Non-Fungible Tokens: Meaning, Prospects and Challenges

A blockchain company bought a Banksy print for $95,000, burned it in a live streamed video, and then sold it for $380,000 as a Non-Fungible Token (NFT), sparking a flurry of interest in what could be the trending buzzword in the cryptosphere. 

How did the Banksy deal come about? A group argued that by eliminating the physical piece from existence and making the Non-Fungible Token available as digital art, the value of the physical piece will be transferred to the NFT. This trend is not only simply sweeping the art world, in fact, artists and even footwear brands are figuring out how to break into the field.

Until 2017, NFTs were not widely discussed in the blockchain community. Increasing numbers of people are being drawn into a market where anyone may sell any property or become the owner of a singular asset thanks to NFTs. 

There was a 200-fold increase in global NFT sales volume in the first half of 2021, hitting $2.5 billion in sales. Because of this, a wide range of stakeholders, including consumers, investors, and financial institutions, are vying for a piece of the NFT pie.

What is an NFT?

A non-fungible token is fundamentally a unique crypto-asset. An NFT is designed to be neither interchangeable nor replaceable, the inherent feature that makes it unique. 

Consider a cryptocurrency like Bitcoin (BTC) for comparison. In essence, one bitcoin may be exchanged by any other bitcoin, and still retain the same value. The analogy is that you are exchanging one dollar bill for another dollar bill, and at the end of the day you still have a dollar note.

Unlike Banksy’s print deal or Fabergé eggs for example, even though they are all jeweled eggs, each one is a one-of-a-kind creation that varies in shape, size, and design. The eggs are not interchangeable since they are not identical in any way. This characteristic is the very essence of an NFT.

This analogy only works because each Fabergé egg is unique and restricted in number and coming from one creator, Peter Carl Fabergé. While in the case of NFTs, its amount in circulation is not capped, and anyone can produce them. That they are unique also makes it straightforward to trace ownership of the NFTs as a crypto asset class.

How does the NFT work?

To comprehend the connection of creative works to NFTs, one must first understand how an NFT operates in its most basic form. NFTs are cryptographic tokens that are administered on a blockchain and they are one-of-a-kind. Because each NFT is programmed to have a unique ID and other metadata that cannot be reproduced by any other token, the blockchain serves as a decentralized ledger that monitors the ownership and transaction history of each Non-Fungible Token.

When combined with digital media, this technique imparts to NFTs the characteristics of uniqueness and rarity that make them so appealing to consumers. 

Unlike traditional financial instruments, non-fungible tokens are written with software code (referred to as smart contracts) that manages elements such as validating ownership and controlling the transferability of the NFTs. 

A variety of other applications and functionality, in addition to the fundamentals of ownership and transferability, can be programmed into NFTs, just as any software application can be. This means NFTs can be linked to another digital asset of the same or different type, which will let the original owner profit from some of the financial rewards associated with trading it on a secondary market.

This marketplace trading arrangement is possible as a smart contract is developed to automatically transfer a percentage of the funds earned for any subsequent sale of the NFT back to its original owner.

The proposed EIP-2981 standard for processing royalty payments for ERC-721 tokens may be found at this site which contains additional information about this standards.

When someone creates (or “mints”) an NFT, they are actually activating the smart contract code that controls the NFT’s characteristics, which is then added to the blockchain where the NFT is being managed.

In order to manage non-fungible tokens, a variety of blockchains can be used, including Ethereum (which has long-established smart contract standards such as the ERC-721 and ERC-1155), Binance Smart Chain (BSC), and Solana (SOL), some of the most popular protocols in the ecosystem.

Particularly noteworthy is the fact that particular NFT marketplaces can only operate with specific blockchains, and thus the choice of blockchain to employ for an NFT can have significant business ramifications for the vendor.

NFTs and Surging Valuation

NFTs had grown in popularity to the point where the Collins dictionary designated NFTs as its word of the year 2021. It is estimated that the monthly sales of digital tokens “hovers” around $2 billion, per JPMorgan analysts. According to the analysts, the overall market capitalization of the NFT universe was around $7 billion at the time of the study.

A significant portion of the money is directed toward the market for digital artwork. Buyers have paid tens of millions of dollars for one-of-a-kind cryptographic tokens signed by artists, making them among the most valuable items on the art market today.

They have, in the process, established a new ecosystem that is populated by both old and new actors. Famous auction houses such as Christie’s and Sotheby’s have already jumped onboard the NFT bandwagon to raise awareness. The popularity of new ones, such as OpenSea and Nifty, has also grown recently. 

Additionally, there are a number of other NFTs that have received high valuations from investors, in addition to some listed below. The artwork Crossroad by artist Beeple, for example, sold for $6.6 million on Nifty, while Twitter co-founder Jack Dorsey’s first-ever tweet, “just setting up my twitter,” sold for $2.9 million on the same platform.

• Beeple

Mike “Beeple” Winklemann’s collage of photographs dubbed Everydays: The First 5000 Days was auctioned for a price of $69.3 million. 

The Beeple’s artwork was credited with igniting the interest for the NFT obsession. Everydays: On March 11, 2021, Christie’s auction house sold The First 5,000 Days to Metakovan, a cryptocurrency investor who paid for the artwork in the cryptocurrency Ethereum.

The NFT buyer received a digital artifact instead of a real thing. With the Everydays sale, Winklemann went from an unknown graphic designer in Florida to the man behind the world’s third-most valuable living artist’s work.

• CryptoKitties & CryptoPunks

There has been a steady rise in the popularity and interest in NFTs since they were originally introduced in the CryptoKitties virtual game in 2017.

Blockchain-based “pixel art characters” known as CryptoPunks, designed by Larva Labs, is also amongst the most prestigious and pioneering NFT collections. 10,000 CryptoPunks were formed by code, at first, they were available almost for free to anyone with an ETH wallet.

Based on this, they have become an important element of the secondary market and may be found for a variety of soaring prices. The initial lot included nine aliens, which are regarded as the most valuable and rare.

Because NFT exchanges do not place constraints on the assets that can be traded, the possibilities for the usage of tokens and other assets in games, collectibles, and other contexts are virtually limitless. 

• Collectibles (WAX NFT Cards)

On the WAX blockchain, a collection of 125,000 NFT cards, featuring images from William Shatner’s private and professional lives, was sold in just nine minutes in 2020. The sole limit to what can be an NFT is one’s own creativity. It is already common practice to use non-fungible tokens to tokenize a wide range of assets like real estate and fine art.

Will NFT be a Need in Our Daily Lives?

The growth of NFTs could have a significant impact on the field of fintech. Fintech’s next big thing will most likely be a combo of NFTs and Decentralized Finance (DeFi). 

In the case of DeFi’s new services, NFTs are being used to produce liquidity, as there are new NFT-based services being offered by some DeFi firms and community projects that are currently in development. Existing asset classes could be transformed into new ones if more digital assets are converted to NFTs. 

Aside from security and environmental concerns, NFTs are expected to have a significant impact on the financial sector and fintech as a whole, a development that will significantly affect everyone.

Reasons for NFTs’ Increasing Popularity

Increasing Non-Fungible Token value has led to an alarming popularity, resulting in an examination of their environmental impact, particularly in relation to their carbon footprint.

More and more individuals are coming to terms with the fact that anything and everything has value. In recent years, it has become possible to remove money from the hands of centralized authority.

While most artists are concerned about preserving the integrity of their collections, some other categories are concerned by quick rise in profit opportunities, and a means to amass more.

NFTs and its Associated Risks

Every Non-Fungible Token is one-of-a-kind and non-fungible, and the blockchain records who owns what. The blockchain is, by its very nature, difficult to alter – while new entries can be added, it is nearly impossible to change any existing ones. 

This should imply that ownership should be extremely easy to trace, and thus crypto assets such as NFTs should be even more secure than traditional financial assets. 

Although NFTs have an owner, ownership isn’t tracked with a unique identifier like an ID card. It is instead tied to two bits of code: your private and public keys, both of which are linked to your “wallet.” If you lose control of this wallet as a result of a hack, you will no longer be able to access your NFTs. 

This has already taken place. Users of the NFT marketplace, Nifty Gateway, began reporting losses of NFT paintings in early March last year, following the penetration of an unknown number of accounts by hackers. One user claimed losing up to $10,000 when hackers gained access to his account and used it to buy and sell NFTs.

Underneath the appearance of subtle rich men buying expensive digital art are nasty and convoluted money laundering strategies for crypto’s ultra-rich elites making unlawful riches appear legitimate. This remains one of the major sources of outcry from regulators as it relates to the emerging NFT space.

Transferring money is as simple as purchasing a Non-Fungible Token with you being both seller and buyer, with illegal funds and claiming that the monies were legitimate funds for buying legal art collectibles, which results in evasion of tax. In no time, it is believed that the NFT scene is likely to catch the attention of financial regulators who would seek to correct some of these loopholes.