Ownership is a fundamental principle of web3. NFTs (“non-fungible tokens”) are digital assets supported by smart contracts that connect to a blockchain. Each NFT is unique, which allows code to autonomously apply, track, and transfer digital signatures and verifiable ownership.
With cryptocurrency supporting the economy of web3, NFTs can be thought of as property within this space. Leveraging the immutable nature of a blockchain, NFTs allow anyone to instantly verify authenticity or trace provenance through the history of ownership.
This caffeinated contribution was written by Will Schneller. This artist turned founder, graduated from Iowa State University and is now an Entrepreneur-in-Residence at Drake University. As a curious creator, volunteer organizer for web3dsm, and owner of Totality – #14, Will has been exploring web3, AI, and how community brings it all together.
The hype of Beeple’s $69M NFT sale led to an explosion of interest in 2021, but the first NFT-like implementation can be traced back to Bitcoin’s Colored Coins Project proposed, in-part, by Ethereum co-founder Vitalik Butrin. Within this 2013 project, the process of making something distinct, like a fungible Bitcoin, was scrutinized by adding metadata into a coin. Smart contracts that include trackable metadata has become a critical component of NFTs. The most common standard for representing ownership of non-fungible tokens, is ERC-721, which has been battle-tested with the most recognizable NFT collections and is continually being refined.
There are two main misconceptions with NFTs. The first is that an NFT is only digital art. This overlooks one of the most powerful attributes of NFTs — flexibility. NFTs are web3 primitives that can represent nearly anything. They allow us to weave together a future that removes the barriers between the physical and digital worlds. The second is that an NFT is only a URL. While some NFTs use generative algorithms to write an image or other types of data directly to a blockchain, most NFTs reduce computational costs (which translates into higher gas fees) by innovating around the theory of ordinals or hosting larger elements of the asset on a decentralized storage system. The token itself goes beyond simply being a pointer and acts as an immutable record of ownership on a decentralized ledger. In an environment where code is law, the entire network recognizes and enforces your ownership via consensus.
Each NFT has no exact equivalent, but they can still evolve. How a token is organized within a collection, where it’s created, who collectively governs the network, and what future states may unfold, gives each NFT its own life cycle.
Before creation, NFTs are often organized into collections, regardless of how many tokens are minted. A blend of “token” and “economics”, tokenomics determine issuance, supply, and any mechanisms that will either reduce supply or incentivize holding. Since NFTs are immutable, a collection’s tokenomics should be carefully considered. Testnets allow for experimentation in the development stage, which aids in NFT development. While coding smart contracts directly into a blockchain is the most powerful, cost efficient, and flexible way to create NFTs, platforms like OpenSea, Thirdweb, Crossmint, and Manifold aspire to make NFT management more accessible.
To begin life on a blockchain, an NFT first needs to be minted. During this creation process, smart contract functions are executed. This assigns token IDs from the collection and may perform metadata randomization before broadcasting the ownership record over the blockchain. Mints can be public, or limited to allow lists. To reduce the potential for scams, allow lists (also called “whitelists”) collect, prioritize, and manage interest using wallet addresses from potential NFT buyers. The release of NFTs within a collection can be done all at once, scheduled over time, or perpetually open. Highly anticipated collections can cause congestion on a network, creating gas wars in which buyers can push their transactions to the front of the queue by paying higher fees.
Once minted, NFTs can be exchanged in many ways. They can be bought and sold using cryptocurrency on marketplaces like OpenSea, Blur, SuperRare, or Foundation. Marketplaces provide key infrastructure which, in addition to facilitating trade, aids in collection discovery. They can also be transferred via an airdrop, which is when NFTs are gifted into a digital wallet. Airdrops provide a creative way to share assets with each other, with senders usually paying any gas fee.
Pay close attention when using your wallet to complete signature requests. Signing a malicious smart contract can grant token approvals for all assets in a wallet. One common hack is packaged in NFT airdrops. If you receive an unknown NFT in your wallet, do not interact, transfer, or sell it as these actions can activate unwanted access. There are many stories of epic heists, so do your research and stay vigilant.
Once acquired, you’ll receive the NFT at your wallet address. Despite the token appearing in a wallet, it’s not really in your wallet; your wallet is like a web browser for the blockchain. Using a wallet address, you can see NFTs you own, and due to the transparent nature of public blockchains, you can also see other people’s collections.
While creator compensation and basic commerce has been the most publicized aspects of NFTs, with over $40B in transaction volume in 2021 alone, there are also ways to extend the life cycle of NFTs. Concepts like “burning”, and “staking” create extensions to what an NFT can become. When an NFT is burned, it’s sent to a null address for which nobody has the private key. Burned tokens are effectively removed from circulation and reduce the initial collection’s supply. This action can support the tokenomics of a project, while also adding depth to ownership within an NFT collection. Another concept is staking, or the act of locking an NFT in a specialized contract that prohibits transactions. Staking also reduces the circulating supply, but does not permanently reduce the size of the collection, as an owner can reclaim the token. Staking is often used as a way to incentivize holding for long periods of time and often yields rewards.
Alright, we’ve covered what an NFT is and how they work. Let’s pour into some current applications of NFTs, such as digital art, curating collectables, celebrating ownership within video games, administering membership benefits, managing events, enhancing security, and even raising financial capital for a new business.
To date, digital art has emerged as the most common use of NFTs. Artists can now monetize their work, push creative boundaries, and even earn royalties on secondary sales. Platform take rates have thankfully plummeted, which further extends the runway for artists to stay creative. Art buyers also appreciate fewer intermediaries, verifiable provenance, and new ways to connect with the creator. Along with access to art, NFTs can also help identify authenticity alongside the dynamic rise of machine learning and generative AI.
Collectables are also being enhanced with NFTs. Sports memorabilia, trading cards, toys, clothing, accessories, or classic cars can now be supplemented with digital assets that go further than a linked QR code. NFTs can add discoverability, more ways to socially trade with fellow collectors, and have enabled creative ways to digitally interact with physical items. For example, imagine buying a fresh pair of shoes that come with an NFT. Whether you decide to wear this prized possession IRL or not, using the connected NFT, your upgraded character can now rock these collectable kicks in your favorite video game. This is just an example, but the convergence of online status and identity makes NFTs a prime way to create communities where people feel a sense of belonging.
Speaking of gaming, NFTs provide a natural fit for gamers to celebrate ownership and authority in video games. Currently, in-game items, whether consumable or cosmetic, are effectively rented by the players. If a game developer shuts down the servers, these treasured items would vanish. In a web3 world, NFTs would support more lasting ownership. A few early examples are blockchain-based games like Cryptokitties and Axie Infinity, but consider when in-game items in Minecraft, Fortnite, or Call of Duty, are NFTs that can be transferred between players and different games. Web3 is inherently permissionless and interoperable, so innovative tools and conventions need to be created to foster these harmonious initiatives. While there’s more to be done, we are seeing more trust-minimizing technologies championed by industry leaders like Yuga Labs and Polygon, who are focused on unlocking such compatibility at a fundamental level.
Beyond entertainment, NFTs offer a decentralized method to managing memberships and associated benefits. A few examples include NFTs that grant access to events with commemorative NFTs, such as POAPs, serving as artifacts to mark the moment. Like a ticket, NFT ownership can also grant access to communication platforms like Discord, decentralized autonomous organizations (“DAOs”), and commercial copyright licenses, enabling token holders to create products or services with built-in network effects. Founders can build real-time brand equity in a crowdsourced startup and established corporations like Starbucks, Lowe’s, and Reddit are inventing new ways to add value, enhance security, and deepen brand loyalty using NFTs.
If we accept that our world is becoming increasingly digitized, there’s a natural fit for NFTs to enhance products, services, and verifiable value. In the neon future, it’s not crazy to think NFTs may soon power simple assets like concert tickets, but also critical belongings such as birth certificates, college diplomas, real estate titles, and more. As web3 matures, the challenges of digital money, property, ownership, and commerce may introduce new barriers, but mainstream adoption into more advanced economic constructs can seamlessly reshape today’s barriers into tomorrow’s non-fungible future.