What is an NFT? A Beginner’s Guide to Non-Fungible Tokens

Apes, Monkeys, Punks ... What the HECK is all of that?

This is a beginner's guide to Non-Fungible Tokens (NFTs) in 2023

So if you want to learn:

1. What an NFT is

2. How do NFTs work

3. Types of NFTs, pros & cons + lots more

Let's dive right in.

CONTENTS:

  1. What is an NFT Summary
  2. Understanding Non-fungible Tokens (NFTs)
  3. NFTs Pros and Cons
  4. FAQs


1. What is an NFT Summary

Non-Fungible Tokens (NFTs) are the latest and most confusing development in cryptocurrencies. It all started in 1993 with Hal Finney’s vision of trading “crypto trading cards.” However, the first applications didn’t come until Yoni Asia, Meni Rosenfeld developed the idea of “colored coins” to represent unique assets or NFTs such as bonds, shares, smart property, coupons, subscriptions, digital collectibles, etc on the Bitcoin Blockchain. Ethereum and its smart contracts have largely supplanted the use of “colored coins.”

In 2014, Kevin McCoy, a digital artist, minted the first-known NFT, Quantum. 

But, what is an NFT? Before understanding what it is, we must first understand the difference between fungibility and non-fungibility. 

  • Fungibility: Fungibility refers to something that can be exchanged for something of equal value. A 5 euro banknote, for example, can be exchanged for another 5 euro bill. 1 Ether can be traded for another 1 Ether. Fungible tokens are interchangeable.  
  • Non-Fungibility: Imagine a 5 euro banknote with a unique serial number on the back for which collectors are willing to pay $1000. That unique 5 euro note is worth more than a regular 5 euro note. Non-fungible tokens (NFTs) are unique and not interchangeable. 

A Non-fungible token (NFT) is is a type of cryptocurrency or token that is used to represent a unique item (e.g., art, music, domain names, in-game items, real estate, etc) and cannot be replaced or exchanged for something else (not interchangeable). They are tokens with unique identifiers that are kept on the Blockchain.

Ok got it, but How do NFTs work? Let’s say we want to mint (create) a Mona Lisa NFT. These are the steps: 

  • STEP 1: Select our digital artwork, The Mona Lisa by Leonardo da Vinci. 
  • STEP 2: Choose a Blockchain and compatible NFT marketplace to mint (create and upload) our NFT.
  • STEP 3: Mint (upload to the Blockchain) our NFT using a smart contract (terms of the agreement). 
  • STEP 4: Our NFT is stored and confirmed on the blockchain
  • STEP 5 (optional): Trade our NFT on a specialized NFT exchange

NFTs come in a variety of types. Intangible NFTs such as one-of-ones (like digital art, domain names, or identities), collectibles/trading cards (art, sports, and gaming), social/community NFTs (music, events, social media communities), and Tangible NFTs (real estate or cars).

NFTs are the most recent development in cryptocurrency and web 3.0 technology. Bitcoin decentralizes money, while Ethereum establishes the foundation for a new financial system, decentralized finance (DeFi). The next phase is to build a decentralized society, which NFTs enable. NFTs redistribute power away from intermediaries and back to artists, inventors, and innovators.

Some of the advantages of NFTs include returning power to artists, marketplace efficiency, anti-fraud solution, value growth, and the opportunity to create new revenue streams for both artists and users

However, there are also drawbacks to using NFTs, such as their illiquidity and volatility, lack of regulation, carbon footprint, the fact that using them incorrectly might perpetuate fraud, and their uncertain and questionable value.

In 2021 NFTs volume exploded  by + 42,988% reaching $13 Billion in sales. Whether hyped or not, NFTs are here to stay and are already opening previously unimaginable doors for artists and innovators all over the world.

If you want to learn more, keep on reading!


2. Understanding NFTs

This section will explain the origins of NFTs, as well as how they work and what applications they can be used for. 

A Brief History of NFTs

Non-fungible tokens (NFTs) are now associated with Ethereum, however, the concept extends back further. The first NFTs ran on the Bitcoin Blockchain.

Hal Finney (1993): Hal Finney, a cypherpunk known for receiving the first Bitcoin transaction from Satoshi Nakamoto and building the first practical “cryptocurrency prototype”, Reusable Proofs of Work (RPoW) so a proof-of-work (PoW) token like Hashcash could be reused, envisioned the concept of NFT over 30 years before. 

In 1993, On the cypherpunk web service CompuServe, Hal Finney posted an email with the subject “Crypto trading cards.” He described an intriguing way of exchanging digital cash using unique “cryptographic trading cards.” These cryptographic trading cards will be referred to as NFTs in the future.

Bitcoin (2009): An NFT cannot be understood without Bitcoin. In 2009, an anonymous developer called Satoshi Nakamoto published the Bitcoin whitepaper, titled “Bitcoin: A Peer-to-Peer Electronic Cash System.”

Satoshi invented the first cryptocurrency, which enables money to be transferred over the internet using the Blockchain, a new groundbreaking technology (digital ledger), rather than a third party. 

Colored Coins (2012): In 2012, Yoni Assia (CEO of eToro) presented the concept of “colored bitcoins or coins” on his personal blog. A year later it was formalized with the help of mathematician Meni Rosenfeld in  “Overview of Colored Coins” and expanded in another paper named  “Colored Coins – BitcoinX” written by Yoni Assia, Vitalik Buterin, Lior Hakim, and Meni Rosenfeld.

In layman’s terms, the Bitcoin programming language (Script), despite its limitations, allows for the storage of small amounts of metadata on the blockchain, which can be used to represent (color transactions) assets such as bonds, shares, smart property, coupons, subscriptions, digital collectibles, and so on. In other words, it can be used to represent unique assets or NFTs. Colored coins have become a thing of the past; instead, smart contracts are used to mint (create) NFTs. 

Quantum (2014): In 2014, Kevin McCoy, a digital artist, minted the first-known NFT on the NameCoin blockchain (the first altcoin ever created). “Quantum” was the name given to the NFT. Quantum is a hypnotic pixelated octagon filled with different shapes. Quantum art piece sold for over $1.4 million at a Sotheby Auction in June 2021. 

Counterparty (2014 – 2017): Counterparty, a peer-to-peer financial platform built on top of the Bitcoin blockchain, was founded in 2014. Counterparty allows the creation and exchange (DEX) of digital assets. It is one of the most popular “Bitcoin 2.0” platforms.

Spells of Genesis (2015): Counterparty collaborated with Spells of Genesis game producers in 2015 to issue the first in-game assets on a Blockchain. With the development of their in-game currency, BitCrystals, they were the first to launch an ICO. This marked the start of NFT or Blockchain gaming.

Trading Cards (2016): In 2016, Counterparty partnered with a popular trading card game, Force of Will, which was the fourth most popular card game in the United States, trailing only Pokemon, Yu-Gi-Oh, and Magic. It was the first time that such assets were stored on a blockchain.

Rare Pepes (2016): Rare Pepes, a type of meme featuring a frog character marked the start of NFT memes, tokens made solely for amusement, but with a sizable fanbase. Counterparty was the platform of choice until Ethereum gained relevance in 2017.

Ethereum (2017): In 2013, programmer Vitalik Buterin published the Ethereum whitepaper. Ethereum went live in 2015 but did not acquire popularity until 2017. Ethereum is a “world computer” or Do It Yourself platform that allows anybody to build smart contracts and combine them to create decentralized apps (dApps) or services without the need for a centralized authority. Ethereum allows minting (create) NFTs with smart contracts (code). 

In 2017, a Counterparty analog was announced as a “decentralized meme marketplace and trading card game (TCG)” that allowed anyone to create memes that would live on the Ethereum blockchain. Pepes and other memes found a home on Ethereum.

Cryptopunks (2017): In June 2017, John Watkinson and Matt Hall started a project called cryptopunks in commemoration of the 1990 crypto cypherpunk movement, which laid the framework for cryptocurrencies. Cryptopunks are unique (no two are the same) and limited (10,000) characters generated on the Ethereum blockchain. Cryptopunks are one of the most popular NFTs in the space, selling for millions of dollars due to their historical value and scarcity. 

CryptoKitties (2017-2018): In 2017, Axiom Zen, a Vancouver-based firm, launched a blockchain-based virtual game in the midst of the world’s largest Ethereum Hackathon, ETH Waterloo Hackathon. Cryptokittes enable the adoption, breeding, and trading of virtual cats. Following the Waterloo Hackathon, Cryptokitties got so popular that it even collapsed, slowing down the Ethereum network. Some virtual cats sold for more than $100,000. 

OpenSea (2017): The world’s first and largest (currently) NFT marketplace was also established in 2017. OpenSea is an NFT platform that offers secure NFT trading, minting (creation), and auction services. Its founders, David Finzer and Alex Atallah became billionaires in early January 2022. OpenSea is a “centralized NFT exchange.” Other NFT exchanges include SuperRare, Mintable, and Portion.

Decentraland (2017): In 2017, the first Ethereum-based decentralized VR (Virtual Reality) game was launched. Decentraland bridges the gap between real and virtual worlds. Decentraland uses a 3D universe called LAND, in which you may play games, purchase, and trade real estate, and other digital assets using Decentraland’s cryptocurrency, MANA.

Decentraland (MANA) sparked a wave of NFT gaming and metaverse projects such as Enjin Coin (ENJ), which allows developers to tokenize in-game items, and Axie Infinity (AXS), which, in addition to the above, introduces a “pay-to-play-to-earn” model in which participants pay the starting costs and can earn cryptocurrency and NFTs by playing. These projects become well-known in the 2021 NFT explosion. 

Rarible (2020): One of the first “decentralized NFT exchanges” was established in 2020. Rarible, unlike other centralized NFT exchanges like as OpenSea, has its own native token (RARI) that it uses for self-governance. RARI holders have the ability to vote on policy changes and other important issues. Rarible’s goal is to eliminate all reliance on third parties while offering the same services as OpenSea. 

The NFT Explosion (2021 – Present)

2021 was the year when NFTs became popular. Solana, Cardano, Tezos, Flow, Binance Smart Chain, WAX, Algorand, and more blockchains began to enter the game with their own NFT standards. Companies such as Facebook even changed their name to META in order to be associated with the Metaverse.

We are in for some exciting times ahead of us!

What is a Non-Fungible Token (NFT)? 

The first thing we need to understand is the difference between fungibility and non-fungibility. 

Fungibility refers to something that can be replaced for something else of equal value. For example, a ten-euro note can be exchanged for any other genuine ten-euro note because they are virtually indistinguishable from one another, implying that both ten-euro notes are fungible. Fungibility is an important feature of money since it allows it to act as a medium of exchange. 

In a blockchain, fungible tokens are any interchangeable cryptocurrencies such as Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC), etc. 

Assume now that good fortune hands you a rare €5 banknote with a peculiar serial number ending in 555. These 5 euro bills are selling for more than €1,000, with one current transaction receiving offers totaling €6,500. Collectors are willing to pay a hefty price to get their hands on unique items. In other words, in non-fungible items

So, What is a Non-Fungible Token (NFT)?

In a blockchain, a non-fungible token (NFT) is a type of cryptocurrency or token that is used to represent a unique item (e.g., art, music, domain names, in-game items, real estate, etc) and cannot be replaced or exchanged for something else (not interchangeable). In other words, non-fungible. NFTs are linked to the digital assets (digital data) that they are meant to represent and act as “digital certificates of authenticity” or proof of ownership. 

Essentially, non-fungible tokens are digital assets similar to Ethereum, with the exception that each unit of data saved and confirmed on the blockchain is assigned a unique identification (ID). Think about them as pieces of data that are “marked” or “colored” to distinguish them from one another. 

Note: Tokens are used to represent fungible tangible assets (such as a dollar note or gold), fungible intangible assets (such as Bitcoin or Ethereum), non-fungible tangible assets (such as real estate, cars, real-world paintings), and non-fungible intangible assets (e.g., copyrights, digital art, in-game items).

How do NFTs work?

The best way to illustrate it is to use an example. Let’s assume we want to mint (create) an NFT token to represent a piece of art, The Mona Lisa by Leonardo da Vinci. 

Note: We’ve assumed that both digital art and NFT are stored on the same blockchain.

STEP 1: Select a digital art piece (e.g., image, video, tweet, ebook, song) or a digital version of a physical artwork. In our case, it is a digital version of a physical art piece, The Mona Lisa, which exists in the real world.

STEP 2: Choose a Blockchain to mint (create and upload) our NFT. You can, for example, select “centralized NFT exchanges” like OpenSea on Ethereum or Binance NFT Marketplace on the Binance Smart Chain (BSC). You could, on the other side, use “decentralized NFT exchanges” like Rarible.

STEP 3: Mint our NFT. The majority of the platforms listed in Step 2 provide simple mechanisms for minting NFTs. An NFT is minted on a blockchain (imagine your artwork being uploaded to the blockchain) and the details of the deal are stated in a smart contract. The “mint function” checks to see if the NFT already exists. If this is the case, an error message occurs. Otherwise, the NFT is minted. 

NFTs are defined and created (referred to as “minted” in NFT parlance) by a smart contract, which is just a piece of code that lives on a blockchain like Ethereum. NFT Smart contract standards, such as ERC-721 on Ethereum or BEP-721 on the Binance Smart Chain (BSC), define the rules for creating and “interacting” with non-fungible tokens.

STEP 4: Our NFT is stored on a blockchain, such as Ethereum, which keeps a permanent record of all changes and actions over time. Blockchains are essentially “state machines” that keep track of transitions (changes) and use a consensus mechanism such as proof-of-work (PoW) or proof-of-stake (PoS) to agree on the network’s global state.

Since NFTs are uploaded on the Blockchain, they are decentralized (stored on a network of computers), immutable (cannot be changed once committed), and open (anyone can see their history) to everyone. 

NFTs with their unique hash (ID) and descriptions can be traced and certified using a blockchain, making it simple to determine whether it is genuine or counterfeit at no cost, because data on a blockchain can never be modified or destroyed. This appears to be the ultimate anti-fraud solution. NFTs act as “digital authentication certificates.”

Although NFTs are always stored on the blockchain, the art (digital version) must be correctly attached (linked) to the NFT. The artwork can be stored in three ways:

  • Digital Art and NFT Token live on the same blockchain. Most secure
  • Token and Art are stored in separate blockchains or on a decentralized storage system (such as IPFS, Arweave, etc). Medium security
  • Token lives on the blockchain and Art lives off-chain (on a private or centralized server). Less secure

STEP 5 (Optional): Trade NFTs. If you like, you can buy an NFT or sell the one you already own. NFTs are tradable assets that can be bought or sold in specialized NFT marketplaces such as OpenSea, Nifty Gateway, or Rarible. Similar to Centralized Exchanges (CEX), you must fund your account for centralized NFT exchanges or connect your wallet for decentralized NFT exchanges.

After you fund your account or wallet, you can buy or bid on various NFTs in the marketplace. Keep in mind that the scarcity of NFTs makes them extremely illiquid.

Note: Here's where it gets tricky: suppose we create a Mona Lisa collection of only ten limited and exclusive Mona Lisa NFTs. If we decide to sell our NFTs as artists, we are not selling the rights to mint fresh Mona Lisa NFTs. Artists own the rights to their work at all times. Just like any rare item, collectors have “bragging rights.”

“The underlying thing that you’re buying is code that manifests as images,”

Donna Redel – crypto-digital assets Fordham Law School

Types of NFTs

Let us investigate the various types of NFTs that can be found.

INTANGIBLE – Art, Identity, media & entertainment, etc. 

1/1s (“one-of-ones”): These are unique NFTs with only one edition available. There is just one original Mona Lisa and one original Guernica. The quality of the art, the artist’s prestige, and the judgments of other experienced collectors all play a role in these works. Domain names and identity names, such as licenses, copyrights, and certificates with your name printed on them, are also included in this category.

  • Digital Art: This is art created by 1/1 artists such as Beeple who sold a collage for $69M, XCopy, Coldie, Hackatao, and Motionscape (who made an Odyssey NFT). 
  • Domain Names: NFT domains such as Unstoppable Domains allow anybody to own a unique domain name and build decentralized digital identities without the need for third parties. 
  • Identity: For instance, the Goldfinch community created Unique identity (UID), an NFT for identity or KYC (know your customer) purposes. Other uses include ID cards or legal identity documents for refugees, as well as unique licenses, medical records, academic credentials and certifications.

Collectibles/Trading Cards: Probably the most popular NFTs. Collectibles are NFTs with multiple limited editions and categories such as sports (e.g., baseball cards), memes (e.g., cryptokitties), music, clips, and games. Basically, anything you can collect. 

  • Art Collectibles: These are artworks with more than one edition available. Paintings, photographs, memes, tweets, and even doodles. 

    • Generative Art: These are collectibles created by an algorithm with artistic input from the Artist. Examples include CryptoKitties, Axie, AutoGlyphs, ChainFaces, and HashMasks
    • Profile Pictures (PFPs): Profile picture NFTs are often used to represent avatars, profile images, twitter banners and access PFP communities. Examples include CryptoPunks and Bored Ape Yacht Club
    • Memes: Memes include a wide range of topics, from cats to dogs to Elon Musk and other amusing web memes that become popular. Memes are intended to be funny. Examples include Doge, Success kid, Bad Luck Brian, etc. 
    • Social Media: Twitter CEO Jack Dorsey sold his first-ever tweet,“just setting up my twttr,” for $2.9M to Bridge Oracle CEO Sina Estavi. 
    • Trading Card Games: streetfighter.cards are trading cards from the popular video game Street Fighter. 
  • Sports Collectibles: Sports collectibles representing sports teams, soccer players (such as Sorare), video clips and moments (such as NBA Top Shots),etc.
  • Game & Metaverse Collectibles: Game collectibles have existed since the ’80s. In Super Mario Bros., for example, collecting 100 gold coins earned you an extra life. The only change today is that collected items (such as rings, gems, weapons, avatar clothing, packages, and other accessories) are NFTs that live on the blockchain

    • In-game NFTs: In-game NFTs are items such as weapons, avatars, clothing,and accessories that have several applications in the game. These things are available for exchange with other players. CryptoKitties is a game that relies solely on the collectibility of in-game NFTs.
    • Play-to-Earn NFT games: In play-to-earn NFT games, players are rewarded with tokens and, on occasion, NFTs, earning more the longer they play. Games like Axie Infinity have proven immensely popular for giving consistent income to low-income countries like the Philippines.
    • Digital (Metaverse) Real Estate: The Metaverse is simply avatars in virtual world simulations (such as the Matrix) interacting and creating things in the same way that they would in the actual world. In those worlds, you can buy and sell real estate, among other things. Decentraland was the first decentralized VR game. 

Social/Community NFTs: 

  • Music NFTs: Musicians can use “Music NFTs” to fund their work and share their profits with their followers, boosting community engagement. Examples include Royal
  • Event Tickets: Event tickets for concerts, conferences, and other gatherings can also be tokenized. Examples include Oveit
  • Social Media Communities: Collab.Land is a new wave of social tokens, which checks the balance of an Ethereum wallet before joining a Telegram or Discord group. 

Fashion, Design, Legal, DeFi (Loans), and even Working Time are some of the other applications. Almost everything can be tokenized. 

TANGIBLE – Real-World Assets

NFT Cambric Explosion

2021 was the year of NFTs. According to some experts, the “NFT mania” is reminiscent of the 2017 ICO frenzy. According to the Block, NFT volume exploded by + 42,988% in one year. In 2021, NFT sales reached $13 billion. 


3. NFTs Pros and Cons

NFTs are the most recent development in cryptocurrency and web 3.0 technology. Bitcoin sparked the revolution by decentralizing money, while Ethereum enabled the formation of decentralized finance (DeFi) and laid the groundwork for a new financial system. NFTs go beyond that, enabling the creation of a totally decentralized digital society. NFTs return power to artists, which is now held by intermediaries.

NFTs, on the other hand, are a brand-new technology with significant obstacles ahead. Here are the Pros and Cons of this nascent technology.

PROSCONS
Return the power back to artists: The art world is rife with intermediaries who take a large cut of the artist’s revenues. Some third parties or agents even have power over artists and tell them what they should and should not do. Most artists in this world don’t own their work. Thanks to NFTs, artists, and creators regain their most valuable assets, freedom, and ownership of their work.NFTs are illiquid and volatile: The NFT market is still in its early stages, and NFTs are not well understood. Even while the number of exchanges and buyers and sellers is growing, when compared to the whole cryptocurrency industry, there aren’t many. As a result, NFT can be difficult to trade and prices can be quite volatile.
Marketplace Efficiency: NFTs generate efficiency with smart contracts by streamlining processes and eliminating intermediaries. This is especially true in traditional industries like real estate. NFTs are new and unregulated: NFTs are not regulated, and numerous “scam artists” and hackers take advantage of the situation. NFT scammers typically deceive users into “opening their wallets (connecting them to suspicious sites)” in order to steal their funds or NFTs
Anti-fraud solution: Global counterfeiting costs luxury brands and art dealers billions of dollars. Blockchain and NFT technologies give immutable proof of ownership in the form of a digital certificate that everyone can trace back to its original source. This eliminates counterfeiting and forgeriesNFTs carbon footprint: This is a general problem for Blockchains that use the proof-of-work (PoW) consensus mechanism. Minting NFTs are energy-intensive for proof-of-work (PoW) blockchains. Ethereum 2.0 is transitioning to Proof-of-Stake (PoS) to solve that problem.
Value Growth: Due to the scarcity of these rare items, the potential for an increase in the value of your investment is enormous (this might change in the future though). For example, CryptoPunk #3100 was first sold for $2127 in 2017, and it was later sold for $7.67 million in 2021.NFTs can be used to perpetuate fraud: Some artists have alleged that an NFT portraying their work was minted without their consent. This is risky since the Blockchain keeps permanent records and the fraud can be perpetuated forever.
Create new revenue streams for both artists and users: Artists and creators now can create new revenue streams, share their profits with their community and increase engagement. Play-to-earn NFT games, on the other hand, can provide users from low-income (and not-so-low-income) nations with a consistent income that exceeds the average country wage.Uncertain and questionable value: The year 2021 was the “NFT mania,” with jpg photos selling for millions of dollars. Some experts are skeptical of the NFTs’ exorbitant price and value.


4. FAQs 

But why buy an NFT when you can easily “right-click save as” a digital asset?

This is a popular skeptic’s question. You may even photograph the Mona Lisa or download a copy of Picasso’s Guernica. However, this does not make you the proud owner of multi-million-dollar artworks. 

Art collectors value the original piece and those are as valuable as the market makes it. Owning the real thing will always be more valuable than not. 

Aside from signaling status, you might buy an NFT because you enjoy the art, want to make a profit, support a cause or artist, or want to join a community. The opportunities are endless. 

Photo of author

AUTHOR

Marc Arbonés
Marc is a millennial economist, systems thinker, crypto investor (since 2017), crypto writer, and peak performance consultant. He is the Editor and Founder of Altcoins Mastery, where he supports creators and investors in capitalizing on a "fairer" financial system powered by Crypto, DeFi, and web 3.0.