Non-Fungible Token (NFT)

What is a Non-Fungible Token (NFT)?

The term Non-Fungible Token (NFT) refers to a cryptographic token with a unique digital identifier that represents the ownership of an asset.

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As a token, an NFT can be bought or sold – but the real value is the asset itself. The holder of the NFT owns the underlying asset – or a certificate of its authenticity. Notably and unlike standard cryptocurrency tokens, NFTs cannot be divided.

Techopedia Explains the NFT Meaning

Non-Fungible Token (NFT)

Fungibility refers to interchangeability. For instance, one US dollar is the same as the next, and one Bitcoin is the same as all other bitcoins. These assets are fungible. However, NFTs use a unique identifier, which makes them “non-fungible.”

In this guide, we’ll explain how NFTs work as well as the potential use cases for NFTs.

Examples of NFTs

Most of us encounter NFTs for the first time in the form of collectible digital art. For example, the Pudgy Penguins collection shown below is one of the most popular NFT collections. Others include the Bored Ape Yacht Club collection and CryptoPunks.

The owner of the NFT token owns the (limited) rights to the digital art.

Examples of NFTs
Source: OpenSea

However, NFTs can represent other assets as well. For instance, Uniswap, a popular decentralized exchange, uses NFTs to represent ownership in liquidity pool positions. 

Users (liquidity providers) who deposit tokens for others to trade own a fractional part of the pool.

Examples of NFTs

Most NFTs point to blockchain assets, but that may change as adoption increases. Metaverse real estate NFTs are common, but in 2022, the first real-world home was sold as an NFT

In an earlier example, a real estate-backed NFT sold for more than $650,000. The home buyer received an NFT linked to an LLC that owns the home.

NFTs can be used for a number of different applications, including music or media, movie or event tickets, lottery tickets, domain names, or any application where uniqueness is of value and ownership is to be assigned. The key to their utility lies in the unique identifier.

How Do NFTs Work?

Like other blockchain tokens, NFTs are created through a process called minting. The token is created using a smart contract. For example, the Pudgy Penguins collection referenced earlier uses this specific smart contract.

NFT smart contracts define the NFT’s properties and usage. The contract also assigns ownership to whoever mints the NFT and transfers ownership to subsequent owners if the NFT changes hands.

Of note, NFT smart contracts can be complex, in some cases returning a royalty – a percentage of the purchase or resale value – to the original creator.

Like other tokens on smart contract networks, NFT smart contracts execute on the network, and the details of the transaction are stored on the blockchain. This makes NFTs transparent in the sense that anyone can see the NFT contract, transactions, and the wallet addresses involved in the transaction.

The ERC-721 Token Standard

Most popular NFTs follow the Ethereum ERC-721 token standard, which uses a unique “tokenID,” assigned as a variable.

The NFT smart contract can use this variable to assign one or more properties, such as a Pudgy Penguin with a red hat and sunglasses or a flaming sword in an online game. In other cases, the NFT seems identical to other NFTs in a series, but the tokenID makes it unique, similar to numbered collectibles.

While NFTs became popular on the Ethereum blockchain and compatible Layer 2 blockchains, several well-established smart-contract chains now support NFTs, including Solana, Sui, and others. However, these NFTs use different token standards and can’t be easily used or transferred across blockchains.

The History of NFTs

While widely known now, NFTs had a slow start. As far back as 2012, the Bitcoin community discussed “colored coins” as a way to represent real-world assets on the blockchain.

  • The first NFT (Quantum) was minted on the Namecoin blockchain back in 2014 (before Ethereum went live in mid-2015). In the same year, NFTs launched on Counterparty, a blockchain network that writes data on the Bitcoin blockchain. 
  • The Spells of Genesis game and Rare Pepes both launched on Counterparty between 2015 and 2016. Part of the challenge for early NFTs was transferability. In effect, the NFTs became trapped, with no easy way to transfer value from one owner to the next.
  • By 2017, however, NFT creators were exploring the possibilities on Ethereum, with the now-famous CryptoPunks collection launching in 2017. In the same year, the CrytpoKitties game launched, giving players the ability to breed unique cats.
  • 2018 brought the ERC-721 token standard Ethereum, giving NFT creators a way to transfer value reliably with a supported token format. 
  • Also in 2018, the Axie Infinity NFT game launched, becoming another worldwide sensation.

Today’s market for NFTs has matured in comparison to the early days, with platforms like BLUR offering insight into the market demand for collections. 

However, today’s popular NFT collections may only be scratching the surface of what NFTs can offer.

NFTs can represent ownership in anything, including fine art, real estate, and companies. And while NFTs themselves can’t be divided, new tokens can represent fractional ownership in NFTs. 

Protocols like fractional.art allow NFT owners to fractionalize individual NFTs or collections.

NFT Scams

With top NFT collections like Pudgy Penguins and Bored Ape Yacht Club trading at floor prices of 20 ETH and up, a single NFT can be a huge score for scammers. Scams range from counterfeits to rug pulls.

In general, use discernment with any crypto transaction, and protect your crypto assets with a cold-storage hardware wallet if possible. 

Here are just a few common scams:

  • Rug Pulls: A rug pull refers to when project developers hype the project to attract investors. In an NFT context, developer and artist support for a collection might simply disappear. Typically prices plummet in the aftermath.
  • Counterfeit NFTs: Scammers or unwittingly duped sellers might post fake NFTs in marketplaces. To defend against this, use reputable marketplaces that verify authenticity and link to the collection smart contract.
  • Shill Bidding and Wash Trades: Crypto networks use pseudonymous wallet addresses, meaning one person or entity can have an unlimited number of addresses without their real identity being known. Unscrupulous sellers can bid on their own listings, driving interest for a single NFT or entire collections with fake demand. In wash trades, sellers can sell to themselves using different wallet addresses, thereby manipulating the market price.

NFTs and Intellectual Property

NFTs may come with some limitations in regard to intellectual property. For example, buying a Bored Ape NFT doesn’t grant you permission to create derivative works or remarket the image as a Not-So-Bored Ape to launch your own collection. In this example, you can use your Bored Ape in your media and branding

What each NFT grants as benefits of ownership may differ. In many cases, an NFT is simply a token that proves the authenticity of a digital asset. In other cases, an NFT may transfer full copyright and the freedom to do whatever you wish with the NFT.

If you’re buying an inexpensive NFT to use as an avatar, the stakes are low. But if you’re investing, potentially spending thousands of dollars, be sure to research the NFT collection first to learn what limitations may apply.

Benefits and Disadvantages of NFTs

NFTs present some exciting opportunities but come with some potential drawbacks as well.

NFT Benefits

  • NFTs can document ownership or rights to just about any asset and permit the transfer of ownership without an intermediary. 
  • NFT’s uniqueness makes them well suited to tokenizing specific assets such as artwork, real estate, or even investment positions.
  • Price appreciation: The floor price for Pudgy Penguins increased nearly fourfold over a 90-day period beginning in mid-November 2022 from 5 ETH to nearly 20 ETH. Floor prices reflect the lowest asking prices within a collection.

NFT Drawbacks

  • Prolific scams and fraudulent trading often make NFTs a buyer-beware purchase.
  • Trading in and out of NFTs becomes costly due to smart contract complexity, particularly on more expensive networks like Ethereum.
  • NFTs can be difficult to sell compared to traditional assets with established markets.
  • Like other blockchain assets, NFTs are unregulated. This eliminates consumer protections but also brings regulatory risk. If regulators take action involving ether, for example, other assets on the Ethereum blockchain could fall in value as well.

How to Buy an NFT?

To buy an NFT, you’ll typically need to make the purchase with cryptocurrency. Some platforms, like OpenSea, offer an easy way to buy cryptocurrencies with traditional currencies like US dollars, enabling the NFT purchase without leaving the platform.

Alternatively, you can use a crypto exchange to buy cryptocurrency with traditional (fiat) currencies.

You’ll also need a cryptocurrency wallet that supports the blockchain for your NFT. For example, the MetaMask wallet supports the Ethereum, Abitrum, and Polygon blockchains, all of which have active NFT communities. A crypto wallet holds the private keys that control your crypto assets on the blockchain.

Crypto exchanges like Coinbase offer an NFT marketplace. However, you may find a more full-featured experience by using a platform that focuses on NFTs. We list several top options in the following section.

Top 8 NFT Marketplaces

Most of the trading action for collectible NFTs takes place on OpenSea and BLUR, two of the top NFT marketplaces. However, several other marketplaces provide NFT selections, sometimes with listings not found elsewhere. You can find the list of the best NFT marketplaces here.

FAQs:

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Eric Huffman

Eric Huffman has a diverse background ranging from business management to insurance and personal finance. In recent years, Eric's interest in finance topics and in making personal finance accessible led to a focus on cryptocurrency topics. Eric specializes in crypto, blockchain, and finance guides that make these important topics easier to understand. Publications include Milk Road, Benzinga, CryptoNews.com, Motor Trend, CoverWallet, and others. Always learning, Eric holds several certifications related to crypto and finance, including certificates from the Blockchain Council, Duke University, and SUNY. When he's not writing, you might find Eric teaching karate or exploring the woods.