Everything you've always wanted to know about NFTs... and more

We already know that NFT stands for nonfungible token. But what exactly does it mean? We've got you covered with a helpful crypto handbook.

Most people are aware that NFT is an abbreviation for nonfungible token. But what exactly does it mean? Begin with the words themselves.

In economics, "fungible" refers to items that can be exchanged for other items of the same kind. The US dollar is fungible, which means that you and a friend can exchange US$1 bills and still have the same spending power. Most cryptocurrencies are also fungible - a bitcoin is a bitcoin, and it makes no difference which bitcoin you hold.

However, most physical objects, like as vehicles and houses, are nonfungible — that is, they contain distinct characteristics that cannot be exchanged for others of the same type. (You might be willing to exchange your 2020 Honda Civic for another 2020 Honda Civic, but the cars aren't identical, and you'd want to know the other car's condition before agreeing to the trade.)

Tokens are units of value that are kept on a blockchain. Tokens include cryptocurrencies such as bitcoin, ether, and dogecoin, although not all tokens are intended to be used as money. Tokens can be connected to actual commodities – Nike, for example, is experimenting with crypto tokens linked to physical shoe ownership – but they can also represent intangible goods, such as access to a private chatroom or storage space on a cloud server.

SO NONFUNGIBLE TOKENS ARE SIMILAR TO CRYPTOCURRENCIES, EXCEPT THEY HAVE UNIQUE QUALITIES AND ARE NOT ALWAYS USED AS MONEY. WHAT IS THE IMPORTANCE OF THIS?

Nonfungible commodities, on the other hand, did not exist on the internet until recently.

The internet is simply a massive copy machine — any digital file can be replicated an endless number of times, and each copy is identical to the original.

The internet's endless copy-making capacity was ideal for increasing the abundance of digital goods. However, it was terrible for making them scarce. If you were an artist looking to create only 100 "first editions" of your digital artwork, or a professional athlete looking to sell digital trading cards to your fans (and have those cards hold value in the same manner that actual trading cards do), your options were limited.

People discovered a few years ago that blockchains (the shared, decentralized databases that underlie bitcoin and other cryptocurrencies) could be used to generate unique, uncopyable digital files. Because these files were merely entries in a public database, anyone could verify who owned them or follow their movement.

That discovery sparked the development of the first NFTs.

BUT AREN'T MOST NFTS JPEG FILES THAT YOU CAN COPY BY RIGHT-CLICKING ON THEM AND SAVING TO YOUR COMPUTER? HOW DOES THIS HELP WITH THE FILE-COPYING PROBLEM?

If it helps, think of NFTs as the certificate of authenticity you'd get if you bought a pricey sculpture. The sculpture could be copied or forged, or someone could enter into your home and steal it, but because you have the certificate of authenticity, you can establish that you own the original.

SO, NFTS ARE BASICALLY A WAY TO CLAIM OWNERSHIP OF A DIGITAL FILE?

Yes. Which may not seem like a huge thing. (And who knows, it might not be!) People who are interested in NFTs, on the other hand, believe that the ability to claim ownership of digital information is a very significant concept.

They contend that scarcity is what gives many items in the offline world their worth. They believe that introducing this quality to the internet via NFTs will open up a whole new market for scarce digital commodities.

NFTs are an intriguing technology. However, why would anyone spend millions of dollars for one? You can drive a nice car or admire a Picasso painting on the wall, but you can't drive a JPEG.

It’s true that most NFTs aren’t valuable because they’re useful. And at the high end of the market – like the Bored Ape Yacht Club, or the NFT collections being auctioned off by Sotheby’s for millions of dollars – a lot of the value boils down to speculation and bragging rights.

However, one defense of NFTs I've heard from industry insiders – or, at the very least, an explanation for their appeal – is that NFTs aren't exceptional in their uselessness. People spend money on things that have no practical value all the time - perhaps to feel good, perhaps to show off to their friends, perhaps to express membership in a group. Some of the items we purchase are actual (for example, designer clothing or pricey jewelry), while others are digital (Fortnite skins, short Instagram usernames).

Empires have been established by selling pointless luxuries to the wealthy, and even if all NFTs represented was a new kind of luxury digital commodity, they would be worth considering as an emerging business.

AND WHAT IS IT WITH ALL THESE CARTOON APES AND PENGUINS CRYPTO PEOPLE APPEARING AS TWITTER AVATARS?

These are called community or pfp (profile photo) NFTs. They're essentially a collection of one-of-a-kind yet thematically connected NFTs that are only available in small quantities.

When these NFTs are issued, or "minted," they become a type of digital collectible as well as a membership card to an exclusive club. Many NFT organizations have their own chatrooms on the Discord messaging service, where owners can hang out and speak with one another. Some community NFT projects even host offline events and parties that you can only attend if you own one of their NFTs.

BUT ARE NFTS JUST DIGITAL BEANIE BABIES? AREN'T THEY ALL GOING TO END UP WORTHLESS?

That is the multi-million dollar question. (Or, more specifically, the US$40 billion question.) It's possible that those investing in NFTs are correct — that we're on the verge of a revolution in the way digital goods are purchased and sold, and that early NFTs will one day be worth as much as original Picassos and Monets.

However, the NFT market appears to be cooling, with dropping transaction values and cancelled auctions of high-priced NFTs. Even ardent NFT proponents are concerned that the market has become oversaturated. Gary Vaynerchuk, an online marketer and NFT tycoon, reportedly projected that 98% of NFTs would fail.

Even within the crypto community, NFTs are divisive. Some investors will not touch them, while others may treat them as speculative bets or acquire them merely for entertainment purposes.

And, within the NFT realm, there's a growing emphasis on "utility" — basically, bundling other items with an NFT purchase (like concert tickets, signed memorabilia, or early access to future releases) to ensure there's something of value included, even if the worth of the NFT itself is zero.

ARE THERE MANY SCAMS IN NFTS? WHAT ABOUT MONEY LEACHING?

Yes, there are numerous scams in the NFT industry. "Rug pulls" - when a crypto developer unexpectedly abandons a project and flees with the money of consumers – are a typical occurrence. Several high-profile ventures have proven to be shams, like Evolved Apes, an NFT fraud whose developer vanished along with US$2.7 million.

Furthermore, many projects are tainted by a practice known as "whitelisting," in which select persons are encouraged to purchase NFTs before they are made available to the wider public. Because of whitelisting, many gains flow to well-connected insiders, who obtain NFTs at a discount and can resell them for a higher price after they are made public. According to a Chainalysis analysis, whitelisted users that resold their NFTs profited 75% of the time, compared to 20% of the time for non-whitelisted users.

Money laundering, wash trading (selling something to yourself to raise its perceived worth), and other dubious behaviors are likely probably taking place in the NFT market as well. It's unclear how frequently this occurs, but it's a significant enough concern that financial regulators in numerous countries, including China, have issued warnings about the possible use of NFTs and other crypto assets for money laundering.

Of course, an NFT supporter would counter that scams and money laundering occur in the conventional economy as well. (A Senate study discovered that the traditional art market, for example, is riddled with money laundering.) It's possible that cryptocurrency will make things easier.

SOME PEOPLE HAVE COMPARED NFTS TO THOSE "NAME A STAR" GIFT COLLECTIBLES, IN WHICH ALL YOU GET IS AN ENTRY IN A DATABASE SAYING THAT A STAR WAS NAMED AFTER YOU - NOT ANY OFFICIAL CLAIM TO THE STAR ITSELF. ARE OWNERSHIP OR USE RIGHTS INCLUDED IN NFTS?

No, not always. In many NFT transactions, the buyer receives nothing more than the unique entry in the blockchain database identifying them as the owner of the digital product – the token – rather than the object the token represents.

The individual who purchased the renowned Nyan Cat NFT, for example, does not own the Nyan Cat picture or the right to turn it into Nyan Cat goods. Chris Torres, the creator, has reserved those rights. In essence, the NFT bidder received a "official" copy of the image that was cryptographically signed by Torres.

NFT creators have the option of including additional rights in an NFT sale. They don't have to, however. And there have already been high-profile copyright issues involving NFTs, such as Miramax's lawsuit against Quentin Tarantino last year, after Tarantino declared he would sell off unpublished passages from the Pulp Fiction screenplay as NFTs.

DO A LOT OF NFTS GET STOLEN?

Yes, as the price of popular NFTs has risen, there have been a lot of NFT thefts in recent months. Thieves recently tricked many members of the Bored Ape Yacht Club — whose NFT cartoons of bored apes frequently sell for six or seven figures – into giving up the passwords to their crypto wallets. In addition, hackers recently stole $1.7 million in NFTs from OpenSea users, the largest NFT trading site.

Another type of theft is the creation of NFTs from copyrighted or protected material, which is also frequent. Many artists have expressed dissatisfaction with their work being transformed into NFTs and sold as "official" versions without their consent. While several platforms have attempted to limit the selling of stolen NFTs, some theft is probably unavoidable given the market's lack of regulation.

WHY DO SO MANY PEOPLE SEEM TO BE OBSESSED WITH NFTS IF THEY ARE SO FLAWED? WHAT IS THE OPTIMISTIC PERSPECTIVE THAT THE REST OF US ARE MISSING?

After speaking with numerous NFT makers and collectors, their pro-NFT argument boils down to a few key points:

— The current internet is overly centralized, and NFTs have the potential to help decentralize it. Currently, the majority of people who create media on the internet (artists, singers, video game broadcasters, etc.) post their work on massive platforms such as Spotify, YouTube, and Facebook. These platforms are wonderful for growing a following, but not so much for making money. They claim that NFTs enable creators to sell unique digital products directly to their followers while keeping a far larger portion of the earnings for themselves. An artist like 3LAU might sell one record NFT to a superfan for US$3.6 million and make more money than a lifetime's worth of Spotify plays.

—We are entering the metaverse era, in which more of our daily interactions and experiences will take place within immersive digital environments rather than offline physical settings. Adults who spend more of their days interacting in virtual places will buy all kinds of digital things to enhance their lives, and many of those objects will take the shape of NFTs, just as many kids today spend real money on Fortnite skins and Roblox accessories.

— NFTs are still a brand-new technology, and we don't yet know how they will be used. Digital scarcity is a very essential concept that will launch a completely new economy of one-of-a-kind digital items, and we should be patient and open-minded while we wait to see what is constructed with it.

IS THIS ALL ABOUT THE "CREATOR ECONOMY" STUFF, WHEN PEOPLE WERE EXPECTING PLATFORMS LIKE YOUTUBE AND TWITTER TO MAKE IT POSSIBLE FOR ALL THESE VLOGGERS, GAMERS, AND MUSICIANS TO MAKE MONEY ONLINE? CAN'T THE NFT MARKET END UP CONSOLIDATING UNDER A FEW MAJOR COMPANIES, LIKE SOCIAL MEDIA?

It is undeniable that there are big platforms in the NFT sector. (The largest, OpenSea, is worth $13.3 billion.) Some crypto enthusiasts have condemned these platforms for engaging in decentralized behavior, such as OpenSea's decision to delist certain NFTs that it deems stolen or fraudulent.

It's also true that NFT ownership is relatively centralized, with a few number of persons appearing to own the majority of high-value NFTs.

However, a market with concentrated ownership is not the same as a market with centralized technology. Furthermore, there are several structural forces that may make it more difficult for large corporations to acquire control of the NFT market.

To begin with, NFTs are personal property in a way that most other digital goods are not. When you post a video to YouTube, YouTube hosts it on its servers and basically determines all of the choices regarding that video - whether it violates community guidelines, is eligible to run advertisements, is recommended by the algorithm, and so on. NFTs, on the other hand, reside in their owners' crypto wallets, which are not tied to any certain platform, and they can be used in any way they see fit.

There's also the concept of interoperability to consider. NFTs have the ability to be made interoperable, which means that, unlike purchasing a skin in Fortnite that can only be used within Fortnite, you can theoretically transport NFTs from one virtual environment to another. An NFT sword purchased in one video game may come in handy in another. Alternatively, a cartoon animal purchased as an NFT may serve as your avatar in a VR metaverse app. If you are dissatisfied with OpenSea, you can easily take your NFTs (which are stored in your crypto wallet, not on OpenSea's servers) and trade them on another platform.

That doesn't happen on social media. If you have a YouTube channel, you can't easily transfer your subscribers to TikTok whenever you want.

I UNDERSTAND THE THEORICAL BENEFITS OF NFTS. BUT NONE OF THIS IS REALLY THAT DEEP, IS IT? NOBODY IS USING NFTS IN VIDEO GAMES, FOR EXAMPLE – THEY'RE JUST BUYING THEM AND HOPING THE PRICE WILL GO UP.

Nobody, I wouldn't say. Axie Infinity, for example, is a popular NFT-based game that allows users to earn real money by winning in-game battles with their NFT characters.

However, it is reasonable to conclude that the majority of today's NFT activity is speculative, and that if another type of digital asset routinely made people rich (or provided them with fun communities of like-minded people to join), some people might stop trading NFTs and instead trade those items.

The main selling point for NFTs isn't that they make trading digital goods easy and cheap (they don't), or that they're permanent and indestructible (the tokens may be, but the digital files they link to aren't), or even that they represent the future of intellectual property (we'll still need lawyers to settle copyright disputes).

For better or worse, they enable people to create and trade scarce digital objects.

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