2021’s NFT Boom

In a nutshell, NFTs present a modern digital way to own the rights to unique items such as art, collectibles or real estate.  Whereas, currently, creators produce works that are often owned, stored, and distributed by third-parties–think record labels for music or video game development companies for gaming items, for example–NFTs enable content creators to retain ownership rights over their own work and reach their audience directly, anywhere around the globe.  As the owner of such works, creators can collect royalties and exercise more control over how they are sold.

The attractive attributes of NFTs have sparked a new digital gold rush.  Everyone from football (soccer) icon Lionel Messi and director of “Pulp Fiction,” “Kill Bill,” and “Django Unchained,” Quentin Tarantino to pop superstar Justin Bieber and even rapper Snoop Dogg have leaped into the NFT space.  In March 2021, “Everydays — The First 5000 Days,” by the artist known as Beeple, set a record for a digital artwork in a sale at Christie’s.

Sotheby’s, another fine art and luxury goods auction house, posted a 46% jump from 2020 and the highest sales figure ever in its 277-year history, due in large part to NFT bidders.  Despite the hype built around NFTs, they are not a fad, the opportunities that can be derived from the underlying technology is real, and they are here to stay.

Where NFTs Fit When Looking at the Bigger Picture

Blockchain.  Coins.  Tokens.  Non-fungible.  NFT marketplaces.  Anyone?  For the uninitiated, explaining how non-fungible tokens work can be a fool’s errand without a proper review of the jargon and acronyms used in the crypto space.  So let’s get started…

BLOCKCHAIN

Everything in the crypto universe starts with the blockchain.  The blockchain stores data in “blocks” that are linked by a “chain.”  

Yeah, so that wasn’t helpful at all.  Let’s try again…

Think of the blockchain as a huge decentralized database that can record information, and even distribute that information across a network of unrelated computers around the world (so that no one party is responsible for storing or verifying the information).  So blockchain is a type of “distributed ledger,” known to some as a shared public ledger.  New information can be added but the original information on the blockchain cannot be edited or deleted.  By preserving the original information (plus any additions) in a space in time, with effectively no risk of tampering, users of the information can be confident of its integrity.

The most popular blockchain platforms (excluding stablecoins) are:

By no means is the table above an all-inclusive list, but it does cover many well-known cryptocurrencies and their respective blockchains.  Then there are cryptos such as Polygon and Chainlink that run as layer-2 scaling solutions on top of layer-1 blockchains like Ethereum.  Too much?  Let’s get out of the weeds!

TOKENS VS. COINS

Tokens and coins essentially have the same meaning with one primary difference: the term “coin” is strictly used when referring to crypto as a currency, while “token” is used to describe crypto as a currency, asset, or utility.  Using the word “token” can be applied more broadly than “coin” and, therefore, you may come across the former more often than the latter.

At its core a token represents the medium through which a particular cryptocurrency is valued and utilized.  For example, Stellar is transacted in “Lumens.”  Put another way, Lumens are the native currency for Stellar.  The token trades under the ticker symbol “XLM.”  

Ether (with the ticker symbol, ETH) is the native token for Ethereum.  Binance Coin (BNB) is the native token for Binance Smart Chain.  …and so on.  Sometimes the name of the blockchain matches the name of the token.  Bitcoin’s native token is bitcoin (BTC), for example.  Other times the name of the token and the ticker symbol are one and the same.  For instance, Cardano uses Ada (ADA) as its native token.  But in natural conversation many just say they are going to “buy or sell Cardano” (not Ada).  Speaking crypto lingo can be confusing but just go with it!

Tokens are often priced in one’s fiat currency of choice (i.e., U.S. dollars, Euro, Japanese yen, etc.) when viewed on exchanges.  Tokens can also be paired against other tokens.  For example, one can convert bitcoin into the equivalent amount of ether.  It’s important to remember that these usages of tokens are strictly applied in a “currency” context. But tokens are not always used as currencies, or even assets for that matter.  

A USE CASE FOR TOKENS BEYOND CURRENCY – DECENTRALIZED APPLICATIONS

Many tokens have use cases that stretch far beyond money.  For instance, they power what are called “decentralized applications” (DApps, dApps, Dapps, or dapps). Dapps are similar to the traditional computer and web applications that we use everyday, except that they run on the blockchain (or other decentralized networks like peer-to-peer a.k.a. P2P) instead of your computer or the Internet.  Their backend code (smart contracts) lays out the logic and rules that govern the application and are available on the blockchain for everyone to see.  In order to interact with decentralized applications, users need to purchase the Dapp’s native token.  Tokens are not limited to one function within their native ecosystem.  They can carry out various roles within the platform.  

Most Dapps exist on the Ethereum platform.  The blockchain houses 2500+ decentralized applications (as of December 2021).  The next runner-up is the EOSIO blockchain with around 300 Dapps.  Decentralized applications can be deployed as exchanges, games, cloud storage, governance frameworks, and more.  But no Dapp category is more popular than the decentralized finance (DeFi) space.

First of Three Types of Tokens – PAYMENT TOKENS

There are many misconceptions and misunderstandings about tokens.  To clear things up, let’s first review the three main types of tokens and drill down from there.  The three overarching umbrellas are payment tokens, security tokens, and utility tokens.  The label “payment token,” is reserved for tokens or “coins” that operate more like currencies.  As the name implies, these tokens offer a means of payment for goods and services, both on-chain and off-chain.  Although payment tokens may have other limited uses, their primary purpose is to function as money, meaning:

• A medium of exchange.
• A unit of account.
• A store of value.
• A standard of deferred payment.

Second Type of Token – SECURITY TOKENS

Security tokens (also known as digital securities or tokenized securities) are digital representations on the blockchain of ownership stakes in real-world financial securities and other assets.  Security tokens can represent holdings in equities, bonds, commodities, and even real estate.  They can also represent ownership in investment alternatives such as venture capital, private equity, and hedge funds.

Note: Security tokens are not the same as “synthetic assets” on DeFi platforms that only reference the value of an asset with no underlying ownership.

Digital securities have the same qualities as traditional securities in terms of their legal status.  Many, depending on the security type, are subject to regulatory scrutiny from the U.S. Securities and Exchange Commission (SEC) and require full approval for activities surrounding public offerings and secondary exchanges.

Digital securities have also garnered the attention of international financial institutions who are now fully engaged in the development of central bank digital currencies (CBDCs).

The benefits digital securities offer over traditional securities include the following:

• Security tokens take less time to settle (framed in minutes versus days).
• Given the differing laws, regulations, and objectives in countries around the globe, access to local investments can be limited.  Security tokens help bring down these barriers and increase liquidity.
• Security tokens are not bound by exchange trading hours and trade 24 hours a day every day. 
• Since digital securities exist in the digital realm, security tokens can be “programmed” to comply with regulations.
• By their nature, security tokens have an immutable ledger of ownership and transaction history.
• As “digital” securities, different asset classes may be able to reference and interact with each other in real-time through what is called “asset interoperability.”

Third and Last Type – UTILITY TOKENS

Utility tokens carry out many functions but, at their base, they typically act as the mechanism through which users can access a platform and its associated services.  They can reward work as contributions are made to the platform–for example, providing updates, liquidity or transaction verification (through “mining” or “staking”).  Profits can be distributed to stakeholders via dividends.  Utility tokens may even allow users to participate in decision-making matters for their respective protocols (by voting).  Although they may hold value inside their native network or on a secondary exchange, a number of them were created for a specific purpose pertaining to the operation of the platform and were not originally intended to be acquired as an investment.

ADDITIONAL SUBTYPES OF TOKENS

While navigating the Internet you may come across all kinds of names for tokens but when you dig beneath the surface you find that virtually all of them are classified as a payment token, security token or utility token.  Some act as hybrids, blurring the lines between payment tokens and utility tokens, which can make labeling confusing.  But even though they may have some characteristics of both, their primary purpose often fits in either one bucket or the other.  

In spite of the fact that there are only three types of tokens, some labels are prevalent among the crypto community and treated as though they are a separate type of token distinct from the three umbrellas mentioned above (when they are really a subtype of the three umbrella tokens).  In view of the popularity of some categories of utility tokens, they are worth mentioning individually:

• DeFi Tokens – DeFi is an acronym that refers to decentralized finance.  DeFi platforms utilize the blockchain to offer products and services around decentralized exchanges, banking, insurance, custodial solutions, credit (i.e., borrowing and lending), derivatives, and asset management.  Plus, auxiliary services such as wallets and oracles.
• Governance Tokens – These tokens elevate users’ influence over a blockchain network and the applications built atop that network.  They do this by granting voting and management powers that can ultimately have a major impact on how networks operate, what services they offer, what patches or updates they issue, and other important decisions.
• And lastly… drumroll please… Non-Fungible Tokens (NFTs)!

Non-fungible tokens can be tied to in-game items, digital files, supply chain components, real estate, identity, regulatory certifications, collectables, and, more broadly, ownership registries. 

…just to name a few.  The possibilities are endless.

NFTs can be utility tokens or security tokens.  Note: NFTs that are currently linked to regulated financial instruments, but treated like utility tokens, will most likely fall under the purview of financial regulators in the future and would need to be treated as security tokens.

What makes NFTs non-fungible?

When dealing with “fungible” tokens, each token is equal.  Accordingly, if Person A owned one XRP and Person B owned one XRP, they could exchange them and the value would be the same.  This is no different than if Person A owned a $20 bill and Person B owned a $20 bill.  If they exchanged the two, both persons would walk away with $20 because the bills represent equal value.

Following so far?

The overall value of the fungible tokens a person owns is based on the quantity that person has accumulated and the market price of those tokens at any given point in time.  So if a person owns five XRPs, they would simply multiply the number of XRP tokens in their possession by the market price of the token on a given day to determine the total value of the tokens they own.

Person A owns 5 XRP tokens x Market Price of $1 = $5 of total value for the tokens owned

But “non-fungible” tokens do not necessarily need to operate as currencies.  So what if the token holds data instead of any sort of monetary value?  The amount of tokens a person owns would be irrelevant because the quantity would not directly correlate with the overall value of the tokens.  Each token would hold a different set of data which would make each token unique.  Therefore, each token would not be equally valued.  The value would be attributed to each token individually and based solely on the specific data each token held.

If each token is unique with different data sets, then the tokens are not easily interchangeable and that’s what makes them non-fungible.  Whereas, each and every single bitcoin (BTC) is exactly the same.  Similarly, each $1 bill (or any other denomination of a currency) is exactly the same, at least in the amount of value it represents.   Person A can buy a shirt for $20 and Person B can come along and buy the same shirt with his or her own $20.  If Person A owned an NFT, it would be unique and not possible for Person B to own the same NFT.  So the terms of exchanging an NFT for a shirt would be individual to that transaction–meaning Person A and Person B could encounter different terms while attempting to acquire the same shirt.

The History of Non-Fungible Tokens (NFTs)

Contrary to popular belief, NFTs did not originate during the CryptoArt market craze in late 2017.  The first-ever NFT was created by Kevin McCoy on May 3, 2014.  He called it “Quantum.”  Kevin later sold Quantum in June 2021 at a Sotheby’s auction for $1.4 million.

But the genesis of the NFT came a couple years prior.  In the early beginnings of NFTs, before the Ethereum blockchain was even thought of, there were Colored coins, which, believe it or not, existed on the Bitcoin network.  A number of whitepapers were written in 2012 and 2013 by the likes of Yoni Assia, ­Vitalik Buterin, Lior Hakim,­ and Meni Rosenfeld that helped conceptualize the framework of what we now know to be NFTs.  

But they were not “coins” in the traditional crypto sense.  “Protocol” (that rested on top of Bitcoin) would be a more accurate description.  Through a class of methods, the colored coin system was able to make use of Bitcoin’s programming capabilities (Bitcoin script) and, thereby, carry out legacy NFT transactions.

Colored coins were created to expand the applications of Bitcoin’s blockchain, which at the time–and even still–focused primarily on monetary transactions.  Users would have the ability to link their tokens on the blockchain to assets and objects in the real world.  Nonetheless, simply being capable of such a feat was not enough.  Bitcoin’s blockchain was not designed for those types of functions and the way it carried out such activities was inefficient.  Hence, other platforms would soon emerge.  But not before this critical first step, which opened the door to further experimentation and laid much of the groundwork for NFTs.

Terra Nullius became the first NFT to be minted on the Ethereum blockchain with a mint date of August 7, 2015 (Ethereum was launched on July 30, 2015).  It is a Latin term meaning “land belonging to no one,” and also has historical value in Australia (see Mabo v. Queensland).  In a Reddit post, the creator invited one and all to interact with the NFT to “stake their claim” on the new, at that time, Ethereum blockchain.

In 2016, came “RarePepes” (among the first set of NFTs), which were based off Pepe the Frog–a cartoon character in the 2005 Matt Furie comic Boy’s Club that became popular as an Internet meme after heavy circulation on sites like MySpace and Gaia Online.  Incredibly, the green anthropomorphic frog with a humanoid body later sold for $3.6 million in October 2021.

In 2017, Larva Labs created 10,000 pixel art characters (like something you would see in a classic 1980’s Nintendo video game) called “Cryptopunks.”  What’s unique about these pieces of art is that they were not created in a graphic design program.  Instead, they were algorithmically generated on the blockchain to create the images you see.  According to crypto tracker CryptoSlam, the platform has exceeded $1.5 billion in lifetime sales.

That same year, Dapper Labs (spun out of Axiom Zen in February 2018) brought us CryptoKitties and, with that move, NFTs were pushed into the mainstream.

Remember Troll Dolls, Beanie Babies, Care Bears, Strawberry Shortcake, and for Gen Z’ers… Squishmallows?!

CryptoKitties are the digital stuffed animals of this era.  More specifically, it’s a blockchain-based virtual game that allows for collecting (or adopting), raising, breeding and selling digital cats.  The cats were and are adorable, shareable, and fun leading to their virality, and even a moment in late 2017 when they jammed up the entire Ethereum platform!

After a huge spike in NFT interest in the back half of 2017 going into 2018, NFT markets cooled off in line with cryptocurrency markets throughout the remainder of that year.  Then out of nowhere, in 2021, NFT markets experienced what is referred to as the NFT “Cambrian Explosion”.  

NFTs reentered the mainstream consciousness.  Multiple NFTs auctioned off for millions of dollars.  NBA TopShot (opened to the public in October 2020) rose to prominence.  According to Reuters, “The market for non-fungible tokens (NFTs) surged to new highs in the second quarter [of 2021], with $2.5 billion in sales so far this year, up from just $13.7 million in the first half of 2020, marketplace data showed.”

And just when everyone thought they had seen it all, NFTs made news again in March 2021 when Jack Dorsey, co-founder and former CEO of Twitter, sold the first-ever tweet for $2.9 million.  The tweet was originally published on Twitter on March 21, 2006.

Piggybacking off of Dorsey, British computer scientist Sir Tim Berners-Lee sold the original source code for the World Wide Web (www.) as an NFT in June 2021 for $5.4 million.  He invented the World Wide Web in 1989.

How to Buy NFTs

With all this talk about NFTs and the crypto world in general, you might be inspired to actually buy one.  If so, you would visit what’s called an NFT marketplace.  Every marketplace is different and many specialize in one particular kind of NFT asset (e.g., digital art, collectibles, sports highlights, music, or entirely new and unexplored compositions).

At first glance, you may view some of the artwork and wonder, “Why would anyone buy this?”  But that’s art, right?  It’s interpretation exists in the eye of the beholder and what you don’t like, someone else will.  Then there are pieces that may amaze you and come in forms that you didn’t even know existed.  It’s up to you to find the NFT asset that matches your personality and interests.

Some of the most common NFT marketplaces are:

• OpenSea
• Nifty Gateway
• Rarible
• Axie Marketplace
• NBA Top Shot Marketplace
• Mintable
• SuperRare
• Foundation
• Async Art
• MakersPlace
• KnownOrigin
• Zora
• Theta Drop
• Binance NFT
• Valuables

Many still think in a traditional sense about the images they see on their screen.  So they wonder why they just can’t save, copy/paste, or screenshot the NFT without actually buying it.  But they forget (or learn) that NFTs are all about ownership.  You may have the image but you won’t have the property rights to use it as you please; nor would you be able to resale the image on a secondary market (meaning it has no value).  Attempting to do so would be like taking a photo of a Picasso painting with the expectation of selling it to a collector.  In the future digitized world we are heading towards, you might not even be able to share or store the image on your local drive without an accompanying token.

Once you select an NFT of interest, check the purchase price.  Most NFT assets will be priced in Ether (ETH) because they are being offered on the Ethereum blockchain.  So your first step is to convert your dollars (or another fiat currency) into ETH.  You can do so through a cryptocurrency exchange like Coinbase, Gemini, Binance.US, Gate.io, or Kraken.  

Once you have ETH in your possession, revisit the NFT marketplace and purchase the NFT of your choice.  FYI: In addition to the purchase price, you may incur a gas fee.

Conclusion

Whew!  That was quite a journey!  If you made it this far, we congratulate you!  We hope that you learned a lot about the fascinating world of NFTs, plus the crypto world in general.

We covered some of the components of crypto infrastructure such as the blockchain and types of tokens.  An explanation was given for why non-fungible tokens are considered “non-fungible.”  And we covered how NFTs came about along with how to acquire one.

Stay tuned for future updates!

The post What in the World is an NFT? Unraveling the Mystique of Non-Fungible Tokens appeared first on Investmos™.