What is a non-fungible token (NFT)?
Distributed ledger technologies (DLTs), including blockchain, is an emerging technology that challenges existing business models. Those historical business models relied on slow and costly intermediaries to create trust between two parties who don't inherently trust each other — such as two businesses attempting to trade money for an asset.
Blockchain was first introduced in 2008 with the inception of the Bitcoin cryptocurrency — the creation of digital money that anyone can own. The second generation of blockchain, Ethereum, was introduced in 2014, and allowed developers to execute programs (smart contracts) on a distributed ledger. Smart contracts enabled developers and businesses to build financial applications that make use of cryptocurrencies and other types of tokens, for things like borrowing and lending, decentralized exchanges, and more.
The advancements in distributed ledger technologies led to the creation of concepts that could simplify and reduce the cost of exchanging value. One way that value is represented on a distributed ledger is through the tokenization of nearly anything. There are two ways of thinking about tokens: fungible and non-fungible. Fungibility is the ability to exchange one with another of the same kind — is an essential feature of any currency. Non-fungibility, on the other hand, is quite the opposite — it's unique and therefore cannot be substituted.
In this explainer, we will dive deep into the world of non-fungible tokens, their applications and use cases, and how these tokens are helping shape digital ownership.
Fungibility and non-fungibility defined
Fungibility roughly translates to the ability to be replaced by something identical — when something is fungible, there are typically many of them that are the same. A fungible token can be divided and exchanged for another. For example, one hbar can be divided into one hundred million tinybars. One hbar is indistinguishable from and interchangeable with another hbar.
Non-fungibility offers uniqueness as its primary attribute. A non-fungible token is unique and there cannot exist another like it. For example, a plane ticket is unique — it specifies a specific seat, on a particular flight, at a specific time.
Non-fungible tokens (NFTs) explained
A non-fungible token is a type of cryptographic token that represents a unique item. These items may be digital or physical and represent things like sneakers, art, a plane ticket, university degree, commercial real estate, or in-game items for an online game. NFTs enable owners of a unique item to prove their ownership and the authenticity of an item. NFTs enable businesses or individuals buying and selling items in a marketplace the freedom to trust that the item they'll receive is truly authentic since the NFTs unique ID will match up with either the original issuer of the item or the service which performs authenticity checks.
Found below are the unique attributes of non-fungible tokens:
NFTs have historically been indivisible when it comes to their utility. For example, a plane ticket cannot be purchased and used partially — someone must buy it in full because only a single person can use the seat.
NFTs can be scarce, and that's one reason driving their value. Though developers can generate as many assets as they like, it is equally within their power to limit the number of NFT for scarcity.
NFTs are also unique because no two NFTs are the same — they're not interchangeable. The metadata of each NFT is an unalterable record that gives it the certificate of authenticity.
NFTs live on a DLT within an associated account. The original creators of the NFT control the private key of that account where the NFT lives, and they're free to transfer that NFT to any account.
Because public distributed ledgers are decentralized and immutable, where records of token issuance, transfer, and activity can be publicly verified, buyers can trust and verify the authenticity of a specific NFT.
NFTs can be traded, purchased, or sold across various DLTs using a decentralized bridge or centralized custodial service.
Standards for non-fungible tokens (NFT)
Multiple frameworks across various networks exist for the creation and issuance of non-fungible tokens. NFTs are typically interoperable. This means that they can be exchanged or traded across different DLTs with relative ease. You can store NFTs within DLT-agnostic wallet providers and trade them in open marketplaces. NFT marketplaces connect creators (issuers) of NFTs with buyers. Found below are various NFT standards which exist across blockchain networks.
ERC-721 is a token standard originally proposed in 2017 and written in Solidity on the Ethereum blockchain. Using a token standard like ERC-721 makes writing code more effortless, predictable, and reusable. ERC-721 is the foremost standard that allows everyone to create unique non-fungible tokens for digital collectibles. This token standard provides a mapping of unique identifiers to addresses, which verifies the owner of these identifiers.
ERC-1155 enables developers to make massive transfers of the tokens as per a smart contract, which minimizes the impact on the network and makes it possible to save on transaction fees. The NFT platform OpenSea has recently developed a repository for the ERC-1155 standard.
The Ethereum network is considered a widely accepted DLT for creating NFTs. However, the network's rising gas fees and lackluster performance have pushed developers to other public DLTs. These alternatives offer better performance, lower fees, and even the ability to tokenized NFTs without having to use slow or potentially faulty smart contracts.
Hedera, for instance, enables developers to mint native non-fungible tokens using the Hedera Token Service at a discount of over 99%, with the ability to transfer those tokens fast (less than 3 seconds), with finality (no waiting for block confirmations), and inexpensively (less than $0.001 USD in hbars). A real-world example is the Hedera user INFINITE by SUKU; they've migrated from Ethereum to create NFTs embedded into physical tags to verify the authenticity of rare sneakers and other luxury goods.
Incoming NFT standards: Fractional NFTs
Today, NFTs are perceived as proprietary and exclusive, meaning the buyer of an NFT is the sole owner. This state of NFT is quite the opposite of the decentralization idea proposed by DLTs. Due to these limitations, a new class of NFTs is being brought to the market called fractional non-fungible tokens. The idea is to enable everyone to own a fraction of NFT.
While F-NFTs are practical and easier to implement use cases with virtual goods, the real use case will be in real-world goods like art, collectibles, and traditional investments. For example, the Hedera Token Service allows native NFT issuance whereby the token can be fractionalized with pieces owned by many individuals.
Non-fungible token (NFT) use cases and applications
In the last few months, NFTs have grown into popularity as several companies and individuals jumped onto the bandwagon. To use NFTs, you need decentralized applications that can create or issue unique and scarce digital objects. The first project to enter the NFT market is CryptoKitties, which represents digital kittens through NFTs. The introduction of the NFT token class can also be used for the tokenization of assets, digital identities, and much more. Let's take a look at some of the more popular use cases:
Physical and digital collectibles
As seen in CryptoKitties, NFTs are used to create an entirely new class of collectibles - it's now possible to buy the tokenized version of a favorite sports star or celebrity. They are also helping traditional collectors' to tokenize their items, such as stamps, coins, and baseball cards.
A platform that can facilitate the tokenization of physical or digital accessories is INFINITE by SUKU. The platform uses Hedera Token Services to create non-fungible tokens and provides a digital identity into physical tags, which a product owner can hold or transfer.
Blockchain and DLT games are dominating the NFT market, with in-game collectibles forming the primary use for the tokens. Collectibles have gained tremendous traction through games like Fortnite, even though they're not using underlying technology. With the help of standards like ERC-1155 — native tokens can be used on the platform and taken advantage of for their utility in-game. Some games have upgraded their infrastructure for the DLT era.
For example, TopShot allows anyone to buy digital trading card packs and trade "cards" that live on the DLT as NFTs in an online marketplace. These platforms enable users to buy, sell, and pit against each other in virtual matches using NFTs and FIAT or cryptocurrencies.
The virtual land sphere is specifically well represented with Decentraland, The Sandbox, and others, all providing virtual land to gamers. Landowners can rent out these virtual plots in the game to advertisers while still retaining land ownership. Weapons, skins, and other in-game objects may also become collectibles over time.
Digital or physical art
NFTs allow for fractionalizing ownership. A valuable item that otherwise wasn't accessible for someone to own has become democratized and available for anyone to own a small piece. Storing a physical item still requires a trustworthy intermediary — but being able to issue, trade, and hold a physical item, as a crypto-asset with immediate liquidity, unlocks use cases and markets never before possible. Several platforms are creating, collecting, and digital trading art on a DLT.
TOKO by DLA Piper makes it possible for art owners to sell their work through NFTs. The technology that underpins TOKO, the Hedera Token Service makes these pieces immutable and hence collectible, while the token represents the work.
Social tokens are a broad category of tokens issued by communities and individuals to represent ownership in building an organization or an individual's success. The term "social tokens" can encompass community tokens, personal tokens, fan tokens, and creator tokens. For instance, Reuben Bramanathan, previously of Coinbase, tokenized his time where one token represented one hour of his time.
An excellent example of a social token is Calaxy, a DLT-based app for both influencers and creators to sell digital tokens. Additionally, users can use these tokens to redeem multiple interactions like speculating on future token value or for producing dividends.
Another emerging asset class of NFTs is blockchain domains, including their licensing and distribution. They are essentially easy-to-read replacements for long digital wallet addresses, which can also behave as payment gateways.
Anyone running a website can purchase a blockchain domain and provide it publicly to receive cryptocurrency payments. These domains can be bought and sold like other assets, thereby enabling a marketplace of buyers and sellers. The two big names in this emerging space are Unstoppable Domains and Ethereum Name Service.
Identification and certification
NFTs can contain unique information programmed into them about a good or asset; this configurability makes them ideal for issuing identities, certificates, or licenses and qualifications. A unique document or certification issued on the blockchain as an NFT can be traced back to the source to ensure its authenticity. Regarding identification, NFTs may be used to make medical history, personal profile, education, and other identity attributes digital and placed in the hands of the individual, thereby giving someone complete control over their data.
The future of non-fungible tokens (NFTs)
The possibilities of non-fungible assets are endless. Beyond in-game collectibles or funky digital art — NFTs have the potential to represent real-world property, a person's qualifications, or any unique and valuable asset. NFTs enable these physical and digital objects to be configured, issued, stored, shared, bought, and sold on a device in the palm of our hand.
Though NFT is the latest buzzword in the DLT space, it's still in its infancy. The exorbitant price of certain NFTs we're seeing sold today isn't justifiable, except that the concept is new to the market. The entire ecosystem is transforming — from gaming and CryptoKitties to decentralized finance, fine art, digital identity, and many other use cases which NFTs can enable.