The Ethereum blockchain has surged in activity in 2020. At a time of a global financial crisis affected by covid, the rise of DeFi (Decentralized Finance) instruments has created alternative financial markets. NFT (Non-Fungible Tokens) have emerged as one of the significant digital asset classes. As the DeFi space continues to make news, NFT has also garnered some attention. It is a part of the DeFi space with total sales reaching $100 Million in July 2020. It's target for 2020 is to reach a market valuation of $300+ Million (from 2019 year end report compiled by NonFungible.com) from $200+ Million in 2019.
Since 2017, NFT have been around in the Ethereum ecosystem. Cryptokitties were an excellent example of the introduction of tokenized digital assets that had a value for trade. During the height of their popularity, they slowed down the Ethereum network and exposed the scalability problem of the blockchain. What made these assets non-fungible is they can come to represent unique assets like collectibles. A real world counterpart of this would be vintage baseball cards or antique coins. In this case you had digital "kittens" which are one of a kind. Now think about a digital version of any collectible item and you have NFT.
NFT are based on the ERC-721 and ERC-1155 token standards on the Ethereum blockchain. These are smart contracts that provide specifications for tokens that will be used for trading within the Ethereum ecosystem. They are much like ERC-20 tokens, but differ in terms of their fungibility. You can exchange any ERC-20 token for another, they are replaceable. A non-fungible asset is irreplaceable and cannot be substituted by a similar asset. A dollar bill can be used for any transaction, and does not require a specific note of tender. That is considered fungible. NFT are unique and cannot be used like an identical item.
The following are features of NFT:
- Unique attributes that cannot be replaced by another asset
- Rare and valuable to own
These are unique digital assets that cannot be substituted with another type. While you can replace a dollar bill with another dollar bill, you cannot do the same with an NFT. If you have an NFT to represent your digital asset, you cannot replace that with another token. Take for example having a "pink haired" cat, if one exists. If your pink haired cat gets stolen, you cannot just replace it with another cat. It is the cat's pink hair that makes it unique from other cats.
These items are also rare. A vintage Willie Mays baseball card is a collectible. It is an item that not many people have, but many people want to have. Gold is perhaps one of the if not the most valuable precious metal on Earth. When an item like gold is rare, it has the additional feature of scarcity. That is what makes it very valuable.
They are also indivisible, meaning you cannot sell a portion of the asset. They must be sold as a whole item. Going back to our baseball card example, you cannot sell 1/4 or half of a baseball card. It can only be sold in its entirety for it to be a collectible. Collectors don't normally buy a piece of an item, they prefer the whole thing.
NFT can provide the following benefits:
- Creates a marketplace for gaming, art and collectibles
- Prevent fraud in the arts and entertainment industry
- Make the purchase of tokenized digital content easier
- Allow anyone ownership of a real world asset from anywhere in the world
- Real estate certificates of ownership
NFT targets digital content creators and artists. This can create new markets for digital art, music and collectible items. Another industry that can benefit from NFT is gaming. Gamers can tokenize their badges, trophies and prizes as proof of their accomplishment. These can be rare items later on that can generate more value, like badges of which only one exists in the world and cannot be replicated.
Keeping track of assets using the blockchain is one way to prevent fraud. This becomes important for creators in the arts and entertainment industry. Using the blockchain, an artist can prove they are the creator of a digital artwork. Since the artwork's ownership will be recorded on the blockchain, it cannot be faked since the original will have a digital certificate as proof of authenticity. A smart contract will also keep track of the ownership of the original digital artwork, making it difficult to tamper or modify.
Tokenization also makes purchasing digital content easier. Take for example tickets to events like concerts. A unique ticket cannot be forged and it becomes proof of attendance. Other digital content besides art work, include poems, stories, photographs, movies, books, scripts and literary items. A writer who wants to take full credit for their work can tokenize their writing with a record on the blockchain with a unique NFT. A photographer can create an NFT to represent their latest photo project available for purchase.
Anyone from anywhere in the world can also own an actual real world asset with NFT. Even if the owner does not have physical access to an asset, their proof of ownership is in the blockchain. A very avid collector who lives outside of the US can purchase an actual work of art that is now their NFT. Normally the transaction includes a certificate to prove authenticity and ownership in paper document format. The problem there is that it can be forged, or the papers could get lost. Now it can be digitized into a token that can be tracked and transferred easily, and the owner can be located anywhere in the world.
Perhaps the role NFT can play in real estate is the most intriguing. While a smart contract has been used in a real estate dealing before, when you can tokenize property using NFT could become a game changer. It could disrupt the real estate industry with a decentralized realty platform that cuts the middlemen in real estate dealings, and allow property owners to directly sell their property using NFT. This would include all the necessary legal documents in the smart contract, making it an automated system for quickly transferring ownership.
ERC-721 And ERC-1155 Standard
ERC-721 introduced a set of standards for token developers of non-fungible assets. This would become the basis for NFT. There are used to identify something or someone in a unique way. These are coded and deployed as smart contracts on the Ethereum blockchain as mentioned earlier. The standard includes the protocol for transferring tokens, balance of account, token supply and the owner of the specific token. All of this covers NFT.
The ERC-1155 is a multi-token standard that allows a smart contract to manage both fungible and non-fungible tokens. Having separate contracts for ERC-20 and ERC-721 tokens can cost more computationally in terms of gas and they use up more bytecode on the network. It is a way to use one contract to manage any type of token on the Ethereum blockchain. In the gaming world, this allows gamers to hold a single smart contract for managing their non-fungible items like "magic scrolls", "armor", "super powers" along with most fungible ERC-20 tokens. It makes ownership of digital assets much simpler and easier for users.
FOMO or HODL
Since NFT have been circulating in the cryptoverse, it is generating plenty of interest. Those who feel they must FOMO in may not really understand what NFT are all about. Perhaps if you are a serious collector, you would consider it to HODL as a valuable investment. To FOMO in and buy NFT with the expectation of an increase in future price value is speculation that may lack education. NFT are not speculative assets, but actual items with value. Will people FOMO in by suddenly buying unique artworks or new cryptokitties?
As a collector, I would not consider it FOMO if someone buys a rare work of art. Perhaps it is a one of a kind that there is only one copy of. Digital is easy to replicate, but the blockchain can help prevent that, so that would make the work of art truly special. Those who do FOMO in may end up with something they don't even need, so they are better off selling. The type of FOMO in NFT is not as chaotic as the rest of the market. NFT, since they are a rarity, has value that can be determined by the current owner of the digital asset.
If you FOMOed in NFT to buy a rare cryptokitten, and you are not a collector, you will have to find a way to sell it. If your intention was to make money, you are going to have to find a buyer who is willing to pay an amount that is more than what you paid for. That gives you a profit, but the problem is if you cannot find a buyer willing to pay. The good thing is that your best chance of selling it is in the open market.
For serious collectors of digital art, music and other content, it is to HODL for sure. Some collectors don't even plan to sell their NFT. There is prestige attached to collectors who own something which only they have. The NFT market and the type of digital assets they represent are still in the early stages. As more assets become tokenized, the market will grow and that is where more value will be created.
While the blockchain is good for verification and tracking, it is not going to enforce physical custody of an asset. Rare real world assets can still be stolen, even its ownership is recorded on the blockchain. You cannot enforce physical security on the blockchain unfortunately. For purely digital assets it is a different story. While the blockchain proves ownership, it can also secure the digital asset by preventing others from copying it. Perhaps only a sophisticated hack, like from a stolen private key, can lead to someone losing their NFT.
Trends tend to create snowball effects, and the hype with DeFi along with NFT will generate excitement as the trend progresses. It will likely never fade and instead become the norm for transactions of all types of digital assets. It seems ideal for art, music, collectibles, virtual items and real world assets including real estate property. The blockchain records and proves ownership, allowing it to be legally binding. The main issue would be enforcing the law for owership of physical items from the blockchain. There needs to be clarity on how ownership on the blockchain can be used to track and secure real world assets.