Non-fungible token (NFT)

A non-fungible token (NFT) is a specialized type of cryptographic token representing something unique, like a domain name, a limited-time skin for a video game, or other digital properties owned by a user. Therefore, the NFTs are not mutually interchangeable, meaning an individual might trade ownership of a domain name for ownership of a rare character skin or a cryptocurrency. NFTs differ from cryptocurrency; NFTs are entirely non-fungible, and they cannot be traded for something identical. Cryptocurrency is fungible and is exchanged for something that is of equal or identical value.

NFTs are used to create digital ownership and scarcity. They develop a possibility of interoperability across multiple platforms through blockchain, which acts as the management layer of NFT. Blockchain allows the exchange of an item from one party to another and enables the NFTs to be displayed in various eBay-style marketplaces. NFTs are used in specific applications to acquire unique or rare digital items like crypto-art, crypto-collectibles, and crypto-gaming.

CryptoPunks by LarvaLabs and traded on Ethereum

Blockchain had early use in the art industry, allowing individuals to own digital intellectual property with records stored in the digital blockchain roster. NFTs are used to prove ownership and authenticity of digital art. In June of 2017, a company called Larva Labs released an art collector line called CryptoPunks. The “Punks” were available free of cost for anyone with an Ethereum wallet. Only 10,000 Punks were developed, no two alike, and all were quickly claimed. Ethereum wallet holders may now sell or trade punks for Ethereum. The average punk sold for approximately 4.12E, which equated to $2,998 on December 29, 2020. CryptoPunks are just one example of rare digital art.

Blockchain games also use NFTs; for example, CryptoKitties, a game developed by a Canadian company called Axiom Zen, allows users to use the Ethereum blockchain to represent in-game assets controlled by the user instead of the developer. In-game assets for CryptoKitties can be traded in third-party marketplaces requiring no added permissions from the developer.

Interest in non-fungible tokens has grown, especially with the relative book of crypto-collectibles and NFT art. The popularity of these two uses of NFTs has caused some to view them as the only use case of this technology. However there are various other use cases for NFTs—and as NFTs see increased adoption, new and previously unconsidered use cases will emerge.

By far one of the most associated uses for NFTs is in digital art. NFTs can be used to make one-of-a-kind digital art items with unique and exclusive properties. Minting an NFT to represent art allows an artist to provide the consumer with proof that the NFT-based art file is the only one that exists. This provides the art NFT a level of rarity and uniqueness due to blockchain's immutability, and enables artists to get a cut of the secondary sale of digital art, as this kind of secondary royalty can be programmed as code into the NFT to send back a percentage to the original artist.

Not dissimilar to NFT art, collectible NFTs have been another popular use of NFTs. These make up a significant portion of sales on NFT marketplaces, and there can at times be large crossover between a collectible NFT and NFT art, especially as one can be both. This use case has seen NFT collectibles that include NBA trading cards, a Binance Anniversary NFT, and Jack Dorsey's first tweet.

The gaming industry stands to benefit from NFTs, as they can be used to create non-duplicable, in-game items to give gamers a form of ownership similar to character "skins" and "lootboxes" but with an emphasis on one-of-one, which could drive players to collect. This has already been done in some games, such as Axie Infinity, where users mint little creatures as NFTs that can be sold on an in-game market. In other games, this could see players earn non-fungible, virtual, in-game coins that could be used to make in-game purchases, such as of NFT objects and uses, or in some suggested cases, even be used to "cash out" or trade on a cryptocurrency or in-game market.

Luxury clothing brands have begun to enter the NFT space. This has included physical assets such as retail clothing and related accessories with digital companions as NFTs that are able to merge real-world with digital-world technology, and with increased use of augmented reality with physical couture could provide a new way of experiencing clothes with digital apparel. And in online or "metaverse" applications, a clothing NFT could be used similar to a character skin in games.

For events, such as sports events or a concert, NFTs could be used to represent tickets, ensuring every attendee has original access and stopping any reproduction of tickets. Furthermore, in the case of a resale of an NFT ticket, the data on the NFT can update to represent the new owner.

In the real estate industry, there is the potential for physical land or property to be represented on a blockchain as an NFT. This means a digital token can have all sorts of attributes, such as location, price, and measurement, which due to the blockchain, would be impossible to tamper with. Furthermore, this could allow landlords or property owners to fragment their ownership of a specified property in order to sell parts, either for short-term capital, or else to allow members of an apartment or condo building to own part of the building and vote on changes in the building as a community. This could also be used to sell digital real estate, especially in virtual reality or the metaverse.

In a decentralized finance (DeFi) scenario, NFTs can also provide financial benefits, as their value can be derived from their utility. For example, JustLiquidity created an NFT staking model, in which a user is able to stake a pair of tokens in a pool for a certain period, and can receive an NFT to access the next pool, which creates a secondary market for these NFTs based on the access they provide. Similarly, BakerySwap's NFT food combos provide increased staking rewards for holdings. By contributing, users receive an NFT that provides a variable amount of staking power which can be sold on the secondary market.

Similar to other collectibles that can be minted as an NFT, users can attach a video or audio file to an NFT to create a collectible piece of music, similar to a digital "first edition" of a record. Besides this similar use case as art NFTs, musicians could use NFTs to get a fair share of royalties, either through blockchain-based streaming platforms or blockchain royalty tracking. Another option is working to get a platform to sell royalties and stream music. This could also be used to divorce artists from streaming services and give artists a chance to have users stream their music and pay the artist directly.

Real-world assets could be linked to NFTs to digitize the way people prove ownership. Similar to real estate, where physical property deeds are used, these could be digitized creating tokenized digital assets of these deeds. This use case has not seen as much support from regulators, but is an expected or possible development given other noted and expected applications of NFTs. It could be used for small items such as jewelry, in which an NFT can provide legitimate ownership, similar to the certificate of authenticity that comes with a genuine diamond. And in this case, the certificate would be an NFT.

Blockchain technology, and by extension NFTs, can be useful for logistics, mainly because of its immutability and transparency. It can be used to ensure supply chain data remains authentic and reliable. With essential commodities and perishable goods, it can be important to know the details related to the goods and how long they can remain usable. An NFT can also represent unique items and could contain meta-data, such as the product's origin, journey, and warehouse location. One problem with the ways that have been proposed to use NFTs on a supply chain is that they require each stage to use the same infrastructure, or for different infrastructures to be interoperable.

Similar to its proposed uses in other forms of ownership, and especially with blockchain domain systems, owners can control the domains using private keys. Domain name NFTs enable easy trading and customizable domain names. This can also reduce the centralization in domain name registry and decentralize the ownership and registration.

NFTs have been proposed as a possible solution for personal identity management. They contain unique information stored in their tokens, which can be used for documenting degrees, certificates, medical records, and qualifications, which can be issued over the blockchain as an NFT and traced back to the owner.

With the metaverse, and in other virtual lands, NFTs can be used to own part of the land or metaverse, similar to applications in gaming. Further, the metaverse offers a place where NFTs could be stored and appreciated. And it offers a chance for users to build digital real estate portfolios, including building a virtual office building, which could be rented out. And these properties can be bought and sold on virtual markets much like property is done regularly.

There are various standards for non-fungible tokens, and the standards are what make NFTs valuable to consumers. Standards give developers a guarantee that the non-fungible assets will behave in a particular way and describe exactly how they will interact with the basic functionality of the specific asset.

The ERC-721 is a standard developed by the CryptoKitties developer, Axiom Zen, and was also the first standard that represented non-fungible assets. The ERC-721 standard is an inheritable Solidity smart contract, which means other developers can use the ERC-721 to create and develop new compliant contracts that fit their assets using the import tool from the OpenZepplin library. ERC-721 provides permissions to transfer non-fungible assets from one party to another and provides an identifier for that asset’s present owner.

ERC-721 transfer codes and owner0f operations

Example of an ERC-1155 token contract

Enjin developed the ERC-1155 standard. It is used primarily in selling classes of assets, meaning if a user has a wallet with 500 shields in it, the user may sell off all 500 shields at once instead of selling them individually. By allowing the sale of an entire class of items, ERC-1155 provides an increased efficiency from the ERC-721 standard, where each item has a unique identifier, even if the item is a duplicate. The downside to ERC-1155 is a loss of information. Due to the bulk sale of items, the history of ownership from one party to the next cannot be tracked for individual shields.

Composables are developing out of the ERC-998 standard and provide a template for NFTs to own both non-fungible and fungible assets.

NFT1 was introduced to the Bitcoin Cash blockchain in 2019 as a part of the Simple Ledger Protocol (SLP), which can be used to support NFTs by minting non-divisible token supply of one without a minting baton called a Simple NFT. The specification code in Bitcoin Cash allows the grouping of many NFTs together.

While cryptocurrencies took nearly a decade to be noticed in the mainstream, NFTs only needed a couple of years, with brands such as Budweiser, Visa, and Adidas entering the space and bringing some of the attention towards the market. While much of the market and valuation of NFTs is driven by scarcity and subjective aesthetic preferences, other factors, such as historical significance or the blockchain they are hosted on, can impact the value of the NFT. Many NFTs are traded in collections, which are sets that, in most cases, share common features. These can include sets of collectible cards, art pieces, virtual spaces, or items in games.

Graphic visualization of the top 5 NFT collections (by number of assets) organized by categories.

In terms of minting and hosting NFTs, users have to choose which blockchain to host them on. Ethereum has been the largest and most used by market cap and transaction volume, with the blockchain intending to transition to a proof-of-stake method to reduce energy usage and possibly reduce fees of the blockchain. These fees can vary between $30 to $80 for transactions and around $130 for minting. This has seen many users explore other blockchains to mint NFTs, although some secondary markets can help cover a portion of fees.

Secondary sales of NFTs are a large part of the market of NFTs. Originally, when Cryptokitties emerged in 2017, the secondary sale prices were typically lower than the price of initial sale. In 2021, the secondary sale prices had gone up, above initial sale prices, due to an increase in potential customers and interest. The marketplaces can allow users to mint, buy, and sell NFTs, with OpenSea emerging as a leader in secondary markets. This platform allows anyone to mint and offer an NFT for sale. However, other platforms limit the NFTs on offer and the users able to mint and sell, resulting in a curated marketplace. Depending on the marketplace, the NFTs capable of being hosted can depend on the blockchain.

Graphic representation of secondary sale prices of top collection in terms of number of sales. The colors refer to change in price.

In Q3 of 2021, the NFT market saw new highs as demand grew over the entirety of 2021. For instance, the number of wallets that interacted with an NFT smart contract increased from 203,719 active wallets in Q2 of 2021 to 412,578 in Q3. Furthermore, NFT buyers increased by 166 percent from 97,658 in Q2 to 260,489 in Q3, and sellers increased from 40,056 to 122,910. In monetary terms, the amount of US dollars exchanged for NFTs in Q2 was $782 million, which rose in Q3 to $5.9 billion. Despite this, the largest market segment of NFTs remained collectibles, representing around 76 percent of the market.

Breakdown of the NFT market landscape for Q3 of 2021.

With the increase of money in the NFT market came an increase in companies and startups earning revenues and growing; although despite the size of the market, it remained top-heavy, with CryptoPunks and Bored Ape Yacht Club maintaining the majority of the market in the collectibles segment.

The controversy around NFTs developed due to the rising energy use associated with blockchain activities and transactions. Academic studies and reports have been performed and published citing high electricity usage directly associated with the Proof of Work validation processes used in Ethereum and Bitcoin networks. Annual greenhouse gas emissions vary depending on the application and use of renewable energy; however, concerns about emissions directly related to blockchain report the potential of emissions rising to hundreds of megatons, or the equivalent of Sweden's annual emissions. This relates to NFTs, as the Proof of Work process includes NFT transactions.

In response to public concern, Ethereum Foundation committed to moving to a less energy-intensive process called Proof of Stake validation protocol, theorized to use less than 1% of the energy levels currently used to utilize Proof of Work. The Ethereum Foundation predicts the transition to Proof of Stake will be complete by 2022. In the meantime, the Ethereum Foundation offers NFT purchasers the option to donate to carbon offset during each NFT purchase.

The popularity gained by non-fungible tokens has encouraged business entities to create NFT marketplaces and marketplace development programs. This offers new ways for businesses to gain profits in the digital world. Depending on the business, these can be primary markets, where an NFT is sold for the first time, or secondary markets, where NFTs can be resold, depending on the conditions of the NFT.