While NFTs are not new, their popularity has exploded in the last couple of months, moving to the front and center of the crypto world, and being picked up by mainstream media publications around the world, including The Washington Post, The Guardian, and the BBC. The catalyst for this seemed to be the US $69.3m acquisition of the digital artist Beeple’s NFT artwork “Everydays: The First 5000 Days”.
Although not the first NFT to be traded for eye-watering sums, since the $69 million sale we have seen a handful of other artists putting their various works up for sale as NFTs, helping to further fuel the expansion of this sector. Some are skeptical of this new venture, others are hopeful that NFTs can help bring both artists and fans better value through fairer ownership of works.
In this blog post, we will provide an overview of NFTs in their entirety, first with by looking at what NFTs are and how they work as a part of blockchain technology, and then moving on to meatier topics such as NFT use for smart contracts, the nexus between NFTs and DeFi, and how NFTs will be impacted by Ethereum 2.0. As you can see, we have a lot to cover, so let’s get stuck in!
What’s an NFT and how does it work
In the simplest terms, an NFT (non-fungible token) is a digital item with a unique identifier signaling its authenticity. Much like in the art world, where a certificate of authenticity would accompany a piece sold at Christie’s, demonstrating its uniqueness, an NFT shows that a GIF, digital artwork, or meme is, in fact, the original – a form of blockchain ownership.
Although there have been many examples of art forgers fooling both high-society and art experts, in most cases it is clear cut whether an object is the real deal or not. If you’ve bought a Picasso in a gift shop or been offered a Monet from a gentleman wearing 3 watches on a street corner, you would have no doubts that you are buying a replica. In the digital world it’s much harder to tell, where infinite exact copies can be made of an image or video.
At this point is where the skeptics come in, asking why people would pay huge sums for an asset that isn’t tangible and isn’t at all distinct from the many copies that can be viewed at any time on the internet. This is indeed a legitimate question, and comes down to ideas of ownership. Owning a cheap knock-off of a product never brings as much pleasure as owning the real thing. Despite the raft of notably older commentators stating that younger people don’t want to own houses or have many possessions, it’s not quite true. Most people have something that they collect or a prized possession, as ownership of these things brings feelings of attachment, self-esteem, and wellbeing.
Knowing that you have paid for a legitimate work by an artist you admire can be a great experience, creating a feeling of connection with them. This can be done by purchasing an album in a shop, for example, or buying it as an NFT. What’s more, the NFT can confer certain rights that can’t be acquired elsewhere, such as with Kings of Leon’s new album, released as three types of NFT tokens. One of these tokens offers real-life perks such as front-row concert seats for life. Then there are the NFT characters that can be used in online games, such as the limited-edition dragons in Forgotten Artifacts. Here, NFT ownership brings something exclusive that can’t be got through a copy, creating an enriching experience for the consumer, while making sure the artist gets paid more fairly for their work than through a streaming service such as Spotify.
There are also some strong criticisms of NFTs; one of which is the issue of taking an artist’s work and rendering it as an NFT without their permission. This is highlighted by an artist selling NFTs for large amounts in the style of Banksy. How do issues of copyright and intellectual property law tie into the creation of NFTs? As the market matures this is definitely an important question.
Also gaining more traction is the argument about NFT and the wider blockchain and crypto industry’s environmental toll. Over the past few months it has been noted that the energy consumption of Bitcoin is greater than that of various small-medium sized economies, however, there is a counter argument. While currently most NFTs run on the Ethereum network, which presently creates lots of emissions, Ethereum 2.0’s move to a Proof of Stake (PoS) consensus model means that the processing power (and therefore energy consumption) required to validate blocks is much lower than the current Proof of Work (PoW) model.
NFTs and Smart Contracts
While NFTs based on art, videos, images and memes are having their moment in the sun, there are wider applications for NFTs, and this is due to the fact that the purchase, ownership and selling of these assets are based on smart contracts on blockchain. The benefits of smart contracts with NFTs are as follows:
- No third-party intermediaries are required, meaning a transaction will take place directly between buyer and seller. Associated fees and needless commission are a thing of the past.
- The terms and conditions of a transaction are visible at any time by any party.
- Real-time data feeds means that contracts can automatically be executed as events happen.
There is enough trust in NFTs and the smart contracts they run on that last week even part-ownership of a house in St. Louis, USA, was offered as an NFT.
NFTs on Ethereum: ERC-721 and ERC-1155
While we know that NFTs run on blockchain and operate through smart contracts, it’s time to go a little deeper, by looking at the two types of NFTs; those that are produced according to the ERC-721 standard, and those produced according to the ERC-1155.
Why are these standards important? Well, they dictate the properties of an NFT, making sure they are interoperable across the right systems and can be used as intended in certain environments, such as in computer games. What the ERC-20 standard is to Ethereum tokens, the ERC-721 and ERC-1155 standards are to NFTs.
What’s the difference between them?
ERC-721 non-fungible tokens were the first to be used for collectible assets. Cryptokitties, the first NFTs that achieved widespread fame, are based on the ERC-721 standard, which ensures that non-fungible digital assets are interoperable across multiple ecosystems, including markets and games. However, a new smart contract needs to be deployed for each new token, meaning batch transfers of items is impossible. There are also complaints that supporting ERC-721 from multiple projects in an application requires custom integration for each token, with the result being wasted space, along with greater production costs and development time.
In contrast, ERC-1155 allows the creation of an infinite number of both fungible and non-fungible tokens in one smart contract. Batch transfers of these tokens are made easy and strict standardization means that tokens from any projects are able to be integrated easily into a game or app. One of the biggest projects in this sphere, Enjin, allows any user to create a NFT on the one smart contract. Millions of NFTs have been created and thousands are on sale through Enjin’s marketplace.
NFTs and DeFi protocols – the next frontier
NFT insurance for DeFi
Despite the tightening of controls and the rise of dedicated blockchain cybersecurity companies such as Hacken, there are still vulnerabilities in smart contracts that saw $120 million stolen over the course of 2020.
The expansion of Decentralized Finance relies on users feeling safe enough to use blockchain financial protocols as an alternative to those offered by traditional institutions. One way to do this is through DeFi insurance, and this is where NFTs come in. The yInsure insurance that covers the Yearn Finance protocol are tokenized as NFTs, meaning they can be easily bought, sold and even staked!
NFTs as DeFi collateral
Lastly, we come to another fast moving area, that of NFTs being used within the decentralized finance ecosystem. Rather than staking Ethereum as collateral when taking out loans, as you would with MakerDAO and other lending platforms, there is now the option to stake NFT collectibles to take out loans, with up-and-coming platforms such as nftfi recently announcing an $890,000 investment round.
A final word
As NFTs continue to trend, everyone seems to have an opinion, which varies widely in terms of enthusiasm. We’ve mentioned the skepticism around owning something that you can’t touch and is available for others to view for free. Then there are the issues of copyright. If someone sells an NFT of an image that is already copyrighted, the person who bought it may indeed own the image, but not the copyright. In addition, people jumping on the NFT bandwagon in order to make a quick buck are causing some to express concern that an oversaturation of mediocre products can harm a vibrant ecosystem.
While with every new technology there are kinks to work out, that doesn’t mean we should reject the advances that are being made. With respected sellers such as Sotheby’s selling digital art and accepting cryptocurrencies as a payment method, there is confidence that the market will expand. Most importantly, often overlooked amidst the fevered speculation are the benefits for the artists themselves. When a musician needs 250 streams to make $1 on Spotify and artists are coerced into signing over more rights than they should to agents and other middlemen, NFTs provide a way to regain control and level the playing field. On the blockchain, all things are transparent, meaning, for example, that the artist, Beeple, can make a 10% royalty every time his artwork changes hands. This wouldn’t be possible in the opaque artworld, where trades are sometimes made behind closed doors.
In summary, 2021 has just started, and with so much innovation in this space, the team at INC4 can’t wait to see what the rest of the year brings. If you’re in need of blockchain services, our team is ready and able to start a project from scratch or work on an existing project as a remote addition to your current IT team. Contact an INC4 representative to see what we can do for you, and while you’re at it, check out our fundraising report, where we detail key blockchain insights to carry us through the current year.