Non-fungible tokens (NFT) Explained – A Beginner’s Guide
Are you trying to understand the NFT gold rush? Well, your search stops here. After so many requests from you, I have crafted a one-stop tutorial for your NFT research.
This guide is apt for everyone from a beginner in this space to a professional who is already aware of the nits and grits of the NFT world. Because this guide also caters to beginners, bear with me while I discuss the most basic concepts related to this sector.
Before diving deep I would like you to ask a question to yourself ‘Why am I here?’.
The answer to this question can be anything, such as:
- I am an artist looking for a marketplace where my art can be appreciated by a wider audience
- I am a crypto enthusiast looking to learn more about this space
- I am an investor trying to identify crazy investment opportunities in this space
- I want to explore what other streams of economy NFTs can contribute towards
The answer to this question is crucial as this will determine your takeaways from this guide. Pick your reason as this guide will justify your research needs just right. I ensure that once we reach the end of this guide, you will be fully equipped to take steps towards your purpose of being in this space.
But first things first, let us understand the concept of fungibility.
What is Fungibility?
Basis Investopedia, “Fungibility is the ability of a good or asset to be interchanged with other individual goods or assets of the same type”.
For example, if you lend me $1 for a day and I return that $1 to you the next day. You are not going to expect the same piece of paper that you gave me, right? Any dollar would do. You are more concerned about the value of the dollar than that specific dollar.
Therefore, when the value of an item is superior to the specifics of the item, it is a fungible item. For example, currency notes, gold bar, etc.
By default, anything is rarely fungible. Most of the things are non-fungible with a degree of fungibility attached to it. For example, a collectible item such as art, and antiques are completely non-fungible.
Not only this, I have a coffee mug which I love very much, and have all my beverages in it. Even though there can be several similar cups in the world, I am emotionally attached to that mug, making it non-fungible. Think of a kid who has a G.I. Joe toy and is very attached to it. For him, his old toy is not interchangeable with a similar new toy. Thus, making the G.I. Joe a non-fungible thing.
So anything can be classified into 3 categories based on fungibility:
What are Fungible items
Anything which is 100% interchangeable with a similar thing is a fungible item. For example, a $5 note is interchangeable with either another $5 note or 5 $1 notes.
What are Semi-Fungible Items (Fungible within classes)
Anything which is fungible within a category can be termed semi-fungible. For example,
- You want to buy a BMW X1 black color. It does not matter from which showroom you buy this car as the item will be the same in all the BMW showrooms. However, a BMW X1 is not interchangeable with an Aston Martin Vantage. Although both are cars, they do not provide the same value or specifics and thus, are not interchangeable.
- You went to the supermarket to purchase Loreal hair shampoo. If there are 100 pieces of Loreal shampoo lying on the shelf, you will be indifferent about which Loreal shampoo you pick up. However, because you want Loreal shampoo only, you will not be indifferent while purchasing a Head & Shoulders shampoo
Most of the world’s items fall under this category unless they are truly unique and scarce in every sense. If an item is truly scarce and unique, it would be a non-fungible item.
What are Non-Fungible Items
A Non Fungible item is usually an item that is collected or desirable because of its age, beauty, rarity, condition, utility, personal emotional connection, and/or other unique features.
It can be a physical item such as furniture, jewelry, paintings, etc., or a digital item such as domain name, email address, digital avatar, digital art, a song, or a movie. These represent the items that are not factory-built for the masses.
It is worth noting that the concept of fungibility is subjective and relative in all aspects. The fungibility of an item depends on how fungible people think an item is. Only society decides how scarce, unique, or interchangeable an item is.
Let us reflect.
So, what have we understood so far? We are clear on what can be termed as a non-fungible item. Now we need to understand the ownership of these non-fungible items.
Ownership of physical items is easy. You pay for a physical non-fungible item such as a physical painting and then you get possession of that painting. Now, you can place that painting in your drawing room.
Historically, people have been predominantly inclined to own and trade physical objects. This is probably best explained by the fact that physical objects stimulate our senses and don’t require the capacity to abstract, as opposed to any service or a digital item (intangibles). Ownership was usually synonymous with possession.
But, ownership of digital items is a bit tricky in the real world which we will just discuss below.
What is Digital Ownership?
There are 2 terms that I would like you to really focus on which are confused with each other and sometimes used synonymously but are completely different from each other.
First, let us try and find the answer to the following questions:
- If you are a Netflix user, do you own the movies and shows or you just have access to the shows available on the platform?
- If you are a Spotify user, do you own the songs or just have access to listen to them?
- If you purchase an ebook from Kindle, are your ownership rights equal to when you own a physical copy of that book? What will happen to the ebook if the Kindle platform is closed?
So, do we really own the above-discussed digital assets?
The answer is a big ‘No’, we do not own these assets but only have purchased access to use these assets. The respective platform can restrict our access on their will. It’s just like renting a car or a house. This is a simple form of an ‘Illusion of ownership’.
“The popularity of access-based consumption has obscured the rise of a range of fragmented ownership configurations in the digital realm. These provide the customer with an illusion of ownership while restricting their ownership rights. Companies such as Microsoft and Apple present consumers with the option to “buy” digital products such as eBooks. Consumers often make the understandable assumption that they will have full ownership rights over the products that they pay for, just as they have full ownership rights over the physical books that they buy from their local bookstore.
However, many of these products are subject to end-user license agreements which set out a more complex distribution of ownership rights. These long legal agreements are rarely read by consumers when it comes to products and services online. And even if they do read them, they are unlikely to fully understand the terms.”
She adds, “Consumers need to become more sensitized to the restrictions on digital ownership. They must be made aware that the “full ownership” they have experienced over most of their physical possessions cannot be taken for granted when purchasing digital products. However, companies also have a responsibility to make these fragmented ownership forms more transparent.”
Therefore, we can comfortably conclude that ownership of digital assets in the real world is mostly an illusion and is nothing more than a “Right to Access”.
So, what can be the possible solution? How can we really own an asset in the Digital World? Think.
How Blockchain Fits into the Equation of NFT?
Blockchain could play an important role as an ownership layer on the internet. Before blockchain, there was no way to achieve trustless digital ownership. Blockchain gives us the ability to own digital assets.
When a digital file is available on the internet, data about the true ownership of that file is absent. The creators of that digital file cannot see how and where their work is being used. Thus, there was a need to establish clear ownership rights and facilitate payment processes wherever required.
Blockchain technology solves a crucial networking problem where individuals who wish to undertake value exchange over a computer network can do so. Further, the exchange can be monitored, verified, and enforced, all without the need for a centralized governance institution.
The blockchain forms a distributed ledger of transactions that is duplicated across many
computers and can be read and verified by anyone, creating visibility of transactions.
Bitcoin is probably the first digital asset that could be owned in a true sense. It is also trustless, which means there is no central authority that must maintain an account (like a bank) for keeping a record of how many bitcoins each person owns.
So, now as we have ample understanding of what true digital ownership would look like, let us address the belle of the ball. N F T
What is a Non-Fungible Token (NFT)?
Non Fungible Tokens are the first step to integrating individual ownership with digital assets (non-fungible assets).
A Non-Fungible Token (NFT) is a digital item that can be created (minted), sold, or purchased on an open market, and owned and controlled by any individual user, without the permission or support of any centralized company.
A Non Fungible Token is a single token that is encrypted on the blockchain network. As it is known, Bitcoin is a changeable coin and can be reprogrammed with the community consensus, but NFTs cannot be changed. The most important feature of NFT is that it is a unique and proprietary asset.
NFTs are a new type of collectibles such as stamps, tickets, coins, etc. with the only difference that it is digital. NFTs are a certificate of authenticity created by the blockchain for a digital asset such as artwork, music, or video.
It is worth noting that these are only current use cases of NFT. Sky’s the limit for potential use cases of NFTs.
Though NFTs are currently being used to identify ownership of Digital Assets, they can also be similarly used for physical assets. Think of the real-world problems that this technology can possibly solve in the physical world such as identity theft, forgery, etc. An NFT consists of details about the digital asset it represents and details of the owner of that asset. Thus, maintaining the ownership ledger without any trusting authority on a blockchain. Literally, the sky’s the limit for what NFTs can do.
Now, let us take Ethereum blockchain as an example and try to understand the standardization of ownership in NFTs. Predominantly, there are three token standards available on the Ethereum blockchain:
- ERC 20 – this token standard is issued for fungible digital assets
- ERC 721 – this token standard is issued for non-fungible digital assets and was pioneered by CryptoKitties
- ERC 1155 – this token standard is used for semi-fungible digital assets and was pioneered by the Enjin team.
So we can say that on the Ethereum blockchain an NFT token would either be ERC 721 or ERC 1155. While Ethereum is the boss blockchain in the NFT space right now, there are other NFT standards emerging on the other blockchains such as Efinity.
Further, the NFT module would solve a number of problems with digital ownership that exist today such as:
- There would be no regional barriers
- There are no middlemen
- Increased liquidity of the asset due to token standards
- Reduced transaction costs
- Asset interoperability
- Redemption is easier
- Easy to trade
- Immutability and provable scarcity
Following is the most comprehensive film on NFT that I could find, have a look!
What is NFT Digital Art?
A digital art encrypted on a blockchain and represented by a unique token can be termed as NFT Digital Art. 2021 has seen a boom in the adoption of NFT digital art which has led to many artists such as painters, web designers, and singers selling their art through an NFT.
What else can be owned as an NFT?
Anything could be owned through an NFT. NFT is a safer and trustless ownership module that can be used for anything or everything. From physical property to digital property, from college degrees to inheritance will, anything can be owned through an NFT.
Exiting Problems with NFT
Well, this is the most important part that you need to understand if you are thinking of getting into the NFT space anytime sooner. NFT is a very new sector and there are a lot of issues that need to be resolved, such as:
Copyright infringement issues
This art is again a product of creativity from Beeple. As this projects Mr. Donald Trump in a compromising position, the art, the artist and the owner of this NFT would never be away from the infringement lawsuit from the Trump family.
So even though blockchain is away from the regulatory authorities, you should always consider the law of the land before purchasing an NFT.
The originality of the art
Although an NFT maintains the ownership ledger, it cannot prove the authenticity of the digital asset that is linked to that NFT. For example, suppose the original Monalisa painting is being sold online as an NFT. NFT will only hold details of the painting and the details of its owner. Whether the painting is real or not is something that the buyer needs to research and identify.
NFT does not encrypt the digital asset but only its ownership details. Further, in case you have been scammed in purchasing a fake painting, there is no law in place to protect you.
Low liquidity in the secondary NFT marketplace
Currently, the secondary marketplace for NFTs is in its development stage and may take a few years till it is fully functional. Thus, an NFT comes with inherent low liquidity.
Thus, these are the limitations that the NFT community will have to face and overcome in the coming years.
But, the limitations are negligible in comparison to the development and innovation that is taking place in this space. I would like to introduce you to some of these amazing projects
Projects that can be looked at in the NFT space
There is definitely a flood of NFT projects in the crypto market. However, I have some favorites which I expect will change the shape of this space indefinitely.
Decentraland (MANA) – A decentralized virtual world
Powered by the Ethereum blockchain, Decentraland is a decentralized virtual world that allows users to use customized avatars, trade collectibles, and participate in the virtual world’s governance process.
Decentraland has the potential to create a whole metaverse on its platform. To read more about metaverse, click here.
Enjin (ENJ) – Integrated digital products
Enjin is a company that offers an ecosystem of integrated digital products, making it easy for everyone to trade and monetize gaming products. This allows game developers to tokenize in-game items on Ethereum, which is backed by Enjin coin, Enjin’s ERC 20 token.
Rarible (RARI) – NFT marketplace
Rarible is the NFT marketplace that utilizes the native RARI token to be a creator-centric platform. Any user can easily create NFT for unique digital items along with a fully functional crypto marketplace. They use a part of the revenue to subsidize the first mint transaction where the NFT is created to fuel the growth of the platform.
Conclusion – NFT For Beginners
So let me sum up my thoughts for the NFT space.
I think the NFT market is still in the incubation stage and there is a lot of innovation and development that will be executed in the coming months. NFT can fuel the whole metaverse ecosystem as well as create value in the physical world with clear and safe ownership standards. Moreover, the removal of intermediaries makes NFTs affordable and fast to transact with.
A specific art has low liquidity similar to the physical world. However, marketplaces and platforms can have higher liquidity and have the potential to grow at an immense scale. Therefore, from an investment point of view, I think that rather than investing in a specific art (unless you are an admirer of art), one should try and invest into the NFT ecosystem with some of the projects that I have mentioned above.
If you are looking to invest in NFT projects, you can invest via NFT Index funds. Here are top 3 ways to invest in NFT market:
Please note that this is not financial advice and I am not a financial advisor. DYOR before investing.
Finally, with blockchain as the torch, DeFi and NFTs can be the torchbearers of our digital future.
Let me know your feedback on the above guide.
Further, let me know your thoughts on the NFT space and whether you invested in any NFT project?
Harsh Agrawal is the Crypto exchange and bots expert for CoinSutra. He founded CoinSutra in 2016, and one of the industry’s most regarded professional blogger in the fin-tech space.
An award-winning blogger with a track record of 10+ years. He has a background in both finance and technology and holds professional qualifications in Information technology.
An international speaker and author who loves blockchain and crypto world.
After discovering about decentralized finance and with his background of Information technology, he made his mission to help others learn and get started with it via CoinSutra.
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