December 3, 2022

Sapiensdigital

Sapiens Digital

Non-fungible what now? NFT basics

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In March 2021 a piece of digital art – essentially a jpg file – was purchased as an non-fungible token, or NFT, for US$69 million at Christies.1 Jack Dorsey, CEO of Twitter, sold his first tweet, allowing the lucky owner to ‘own’ it for US$2.9 million.2 Paris Hilton and Jimmy Fallon showed off their NFT artwork purchases on The Tonight Show.3

Every article about NFTs starts off the same way: big names and big numbers – this one is no different. It’s hard not to start at such a point given the stratospheric hype around them. But are NFTs just the newest digital fad or technology that business should keep an eye on? Let’s take a look!

The blockchain behind the NFT

To understand NFTs, it’s first necessary to understand blockchain. In metaphorical (and simplistic) terms, a blockchain can be thought of as a length of chain.  

Each ‘link’ in the blockchain is a unit of data, referred to as a block. Each block points backwards with an encrypted ‘hash’ (think of this like a super-long near unbreakable password) to the block before it. For the length of the chain, these blocks form a chronological history (a ledger) of discrete moments or actions. In cryptocurrencies, like Bitcoin, these blocks would represent transactions. In other blockchains, blocks might contain different information, such as executed steps in a smart contract.* 

Public blockchains are visible to everyone, and stored as copies across multiple computers or servers on the network (this is why blockchains are referred to as decentralised). The network cross-checks pieces to verify any changes or additions to the chain before agreeing if they should be actioned. This, plus the encrypted hashes for each block, make altering the blockchain with nefarious intentions pretty difficult.

So what exactly is an NFT?

NFTs are items represented on a blockchain. So far, they are possible on the Ethereum blockchain, which is a particular blockchain that can power smart contracts (it also has its own cryptocurrency, Ether, which is used to buy and sell things, such as NFTs). In a digital art example the metadata of the art file, including who the creator is, who buys and owns it, any royalties to be paid if it gets resold and so on, would reside on the chain.

Unlike cryptocurrency, where one bitcoin is the same as any other bitcoin (like the cash in your wallet), NFTs are ‘non-fungible’ meaning they’re unique. One piece can’t be exchanged for another piece as if it were of equal value – just like one Picasso painting is not the same, in physicality or value, as another.

So why is a blockchain needed for a file that already exists digitally? Being digital, a jpg image (or any other kind of file) is inherently copyable – if you save it to your computer you have an exact duplicate. This is great for storing and viewing a piece, but, with multiple copies, who owns the ‘original’? Without an official owner, and therefore clear property rights, there’s no way to sell it by transferring the rights to a new owner in return for money.4 As an NFT, however, the blockchain can store this information publicly, unchangeably and theoretically, forever. Yes, the image can still be saved by many people, but while they may have a copy, they don’t own it. As The Verge succinctly describes this, “to put it in terms of physical art collecting: anyone can buy a Monet print. But only one person can own the original.”5

NFTs, therefore, enable a whole new market (and indeed their own marketplaces) where transactions can occur around digital objects.6

Possible use-cases for NFTs

  • Digital art – Sotheby’s, Christies and other auction houses are exploring NFTs as a way to expand their traditional business.7 With creator rights built in, it’s understandable why digital artists, who often have work go unattributed or stolen, are interested. On the buyer side, displaying an owned NFT, such as on social media profiles, adds to a user’s identity and holds the potential for great dividends if the artwork increases in value.8

  • Collectibles – The digital version of fan trading cards where scarcity helps drive value. The NBA, for example, sold video snippet NFTs of memorable game moments – only one fan can own a particular clip. Marvel created a limited number of digital 3D figurines for their Spiderman and Captain America franchises.9 Celebrities are also using NFTs to sell limited edition collectible artworks to their fanbases.10

  • Memberships and ticketing – Club memberships or season passes for sports teams could be verified, owned and transferred as NFTs. Many digital art NFTs, such as those of the Bored Ape Yacht Club, Gutter Cat Gang and Goat Society serve as tokens that allow access to exclusive social clubs.11 Using NFTs to issue tickets to events would allow them to be legally resold, allowing seats to be filled and royalties paid. Music festival Coachella is selling NFTs alongside lifetime passes for its 2022 event.12

  • Games – CryptoKitties, the NFT that started the craze, is a game where digital cats can be bred, providing unique NFT offspring kittens created from combinations of their ‘parents’ ‘genetic’ traits. NFT horse racing similarly enables virtual races, won based on the race history and heritage of the digital horses running. In 2021 the Victoria Racing Club partnered with NFT racing platform Zed Run to host a virtual Melbourne Cup and auction off a collection of historical Cup moments as NFTs.13

  • Dining – NFTs have potential uses in restaurants, such as for ease of booking and to address the lost revenue of ‘no-shows’ with a market for re-selling reservations.14 NFTs could also be used to verify reviews, dynamically price limited food items (want the fugu anyone?) and, as in the case of the upcoming NYC restaurant complex, The Flyfish Club, create special member-only eating areas.15

  • Education – MIT already uses blockchain technology to issue virtual credentials and NFTs could work in a similar way.16 As micro-credentialing grows, the ability to display and verify skills on resumes or LinkedIn could be increasingly useful. NFTs could also be used for academic results and student records more generally.17

  • Supply chain – Moving into the world of the ‘phygital’ (yes, it’s a thing… it refers to the merging of physical and digital products and experiences) NFTs could contain shipping information. By using blockchain technology, it would be possible to track shipments –  from the factory floor to the shopping basket.18 Similarly, they could verify the provenance or authenticity of items that need traceability, such as pharmaceuticals or luxury goods, and are already being used as additional value alongside purchases like wine to whisky.19,20

  • Customer experience – NFTs offer the unique ability to directly connect a creator to a buyer. Brand communities built around NFTs could offer exclusive access to consumers and, in turn, build brand loyalty. Streetwear brand TheHundreds uses NFTs as tokens to an online community who gain early access to product releases.21 Nike has patented, although not yet produced, NFT-linked shoes (‘cryptokicks’) alongside the ability to mix digital pairs and have them made physical.

  • … and of course, with the amounts of money changing hands after some of these NFT releases (called ‘drops’), NFTs as a speculative asset class in their own right are being eyed carefully by investors.22

Hype vs Reality

Should business be jumping on board? Despite the US$24 billion NFTs traded so far, there are reasons to be cautious.  According to the Financial Times, despite these billion dollar amounts, the actual number of users doing the buying and selling is not as high.23

There are barriers to adoption by mainstream consumers – most NFTs are bought and sold using cryptocurrency, although some platforms can submerge the crypto mechanisms so that buyers can deal in more familiar currency. There is also increasing evidence of so-called ‘wash trading,’ where owners sell and resell their NFTs to each other to artificially inflate prices.24

The NFT creation process itself has issues. Some NFT markets list hundreds of pieces, many of which are found by bots scraping images from the web and artists having their art sold as NFTs without their knowledge or attribution.25  ‘Rug pull’ scams, where unscrupulous developers list fake or wildly over-valued NFTs only to take the money and run, are not uncommon.26

And this is all before mentioning the fact that minting blockchains, be they for NFTs or the cryptocurrencies used to buy them, uses huge amounts of processing power – to the tune of millions of tons of carbon-dioxide emissions.27

The fungible bottom line

So where do NFTs stand at the beginning of 2022? Despite the millions, it is fair to say that NFTs are still in their infancy. How far society, let alone business, embraces has not yet been tested. There are legitimate concerns around their use and abuse, but the concept is one that could solve some very real digital – and phygital – challenges and create unique opportunities for brands.

It may not be time to hang the virtual NFT on the wall, but it might be worth stocking up on some nails.

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