UNDERSTANDING THE FUNDAMENTALS OF A NEW DIGITAL ASSETSEGMENT: NON-FUNGIBLE TOKENS (NFT)
Author: Ajith N Kale, II year of BBA LLB from School of Law, Christ (Deemed to be University)
What are Non-Fungible Tokens or NFTs?
Collectors for a long time have been willing to spend vast amounts of money on unique or rare items such as artwork, action cards, vintage cars, old albums records, etc., But now with the help of blockchain technology, collectibles items have moved into the digital space in the form of NFTs or Non-Fungible Tokens. NFTs or NFTies, known by the insiders, are a type of digital asset. Ownership of these NFTs is recorded on a blockchain, a digital public ledger using similar technology to the network underpinning bitcoin and other cryptocurrencies. Unlike cryptocurrencies, where every token is of equal value and could be swapped for any other, NFTs have unique qualities (Fungibility) that prevent them from being interchangeable and replicated. Fungible in economics means “Goods contracted for without an individual specimen being specified replaceable by another identical item and is mutually interchangeable.”[i] Fungible assets can be easily substituted or exchanged with each other; for example, if a $500 note is exchanged for five notes of $100, the total value still remains the same even though the notes were exchanged. However, in Non-Fungible assets are an asset that cannot be substituted or is irreplaceable.
The birth and rise of the internet meant that images, videos, and songs could be reproduced and distributed unlimited times online, often without any royalties paid to their creators or artists. Significant companies like YouTube, Spotify, and Apple music have been criticized for not compensating artists sufficiently for their work. NFTs address this problem by allowing ownership to be recorded in the blockchain, preventing unlimited replication or potential piracy, and enabling creators to enjoy the financial benefits without any middleman. Kings of Leon, a famous rock band, sold an NFT for an exclusive period of two weeks, which gave their fans access to the deluxe version of the album for $50, simultaneously also auctioning off a more expensive version limited to 18 copies. Subsequently, an NFT of Twitter CEO Jack Dorsey's first tweet[ii] sold for nearly $3 million to Sina Estavi[iii], a Malaysia-based crypto entrepreneur. Art dealers across the world auction in the auction house Christie's running an auction for a virtual artwork from the artist named Beeple which was sold for nearly $69 million.
Characteristics and benefits of NFTs
Non-fungible Tokens are very versatile. They are most importantly Non-interoperable, which means using A CryptoPunk[iv] an NFT as a character on the CryptoKitties[v] game (a blockchain integrated game) or vice versa. This is also applicable for collectibles like NBA or Pokemon trading cards.
The uniqueness[vi] of NFTs as these assets have many buyers or has great demand especially artworks, they can be digitally be replicated unlimited times, but the original artist or creator or the owner can certify themselves as the original owner of the artwork by the metadata provide and recorded in the blockchain preferably the Ethereum blockchain.
NFTs are also indestructible as the metadata are stored on the blockchain via smart contracts. Individual tokens cannot be destroyed, replicate, or be removed. Ownership of NFTs is also immutable, wherein gamers and collectors in actuality possess their NFTs, and no middlemen like not the companies own them. NFTs are indivisible, which refers to them not being able to divide themselves into fractions like cryptocurrencies or digital gold.
Verifiability[vii] of an NFTs is another unique characteristic wherein the preliminary data of ownership of a particular NFT on the blockchain is stored, recorded, and maintained. This helps in tracking the original creator and gives the NFT a sense of security and authenticity. Verifiability characteristics also give the NFTs a sense of trustworthiness as no counterfeit replication of the digital asset is possible or allowed.
How is an NFT fundamentally different from Cryptocurrencies?
Non-Fungible tokens, for the most part, are fabricated using a similar sort of programming as cryptographic money[viii] like Bitcoin, Ethereum, or Dogecoin; however, that is the place where the similitude ends. Real cash and digital currencies are fungible, which implies that they can be traded or exchanged for each other. They’re likewise equivalent ₹100/- note is consistently worth another ₹100/- note or one Ethereum is consistently worth another Ethereum. Cryptocurrencies fungibility aspect or feature makes it confined in methods of managing or exchanging value on the blockchain; on the other hand, NFTs are unique or extraordinary as each token has computerized metadata or signature that makes it incomprehensible for NFTs to be traded in the open market, therefore, making it non-fungible or irreplaceable. NFTs are non-fungible, making them ideal for trading non-fungible asset classes such as artwork, viral video clips, music, etc.
Why did NFTs gain significance now?
The coronavirus pandemic played a significant role in the NFT boom. Just for reference, in 2020, the total value of NFT transactions quadrupled to 1/4th Billion dollars, and the market is said to grow further in 2021. Due to stay-at-home restrictions, most people spent a lot of time on the internet, and many were having spare cash on hand as in-person spending was limited. Additionally, the craze on NFTs skyrocketed as Bitcoin, Ethereum, and other cryptocurrencies surged in value, with bitcoin being valued at over $60,000 in March 2021. NFTs are mostly recorded or listed on the Ethereum blockchain as digital tokens, and Ethereum in May 2021 was valued at over $4,000 but soon dipped back to around $3000.
Investors from all across the world are buying into NFTs as a speculative investment[ix], hoping to one day flip them at a profit, but there are a significant number of people who are also holding NFTs for the long term as collectibles and believe the value will go up. Big leagues like the NBA and the F1 have already launched plans and projects centered around NFTs, which can be traded or collected. Some creators are also finding new ways to use NFTs, including buying virtual real estate and video game assets or collectibles. Nevertheless, the NFT marketplace has been met with much skepticism from creators and investors. Crypto and investment critics view NFTs as another hype or fad that will eventually die down and lose relevance. NFTs are here to stay, though they aren't fully ready to change the economic behavior yet; it has a lot of potential to grow as new modes of usage are adopted on a large scale.
[i] Victoria Wilson, Fungible is more Fun Home Economics (2020), https://home-economic.com/2020/09/26/fungible-is-more-fun/ (last visited May 12, 2021).
[ii] Justin Harper, Jack Dorsey’s first ever tweet sells for $2.9m BBC News (2021), https://bbc.in/3y9UOyJ (last visited May 14, 2021).
[iii] Who is Sina Estavi, man who purchased world’s first tweet for ₹21 crore?, Inshorts - Stay Informed (2021), https://bit.ly/33LE7Mh (last visited May 14, 2021).
[iv] CryptoPunks, Larvalabs.com (2018), https://www.larvalabs.com/cryptopunks (last visited May 14, 2021).
[v] CryptoKitties, CryptoKitties | Collect and breed digital cats! CryptoKitties (2021), https://www.cryptokitties.co/ (last visited May 14, 2021).
[vi] JuanSC, WHAT ARE NFTS? — THE COLLECTIBLE CRYPTO TOKEN, EXPLAINED MEDIUM (2021), https://bit.ly/2RhM1Kw(last visited May 14, 2021).
[vii] Jyoti Gupta, WHAT IS A NON-FUNGIBLE TOKEN? ITS CHARACTERISTICS AND USE CASES | CUSTOMERTHINK CUSTOMERTHINK.COM (2021), https://bit.ly/3bsAGyi (last visited May 14, 2021).
[viii] Cryptocurrency, Investopedia (2021), https://www.investopedia.com/terms/c/cryptocurrency.asp (last visited May 14, 2021).
[ix] What is a speculative investment? Definition and examples, Market Business News (2020), https://bit.ly/2RQncFI (last visited May 14, 2021).
AjithN Kale is a law student at the School of law Christ (Deemed to be University). His interests lie in the latest developments in tech law, company secretary, capital, and securities markets. For any further discussion related to the article, he can be contacted via mail at email@example.com