyber security, we have a wide range of courses available. Many of these emerging industries are looking for skilled individuals, so understanding the key principles could benefit your career. Whether they’re the future or not, NFTs are a fascinating part of popular culture. 

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