Non-Fungible Tokens (NFTs): What are NFTs & How do NFTs Work?

NFTs or non-fungible tokens are unique digital assets that can be bought using and sold using crypto. Continue reading this article to know everything about what are NFTs, their features, how do NFTs work & much more.

5 JUN 2023, 11 min read

In recent years, a revolutionary technology has emerged that is transforming the way we perceive and trade digital assets. Non-Fungible Tokens, or NFTs, have garnered immense attention and popularity across various industries. From NFT art and music to virtual real estate and collectibles, NFTs have opened up a whole new realm of possibilities for creators and collectors alike. In this blog post, we will delve into the fascinating world of NFTs, exploring what they are, how they work, and their implications for the future of digital ownership. This blog covers the following sections:

What is an NFT and what does it stand for?
How do NFTs work?
History of NFTs
Top benefits of NFTsExamples of famous NFTs
How and where to buy NFTs from?
What is an NFT marketplace
Examples of NFT marketplaces
What are NFT scams
Top reasons to invest in NFTs
Bottomline

What is an NFT and what does it stand for?

To comprehend the concept of NFTs, it is essential to grasp the difference between fungible and non-fungible assets. Fungible assets are interchangeable and hold the same value, such as cryptos like Bitcoin or traditional currencies like the US Dollar. On the other hand, non-fungible assets are unique and possess distinct characteristics that set them apart from one another. NFTs fall into the latter category.

An NFT is essentially a digital certificate of ownership that verifies the authenticity, uniqueness, and provenance of a specific digital asset. These assets can range from non-fungible token art, music, videos, virtual real estate, domain names, and even tweets. What sets NFTs apart from traditional digital files is their ability to be tokenized on a blockchain network, most commonly using the Ethereum blockchain.

Tokenization is the process of creating a digital representation of an asset on a blockchain, which serves as an immutable record of ownership. When a digital asset is tokenized as an NFT, it is assigned a unique token that acts as a cryptographic proof of its authenticity and ownership. This token contains metadata that defines the specific characteristics and attributes of the asset.

Smart contracts which are self-executing contracts with the terms of the agreement directly written into the code, play a vital role in NFTs. Smart contracts facilitate the automatic execution of transactions, including the transfer of ownership and the payment of royalties to creators each time the NFT is resold.

How do NFTs work?

Here's a simplified explanation of how do non fungible tokens work:

1. Blockchain Technology

NFTs are built on blockchain networks, commonly using Ethereum as the underlying blockchain. Blockchain is a decentralized ledger that records and verifies transactions across multiple computers.

2. Token Creation

To create an NFT, an artist or creator typically mints a digital asset using smart contracts on a blockchain platform. The smart contract includes the details of the NFT, such as its unique identifier, metadata, and ownership information.

3. Unique Identification:

Each NFT has a distinct digital signature or token ID that distinguishes it from other tokens on the blockchain. This token ID serves as proof of authenticity and ownership.

4. Ownership and Transfer

NFTs enable verifiable ownership and transferability. The ownership of an NFT is recorded on the blockchain, and ownership changes are also recorded as transactions. These transactions are publicly visible, transparent, and tamper-proof.

5. Metadata and Content

NFTs can include additional metadata that describes the asset, such as the artist's name, description, image, or even a link to the original file. The actual content of the NFT, such as an artwork or music file, is often stored off-chain, while its metadata and ownership information reside on the blockchain.

6. Interoperability

NFTs are compatible with various platforms and marketplaces, allowing creators to sell or auction their digital assets. These marketplaces provide a venue for buyers and sellers to trade NFTs, often using crypto as the medium of exchange.

7. Royalties and Smart Contracts

NFTs can include programmable smart contracts that enable creators to earn royalties from subsequent sales of their NFTs. Through these contracts, creators can specify a percentage of the sale price that they receive whenever the NFT is resold in the future.

8. Verification and Authenticity

The blockchain technology behind NFTs ensures the uniqueness and provenance of each asset. The decentralized nature of blockchain eliminates the need for centralized authorities to verify authenticity, as the information is recorded and verified by the network of computers participating in the blockchain.

Read More: What is Crypto Staking?

History of NFTs

The concept of NFTs has its roots in the early development of blockchain technology. Here's a brief history of NFTs:

1. Early Blockchain Experiments

The idea of using blockchain technology for unique digital assets was explored as early as 2012. Projects like Colored Coins on the Bitcoin blockchain aimed to create tokens representing unique assets, but they had limited functionality.

2. Introduction of Ethereum

In 2015, Ethereum, a blockchain platform with smart contract functionality, was introduced. Ethereum allows developers to create decentralized applications (DApps) and execute smart contracts, providing a more flexible framework for building NFTs.

3. CryptoKitties

In 2017, CryptoKitties, a game built on Ethereum, popularized the concept of NFTs. CryptoKitties allowed users to collect, breed, and trade unique digital cats, each represented by an NFT. This game gained significant attention and caused congestion on the Ethereum network due to its popularity.

4. ERC-721 Standard

In the same year, the ERC-721 token standard was proposed by the developer Dieter Shirley. ERC-721 provided a standardized interface for creating NFTs on the Ethereum blockchain, allowing for the seamless exchange of unique digital assets.

5. Expansion of NFT Use Cases

Following the success of CryptoKitties, NFTs started to gain traction in various industries. Artists began to tokenize and sell digital artwork, musicians experimented with releasing music as NFTs, and other collectibles and virtual assets started to be represented as NFTs.

6. Growth of NFT Marketplaces

NFT marketplaces emerged as platforms for buying, selling, and trading NFTs. Platforms like OpenSea, Rarible, and SuperRare gained popularity, providing a space for creators and collectors to interact and transact with NFTs.

7. Mainstream Adoption and High-Profile Sales

In 2021, NFTs experienced a surge in mainstream attention. Several high-profile NFT sales garnered significant media coverage, including the $69 million sale of Beeple's artwork, "Everydays: The First 5000 Days." Celebrities, musicians, and athletes also joined the NFT space, further driving its popularity.

8. Expansion to Other Blockchains

While Ethereum remains the dominant blockchain for NFTs, other blockchains, such as Binance Smart Chain, Flow, and Tezos, have introduced their own NFT standards and platforms, expanding the NFT ecosystem.

Benefits of NFTs

NFTs offer several benefits to creators, collectors, and the broader digital ecosystem. For creators, NFTs enable new monetization models by providing a direct channel to sell digital assets without intermediaries. Additionally, smart contracts embedded in NFTs can enable creators to receive a portion of the proceeds every time their NFT is resold, ensuring ongoing royalties and incentivizing creativity.

Collectors, on the other hand, gain the ability to prove the authenticity and ownership of their digital assets, enhancing the value and prestige associated with their collections. NFTs also enable fractional ownership, allowing individuals to own a fraction of high-value assets, which was previously inaccessible to many due to financial constraints.

Examples of famous NFTs

There have been several famous and notable NFTs that have garnered significant attention and value in recent years. Here are a few examples:

Everydays: the First 5000 Days by Beeple

'Everydays: The First 5000 Days' by Beeple

This digital artwork by the artist Mike Winkelmann, known as Beeple, was sold as an NFT for a staggering $69 million at a Christie's auction in March 2021. It became one of the most expensive NFT sales to date and brought mainstream attention to the market.

'Crossroads' by Beeple

Another artwork by Beeple, "Crossroads," was sold as an NFT for $6.6 million. It showcased a former US President Donald Trump lying in a deserted landscape, reflecting on his presidency. The sale took place in February 2021.

CryptoPunks

CryptoPunks are a collection of 10,000 unique pixelated characters on the Ethereum blockchain. They were one of the earliest examples of NFTs and gained significant popularity. Some of the rarest CryptoPunks have sold for millions of dollars.

NBA Top Shot Moments

NBA Top Shot is an NFT platform that allows fans to collect and trade officially licensed NBA video highlights as NFTs. Some of the moments have sold for substantial amounts, including a LeBron James dunk that fetched over $200,000.

Jack Dorsey's First Tweet

Twitter CEO Jack Dorsey sold his first tweet, "just setting up my twttr," as an NFT for $2.9 million. The tweet was minted as an NFT and purchased by a Malaysian businessman in March 2021.

'The First Tweet' by Twitter

In a similar vein, Twitter itself sold its first-ever tweet as an NFT. The tweet, "just setting up my twttr," was sold for $2.9 million.

How and where to buy NFTs from?

To buy an NFT, you typically follow these steps:

1. Choose a Marketplace

There are several online platforms where you can buy and sell NFTs, such as OpenSea, Rarible, SuperRare, and NBA Top Shot. Each platform may have its own selection of NFTs and specific processes.

2. Set Up a Digital Wallet

Most NFT marketplaces require you to have a compatible digital wallet to store and manage your NFTs. Ethereum-based NFTs usually require an Ethereum wallet, such as MetaMask or Trust Wallet. Some marketplaces may support other blockchain networks, so make sure to check the wallet compatibility.

3. Fund Your Wallet

Once you have set up a digital wallet, you need to acquire some crypto to use for purchasing NFTs.

4. Connect Your Wallet

Connect your digital wallet to the NFT marketplace of your choice. This is typically done by logging into your wallet within the marketplace website or using a browser extension like MetaMask.

5. Browse, Select and Purchase an NFT

Explore the marketplace to find the NFTs you're interested in. You can filter by categories, artists, collections, or search for specific items. When you find an NFT you want to buy, click on it to view its details, including its price, description, and any additional information provided by the creator and purchase the NFT.

What is a NFT Marketplace?

An NFT marketplace is an online platform where creators can mint, buy, sell, and trade NFTs. These marketplaces provide a venue for artists, collectors, and enthusiasts to interact and transact with NFTs. They typically facilitate the listing, discovery, and exchange of NFTs, often using crypto as the medium of exchange. NFT marketplaces serve as a central hub for the NFT ecosystem, offering a wide range of digital assets across various categories.

Examples of NFT Marketplaces

1. OpenSea

OpenSea is one of the largest and most well-known NFT marketplaces. It supports a wide variety of NFTs, including art, collectibles, virtual land, and more. Users can create, buy, sell, and auction NFTs on the platform.

2. Rarible

Rarible is a decentralized NFT marketplace that allows users to mint, buy, and sell NFTs. It also incorporates a governance model where users can participate in platform decision-making.

3. SuperRare

SuperRare is a curated marketplace for digital artwork NFTs. It focuses on showcasing and selling limited-edition, single-edition, and rare digital art pieces. Each artwork is authenticated on the Ethereum blockchain.

4. NBA Top Shot

NBA Top Shot is an official marketplace for NFTs that represent officially licensed NBA video highlights called "moments." Collectors can buy, sell, and trade these moments, which are sold in packs or as individual items.

5. Decentraland Marketplace

Decentraland is a virtual reality platform built on the Ethereum blockchain. It has its own marketplace where users can buy, sell, and trade virtual land, digital assets, and wearables for their avatars.

6. Binance NFT Marketplace

Binance, one of the largest crypto exchanges, launched its own NFT marketplace. It allows creators to mint, buy, and sell NFTs, and it supports a range of categories, including art, gaming, sports, and more.

These are just a few examples of NFT marketplaces, and new platforms are continuously emerging as the NFT ecosystem expands.

What are NFT Scams?

NFT scams refer to fraudulent activities and deceptive practices that occur within the non-fungible token (NFT) space. As with any emerging and popular market, scammers may attempt to take advantage of unsuspecting individuals by employing various schemes. Here are some common NFT scams to be aware of:

1. Fake NFTs

Scammers may create counterfeit NFTs that mimic popular artworks or collectibles. It's important to thoroughly research the authenticity of an NFT and verify the credibility of the marketplace or seller before making a purchase.

2. Phishing and Impersonation

Scammers may use phishing techniques or impersonate well-known artists or NFT platforms to deceive individuals. They may send fake emails or messages with links that resemble official platforms, aiming to trick users into providing sensitive information or sending funds to fraudulent accounts. Be cautious of unsolicited communications and double-check the authenticity of the source.

3. Pump and Dump Schemes

In some cases, scammers artificially inflate the value of an NFT through coordinated efforts, creating a sense of hype and urgency. Once the price is inflated, they sell their holdings, causing the price to crash and leaving unsuspecting buyers with devalued assets. Exercise caution when encountering high-pressure buying situations and be mindful of market manipulation.

4. Unauthorized Resales

NFTs often have resale markets where buyers can sell their acquired assets. However, scammers may attempt to sell NFTs they don't actually own or have the rights to sell. It's crucial to verify the authenticity and ownership history of an NFT before engaging in any transaction.

Top Reasons to Invest in NFTs

Investing in NFTs has gained significant attention and popularity due to several reasons. Here are some key factors that attract people to invest in NFTs:

1. Unique and Scarce Digital Assets

NFTs represent unique digital assets, such as artwork, music, videos, or virtual collectibles. They offer a new way to own and trade digital content, which can be appealing to collectors and enthusiasts who value uniqueness and exclusivity.

2. Potential for High Returns

NFTs have shown the potential for substantial returns on investment. Some NFT investments have been sold for millions of dollars, generating significant profits for early investors. This potential for high returns attracts investors seeking opportunities for financial gains.

3. Participation in Digital Culture

NFTs allow investors to participate in and support digital artists, creators, and communities. By purchasing NFTs, investors can directly support their favorite artists and engage with digital culture in a meaningful way.

4. Authenticity and Ownership

NFTs provide a way to verify the authenticity and ownership of digital assets through blockchain technology. The decentralized nature of blockchain ensures the transparency and integrity of ownership records, which can be appealing to those looking for secure digital ownership rights.

5. Royalties and Secondary Market Profits

Some NFTs are built with smart contracts that enable creators to earn royalties whenever their NFTs are resold. This feature allows artists to continue benefiting from the increasing value of their creations even after the initial sale, creating potential ongoing revenue streams.

6. Access to Exclusive Content and Experiences

NFTs can grant holders access to exclusive content, experiences, or perks. For example, owning an NFT may provide VIP access to events, meet-and-greets with artists, or early access to future releases. This aspect of ownership can enhance the overall value proposition of certain NFTs.

7. Diversification of Investment Portfolio

Investing in NFTs can offer diversification for traditional investment portfolios. NFTs represent a unique asset class that is not directly correlated with traditional stocks, bonds, or real estate. Including NFTs in a broader investment strategy may provide exposure to potential growth and diversify risk.

Bottomline

It's important to note that while investing in NFTs can have significant upside potential, it also carries risks. The NFT market is relatively new and volatile, with uncertain long-term value and liquidity. Investors should thoroughly research and understand the market, evaluate the quality and authenticity of the NFTs they are considering, and be mindful of the potential for market fluctuations.

To protect your investments in NFTs, it's essential to exercise due diligence and follow best practices:

Thoroughly research the NFT, the creator, and the marketplace before making any purchases.
Validate the authenticity of the NFT and confirm the ownership history, metadata, and provenance if possible.
Stick to reputable and established NFT marketplaces to minimize the risk of encountering scams.
Be cautious of promises of high returns, exclusive access, or guaranteed profits.
Use secure payment methods and be mindful of sharing sensitive information.
Keep up with the latest news, developments, and security measures within the NFT space.

Frequently Asked Questions

1. How does an NFT make money?

By purchasing NFTs that are undervalued and holding onto them until their value appreciates. Another way to make a profit is by creating valuable NFTs that are in high demand.

2. How can you create an NFT?

One can create NFTs by utilizing available marketplaces like OpenSea, Rarible, NBA Top Shots and Binance.

3. Is there any risk in selling NFT?

Yes, there are risks associated with selling NFTs. Some of the potential risks include market volatility, lack of demand, authenticity concerns, scams and fraud, transaction costs, and legal and regulatory considerations.