What is an NFT, and why is it Valuable?
NFT, aka, 'Non-fungible Token' is a token that can be traded or exchanged for another cryptocurrency. NFT's are created on the blockchain through smart contracts, which facilitates their tradability and secures them from being replicated.
Ownership of an NFT is determined by who holds the corresponding private key to the public address. In the Ethereum blockchain, the standard unit of Non-fungible Token is called 'ERC721'.
Non-Fungible Token was coined by Dieter Shirley in 2017 when he submitted the idea of 'NFT' to discussions on Ethereum's official forums. At that time, NFT's did not exist, but it had been something talked of before by crypto enthusiasts.
After the successful implementation of NFT's on the blockchain, ownership of these tokens is tracked and authenticated by a contract. The benefit of tracking real-world assets on the blockchain is that they can be bought and sold in a peer-to-peer fashion while retaining their scarcity.
As mentioned above, Non-Fungible Token (ERC721) does not have a standard unit of measurement; but instead, the standard is determined by its smart contract.
However, for this article, we will use 'token' and 'NFT' interchangeably as they mean the same thing. Let’s discuss in detail what is an NFT and why is it valuable?
How NFTs Work?
NFTs are created on the blockchain through smart contracts. However, it is important to note that not all tokens are Non-Fungible Token(ERC721). It must be an ERC721 token to have the same characteristics of non-fungibility and tradability.
An NFT's ownership can be recorded in a few ways:
- By having a wallet that holds both sender and receiver public keys
- By ensuring an ENS name is held by the owner of the token
- By having a smart contract that tracks ownership on the blockchain, which will be covered in greater detail below
NFTs are traded or exchanged for another cryptocurrency with compatible wallets, such as wallets that can receive and send ERC20 tokens.
The benefit of NFTs is that they:
- Are tradable and transferable just like all cryptocurrencies, yet because of their unique characteristics, they can be distinguished from other assets.
- Instead of having to go through the tedious process to prove ownership, such as by signing a message, ownership can be authenticated by anyone through checking the blockchain.
- Are algorithmically generated, and because of this, there is no central authority to govern or control NFTs.
- Cannot be replicated, which means that every single Token has its own unique identifier (token ID). This establishes trust among users as it guarantees assets cannot be counterfeited.
- Most importantly, Non-Fungible Token allows for validation of scarce digital assets that can also provide a revenue stream for their owners.
How are they created?
NFT's are created through smart contracts according to standards set in place by EIP 521. They are not mined like cryptocurrencies because they already exist on the blockchain. The way these tokens are produced is via algorithms that are generated by the NFT's smart contract.
Why are they valuable?
Non-Fungible Tokens provide a pathway for asset verification and revenue stream to their owners. They allow users to authenticate any number of scarce digital assets without having to go through any third-party authority, such as governments or banks. The benefit of this is that NFTs can be listed in cryptocurrency exchanges for trading.
Many cryptocurrencies are fungible, which means that they cannot be differentiated from each other by any one that is not holding the private key to one's wallet.
However, with Non-Fungible Tokens, the ownership of each Token is guaranteed and verified by the blockchain. For example, if one was to have a token that is the same as another, it would be seen as having no value.
The use case for NFTs are vast, and they can be applied to many different sectors such as:
- Anonymous marketplace or decentralized marketplaces
- Digital advertising
Advantages of NFTs
- NFT's are unique, which establishes trust among users, provides security, and prevents counterfeiting.
- They can verify ownership of digital assets without the need to have a 3rd party authority, such as the government or banks. This means transactions do not have to go through any unnecessary procedures that could potentially take weeks or months.
- NFT's are algorithmically generated, which means they cannot be replicated. Therefore every Token has its own unique identifier.
- All cryptocurrencies are tradable, transferable, and verifiable on the blockchain regardless if they are fungible or not. They can easily be traded for other cryptocurrencies in compatible wallets.
- The ownership of NFTs can be recorded in a few ways, such as by having a wallet that holds both sender and receiver public keys, ensuring an ENS name is held by the owner of the Token, and by having a smart contract that tracks ownership on the blockchain.
Downsides of NFTs
- As with all new forms of technology, there is a learning curve. Users will need to become more familiar with smart contracts and how they work before they can fully realize the benefits NFTs offer.
- There is relatively low liquidity compared to other cryptocurrencies such as Bitcoin and Ethereum. This means that the price of one Token could be inherently unstable, especially if it remains illiquid for a prolonged period of time.
- NFTs are still in their development stage, and as such, they will require more security and transparency before they can be seen to offer the same level of trust and security that is provided by governments or banks.
- The technical background needed to understand blockchain technology and how it works may put off less tech-savvy individuals. This may impact its adoption and, in turn, prevent it from becoming a widely used technology.
Since becoming a tradable asset on the blockchain, NFT's have been very popular among crypto-collectors and investors. There are many reasons why NFT's are valuable, but to understand these reasons, it is best to look at one example of an NFT which was the first to be released, Cryptokitties.
Cryptokitties became popular as one of the first NFT's that was widely adopted and marketed as virtual cats that can be bred and traded for profit. Each Cryptokitty is unique as it has a distinct set of visual characteristics such as the face, fur, and eyes.
Because of this uniqueness, they were able to generate a significant amount of user interest and demand, which resulted in the CryptoKitties developing international marketing campaigns and even sponsoring sports teams.
Since then, more NFT's have entered the market. Some examples of popular tokens that are currently on the blockchain are CryptoCelebrities, CryptoPuppies, Crypto bots, and Ethereum Fish.