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Baba’s Explainer – Non Fungible Tokens (NFTs)

  • IASbaba
  • July 9, 2022
  • 0
Science and Technology
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Syllabus

  • GS-3:Science and Technology- developments and their applications and effects in everyday life. 

Context: Non fungible tokens (NFTs) have, thanks to their ability to assign value to everything from art to music to a simple selfie, taken the world by storm.

  • The sales of NFTs surged $25 billion in 2021 as the crypto asset exploded in popularity, fuelled by the rising interest of celebrities and tech evangelists.
  • Where Bitcoin was hailed as the digital answer to currency, NFTs are now being touted as the digital answer to collectables, but plenty of sceptics fear they’re a bubble waiting to burst.
  • Also, With the two most valuable cryptocurrencies, Bitcoin and Ethereum, hit hard in recent times, attention has returned to the newest type of crypto asset – NFTs.
What is a non-fungibility?
  • In economics, a fungible asset is something with units that can be readily interchanged – like money.
    • With money, one can swap a £10 note for two £5 notes and it will have the same value.
  • However, if something is non-fungible, this is impossible – it means it has unique properties so it can’t be interchanged with something else.
  • It could be a house, or a painting such as the Mona Lisa, which is one of a kind. One can take a photo of the painting or buy a print but there will only ever be one original painting.
What are NFTs?
  • NFTs are “one-of-a-kind” assets in the digital world that can be bought and sold like any other piece of property, but which have no tangible form of their own.
  • The digital tokens can be thought of as certificates of ownership for virtual or physical assets.
  • Anything that can be converted into a digital form can be an NFT.
  • Everything from your drawings, photos, videos, GIF, music, in-game items, selfies, and even a tweet can be turned into an NFT, which can then be traded online using cryptocurrency.
  • But what makes NFTs unique from other digital forms is that it is backed by Blockchain technology.
    • Blockchain is a distributed ledger where all transactions are recorded. It is like your bank passbook, except all your transactions are transparent and can be seen by anyone and cannot be changed or modified once recorded.
  • Therefore, Non-fungible tokens (NFTs) are designed to be i) cryptographically verifiable, ii) unique or scarce and iii) easily transferable.
  • Leveraging cryptographic signatures native to the blockchain on which an NFT is issued, one can easily determine the origin and the current owner of the asset in question in seconds.
How do NFTs work?
  • Traditional works of art such as paintings are valuable precisely because they are one of a kind.
  • But digital files can be easily and endlessly duplicated. With NFTs, artwork can be “tokenised” to create a digital certificate of ownership that can be bought and sold.
  • NFT works on blockchain as it gives users complete ownership of a digital asset.
  • As with crypto-currency, a record of who owns what is stored on a shared ledger known as the blockchain.
  • The records cannot be forged because the ledger is maintained by thousands of computers around the world.
  • For instance, if you’re a sketch artist, and if you convert your digital asset to an NFT, what you get is proof of ownership, powered by Blockchain.
  • Legally, these tokens are a mix of a deed, a certificate and membership rights.
So why are people willing to spend millions on something they could easily screenshot or download?
  • In simple words, when you list your NFT on a marketplace, you pay something called a gas fee (transaction fee) for using the Blockchain, following which your digital art is then recorded on Blockchain, mentioning that you (your address) own the particular NFT. This gives you full ownership—which cannot be edited or modified by anyone, including the marketplace owner.
  • An NFT is thus created or “minted”, to get exclusive ownership rights. NFTs can have only one owner at a time.
  • Apart from exclusive ownership, NFT owners can also digitally sign their artwork and store specific information in their NFTs metadata. This will be only viewable to the individual who bought the NFT.
How is an NFT different from cryptocurrency?
  • Like physical money, cryptocurrencies are fungible, meaning that they can be traded or exchanged, one for another.
    • For example, one bitcoin is always equal in value to another bitcoin. Similarly, a single unit of ether is always equal to another unit.
  • This fungibility characteristic makes cryptocurrencies suitable as a secure medium of transaction in the digital economy
  • But NFTs are non-fungible, which means the value of one NFT is not equal to another. Every art is different from other, making it non fungible, and unique.
  • NFTs shift the crypto paradigm by making each token unique and irreplaceable, thereby making it impossible for one non-fungible token to be equal to another.
  • NFTs are digital representations of assets and have been likened to digital passports because each token contains a unique, non-transferable identity to distinguish it from other tokens.
  • NFTs are also extensible, meaning you can combine one NFT with another to “breed” a third, unique NFT.
Who can buy NFTs?
  • Anyone who holds a cryptocurrency wallet can buy an NFT. That is the only prerequisite to purchase an NFT.
  • One doesn’t need any KYC documents to purchase an art. All one needs is a cryptocurrency wallet powered by Metamask, and an NFT marketplace where you can buy and sell NFTs.
What types of use cases are non-fungible tokens being utilized for?
  • Smart Contracts – NFTs can also contain smart contracts that may give the artist, for example, a cut of any future sale of the token. It is not just art that is tokenised and sold.
  • NFT event tickets — companies can distribute and sell tickets to events using NFTs, reducing friction for verification of ownership and authenticity and helping to eliminate fraud. Furthermore, there are infinite possibilities for post-purchase collectability of tickets through exclusive experiences and digital art.
  • Fan/customer engagement – brands or organizations can issue or sell NFTs that represent exclusive collectibles, products, experiences, or voting rights for the future development of a product or service in order to deepen the engagement customers / fans have with the brand/organization.
  • In-game items – video games are walled gardens today, players do not own their digital items and secondary markets are hard to implement. NFTs can be used to create a widely varied ecosystem of in game digital items that can be bought sold and exchanged on open secondary markets and used across a broader gaming ecosystem rather than anchored to one game
  • Digital collectibles – organizations or individuals who have a well-defined brand can create NFTs that can be sold on the open market to fans or brand-loyal customers as collectibles.
    • Perhaps the most hyped space is NBA Top Shot, a place to collect non-fungible tokenized NBA moments in digital card form. Some of these cards have sold for millions of dollars.
    • In early March 2021, a group of NFTs by digital artist Beeple sold for over $69 million.
  • Credentialing – identity credentials like driver’s licenses or professional certifications like AWS’ wide range of cloud certificates can be issued as NFTs to reduce the burden of proof for these credentials and eliminate the siloed nature of credentials today
  • Royalties – NFT’s can track fractional ownership or royalty entitlement for a piece of media or content or art.
  • Real Estate – They can also work as a vehicle to digitally represent physical assets like real estate. NFTs can democratize investing by fractionalizing physical assets like real estate. It is much easier to divide a digital real estate asset among multiple owners than a physical one

What are the concerns with NFTs?
  • Complexity: The technology and tooling behind non-fungible tokens and the decentralized applications that underpin them are still nascent despite the increasing adoption amongst startups and enterprises alike; Many of the complexities associated with building NFT-related solutions are not yet abstracted by quality tooling.
  • Fake Marketplaces: One security risk for NFTs is that you could lose access to your non-fungible token if the platform hosting the NFT goes out of business.In the recent past, several incidents of NFT scams have been reported including: emergence of fake marketplaces, unverified sellers often impersonating real artists and selling copies of their artworks for half prices.
  • Ecological Impacts: Another risk associated with NFTs that cannot be swept under the rug is the unquestionably negative impact on the environment. In order to validate transactions, crypto mining is done, which requires high powered computers that run at a very high capacity, affecting the environment ultimately.
  • Regulatory/Legal Implications: There are concerns that it can be used for money laundering mechanisms, and illicit funding activities. These being speculative or high-value assets also make people gullible to investment for quick returns. Because of all these, there is distinct regulatory and legal concerns expressed by governments.
  • Rapid Innovation: The rapid pace of innovation in the NFT ecosystem and the blockchain networks on which they are issued presents challenges for those adopting the technology in the form of consistent change; agility and modularity are critical.


Mains Practice Question – What are NFTs and what are the concerns associated with it?

Note: Write answers to this question in the comment section.


 

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