A deep-dive into the recent crypto-collectible or NFT craze and separating the hype from the facts.

I recently watched “Made You Look: A True Story About Fake Art” on Netflix, which tells the story of a multi-million dollar fake painting scam that fooled the super-rich into buying forged works in the likes of Jackson Pollock, Mark Rothko, and other iconic Abstract Expressionism artists. The con artists sold their counterfeit artwork to Ann Freedman at the Knoedler Gallery, who then (un)knowingly sold to the rich despite questionable provenance (history of ownership). The documentary poses the question of criminality in Freedman’s involvement, but the thing that stood out to me the most is how difficult it is to prove something as authentic in the physical world. Aside from material analysis to match how old the paintings/frames are, authentication came in the form of analyzing the style of each artists (i.e. eye test) from respected art historians and authenticators.

This documentary seems timely given the recent hype surrounding NFTs, or non-fungible tokens. Just few days ago, the digital artist Beeple sold his NFT art for $69 million, following the news of Jack Dorsey offering to sell the first-ever tweet as an NFT. But what exactly is a NFT, and why are people spending millions to buy something digital? In this article, we’ll define what NFTs are, take a brief look at its history, and dispel some myths surrounding NFTs.

To understand non-fungible tokens, we need to first grasp the concept of fungibility. Fungibility is defined as the property where “individual units are essentially interchangeable, and each of its parts is indistinguishable from another part.” The best example of a fungible asset is fiat currency. My $1 bill is the same in value as the $1 stored in my bank account or as the $1 bill that you might own. I can exchange my $1 bill with yours without changing the fundamental characteristics of its use, thus making currency fungible.

On the other hand, we have non-fungible assets. In the physical world, look no further than the stuff you own as examples: the signed t-shirt you have from your favorite artist’s concert, a polaroid album of your precious memories, or the ticket you bought for a sporting event. None of these items are interchangeable in a way that currency is.

The idea of fungibility, however, is not alway binary. Let’s take the tickets to a sports game as an example. Some may view the tickets as fungible if they are in the same section (i.e. a court-side ticket for another), but not fungible in other cases (i.e. seat at the 50 yard line vs. behind the goal post at a football game). Keep these nuances in mind as we extend the idea of fungibility to digital assets.

One of the common misconceptions with digital assets is that since the Internet enables global access and easy ways to share things (e.g. copying an image), digital assets are not scarce by nature and thus cannot be non-fungible. Look no further than the URL of this page to dispel that notion. We already are comfortable with the idea of digital non-fungible assets in the form of domain names and unique IDs on various social networks. Another good example is in-game assets. Many of the popular free-to-play games like Fortnite and League of Legends sell character costumes or skins (non-fungible assets) to drive revenue. In fact, in 2018, Fortnite amassed $2.4 billion in revenue, mostly from selling skins and emotes.

So if we already have non-fungible digital assets, what makes non-fungible tokens special? NFTs, by the virtue of being on the blockchain, provide some desirable characteristics to underlying digital assets:

• Standardization: blockchain provides a standard way to represent non-fungible asset via tokens, which allows developers to create new marketplaces that provides buyers and sellers a common means to exchange different types of assets (e.g. digital art for game items)
• Tradability: once an asset is tokenized, it can be traded on the blockchain unlike other digital assets that require coordination outside the immediate domain (e.g. selling Fortnite items via third-party marketplaces)
• Provenance: history of ownership is viewable and provable on the blockchain. This information remains on the blockchain and cannot be destroyed by a central entity.
• Programmability: NFTs can be programmed via smart contracts to bake in complex mechanics (e.g. CryptoKitties stores its unique digital genome that drives its appearance and genetics makeup of its offsprings on the smart contract)

While there are non-Ethereum-based NFT standards emerging (e.g. EOS, Cosmos), a vast majority of the NFTs falls under the following Ethereum standards:

• ERC-721: the first NFT standard pioneered by CryptoKitties. ERC-721 defines the interface for unique tokens to be owned and traded. Tokens hold a mapping of its unique identifier with the owner’s address and also implements a transferFrom interface to exchange NFTs in a programmable way.
• ERC-1155: developed by the Enjin team, ERC-1155 defines a multi-token standard that introduces the idea of classes to assets. This allows developers to capture more complex representations beyond a simple one-to-one relationship between an asset and a token. A classic example is the different classes of items in a game. ERC-1155 can represent different types of items (e.g. swords, guns, shields, armor) that are semi-fungible similar to how we view tickets within the same section in the physical world. This facilitates large scale trades, instead of having to create a new contract per item. Since ERC-1155 is a superset of ERC-721, the advantage here is efficiency in the representation and batch transfers.

Note that these standards do not mandate much beyond ownership, classification of assets, and transferring mechanism. This allows developers to enrich each NFT token via metadata to bake in special features of their token. This may include the characteristics of the asset (e.g. how quickly a CryptoKitty can breed) or visuals (e.g. what the asset looks like). Due to the storage and performance limitations of Ethereum, most NFTs store these metadata off the blockchain and only hold references to these metadata in the contract itself.

The first attempts at NFTs actually started on the Bitcoin network with Colored Coins. CryptoPunks from Larva Labs followed suit on Ethereum, creating 10,000 collectible punks and inspiring the creation of the ERC-721 standard. In late 2017, CryptoKitties officially put NFTs on notice with the gamification of the breeding mechanics and creating a marketplace for breeders to sell rarer cats. There was a small hype cycle surrounding NFTs with some CryptoKitties selling for hundreds of ETH (e.g. Founder Cat, Dragon) that came crashing down with the rest of the cryptocurrency market.

Now in 2021, following the DeFi summer that saw heightened activity in the fungible token space, NFTs are poised for a comeback with new assets being traded for massive capital. Still, we are early in the development of the NFT ecosystem with some corrections due like in the days of ICO mania. We are already seeing crypto art, games (items and virtual lands), and other digital assets like Tweets being minted as NFTs. Recently, I came across an interesting attempt at using NFTs for an exclusive analysis piece on the Coinbase IPO. Personally, I’m interested in seeing how the ecosystem grows beyond marketplaces into areas of crowdfunding, IP protection, and monetization schemes outside of advertising and subscriptions.

Some key players to watch:

Amidst the NFT craze, I often hear critics dismissing digital assets for having no value. Why would anyone pay thousands of dollars for a digital cat? Why is crypto art worth millions when I can take a screenshot and share it freely on the Internet? NFTs are worthless!

There is some valid criticism on the point of every NFT project suddenly gaining massive attention. However, like the ICO craze, I believe the market will eventually self-correct, and the added attention will bear some useful projects in the end. The biggest misconception may be that scarcity alone drives value. Maybe the key to understanding the propelling force behind NFTs are provable scarcity.

After all, NFTs are not that different than the things we are used to already. People already spend thousands on rare items online as we’ve seen with Fortnite and other games. As for art, look no further than the documentary we began this post with. What makes the counterfeit Pollack and Rothko worthless versus the originals? What about the value of the picture taken from Netflix of the Rothko painting embedded on this post? It’s not scarcity alone that drives value. Yes, we can easily copy and paste photos online, but what gives the original artwork value is its provable scarcity. In other words, it is the fact that Pollack or Rothko verifiably drew those masterpieces that assigns value.

Don’t put off NFTs as a whole simply because of the NFT craze. We will see some scammy projects, but there may be some gems with actual utility and value that may unlock new ecosystems.

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Source: https://levelup.gitconnected.com/understanding-non-fungible-tokens-nfts-1c3912f8ac1?source=rss——-8—————–cryptocurrency