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Non-Fungible Tokens (NFTs) Explained

Edwin Munyui
Content
March 9, 2021

Introduction to Non-Fungible Tokens (NFTs)

Non-fungible tokens (NFTs) are gaining popularity quite fast - the past year has seen this niche grow into one of the most promising areas in crypto. So, what is about NFTs that has excited the crypto community and other industries like gaming? Let's start by looking into their fundamentals in detail as we narrow down to the value proposition.

NFTs are designed as unique cryptographic tokens that represent the ownership of a digital collectible or tokenized asset on a blockchain platform. Unlike normal cryptocurrencies, NFTs are unique in terms of their inherent properties. This simply means that each NFT has its own fundamentals and carries a different value from other tokens - hence digitally scarce.

As for the fungible crypto assets like Bitcoin, one unit can be interchanged with another unit of similar quantity - this is because the two BTC units would be essentially indistinguishable. On the other hand, NFTs are not interchangeable since every token represents a unique digital collectible or tokenized asset. Basically, part of their underlying value is derived from proof-of-authenticity and digital ownership.

While most NFT innovations are still in the early stages, projects in this niche have started attracting both value investors and users. The first major debut was

Crypto Kitties

crypto-kitties-drixx.jpg

Source: https://www.cryptokitties.co/

an NFT digital collectibles project which soared at the heights of the 2017 bull-run. In fact, one of the main reasons it came light was because of the congestion it caused on Ethereum's network.

Today, the NFT ecosystem has evolved a great deal to feature other potential projects and marketplaces for these upcoming crypto assets. According to the 2020 annual report by analytics firm DappRadar, daily activity and trading volumes across NFT marketplaces shot up by 226% and 785%, respectively. Most of this growth was fueled by integrations with the gaming industry.

Other notable areas that are integrating with the NFT ecosystem include fine art, digital identity, licensing and certifications. This emerging form of digital ownership is gradually changing the game for artists and creatives through the immutable nature of blockchains - one can simply create their own NFT on a blockchain to act as proof of authenticity or ownership for their work.

NFTs Technical Fundamentals

The technical underpinnings of NFTs are based on blockchain technology - some of these unique cryptographic tokens are built on networks like Ethereum, EOS, NEO and TRON. On Ethereum, they can be issued or traded based on the ERC-721 standard. This is quite different from the normal ERC-20 standard, which is the fundamental framework for most Ethereum-built tokens.

The ERC-721 standard is particularly designed for the issuance and trading of NFTs on Ethereum - more innovators are now creating tokens within this standard to leverage the opportunities in digital collectibles and real-world asset tokenization. A more advanced standard dubbed 'ERC-115' further enables the combination of fungible and non-fungible tokens into one smart contract.

These smart contracts that are used to create NFTs enable the addition of detailed properties such as the owner's identity, secure file links or specific metadata. Owners can customize their NFTs to make them even more valuable through distinguishing attributes. This is probably the most lucrative fundamental value of NFTs.

Like any other asset in the markets, NFTs can be bought or sold - they are traded in open marketplaces that are designed to facilitate value realization. These market ecosystems link buyers and sellers looking to trade the digital collectibles - each NFT has its own value depending on the market demand that deems it valuable.

Having been around for some time, NFTs are growing into a potential cryptocurrency niche. The next sections of this article will feature their value proposition, market trends and potential future.

NFTs Value Proposition


As highlighted earlier, NFTs already have some practical use cases - more potential areas continue to emerge as the space develops. Currently, the most common use case is the issuance of crypto-collectibles or unique digital assets by decentralized applications (DApps). The NFTs that are issued by projects in this space can take the form of a digital collectible or investment product amongst others.

Of course, NFTs are easily compatible with the gaming industry - their emergence is a big plus to the gaming economies that have long existed. These unique crypto assets further enhance the gaming experience by introducing a way to create, collect and exchange digital items - some of which may include virtual land, advanced weapons or customized skins. It is almost like NFTs and the gaming industry are naturally compatible.

Another value proposition of NFTs is in the digital identity realm - they can be used to improve how personal data is stored in the age of privacy and integrity. Today, these two values are highly important when it comes to dealing with personal information. With NFTs in the picture, digital identities can be stored on trustless blockchain ecosystems and shared across global economies. This will ultimately reduce the friction of doing business or international relations.

NFTs have also shown the potential of integrating real-world assets with blockchain through tokenization - an idea that could speed up the reality of a virtual world. Physical assets like rare collectibles, real estate and fine art can be tokenized and represented by NFTs in fractions. In doing so, NFTs stand a chance of attracting more liquidity into the crypto ecosystem.

NFTs Market Trends

The NFT market has been the fastest growing area in crypto since the beginning of 2021 - it is getting more traction by the day. While it appears that crypto collectibles are just joining the party, there has been solid work in progress that dates back to 2018. This is when the ERC-721 standard was invented by Nastassia Sachs, Jacob Evans, Dieter Shirley and William Entriken.

eip-721-drixx.png

Source: https://eips.ethereum.org/EIPS/eip-721

Crypto kitties which debuted as the first mainstream NFT oriented game spurred the concept of digital collectibles and their potential in existing economies. This game bases its fundamentals on breedable collectibles dubbed 'cryptokitties' - they are basically virtual cats with adorable features. Players can collect, breed, purchase or sell their distinguishable cryptokitties.

Fast forward to 2021, other crypto collectibles have emerged and they appear to be taking the market by storm. In January alone, the NFT marketplace on Ethereum grew by 1000% according to DappRadar - this growth was mainly fueled by two crypto collecticle projects:

hashmasks

hashmasks-drixx.jpg

Source: https://www.thehashmasks.com/

and

cryptopunks

cryptopunks-drixx.png

Source: https://www.larvalabs.com/cryptopunks

NFT sales from the two projects generated a total of $15 million while the overall market had grown to $33 million at the time.

Other emerging trends in NFTs include integration with the sports industry - in fact, some of the most valuable collectibles today fall under NBA Top Shot 'moments'. This NFT innovation was developed by the NBA in collaboration with Cryptokitties creator, Dapper Labs. NBA Top Shot moments are currently the highest ranking collectibles with the latest weekly volumes ranging around $66 million.

Some NFT innovators are taking the game to another level by integrating their collectible projects with Decentralized Finance (DeFi). One such innovation is Aavegotchi - this NFT project combines retro pixel art and blockchain to introduce collectibles that can be staked. Unlike normal crypto collectibles, Aavegotchi allows the NFT owners to earn some yield by staking their tokens on Aave - an affiliated DeFi lending and borrowing platform.

Like most Ethereum-built applications, NFTs are also experiencing some challenges when it comes to using this blockchain. However, innovators in this space seem to be adopting faster than the rest of the pack. They are shifting to other protocols and layer 2 solutions which include the likes of Flow and Matic, respectively. NBA Top Shot is built on Flow protocol while other popular NFT projects such as Marble.Cards leverage the Matic protocol.

Summary

NFTs are still in the early stages of innovation - the upside potential of integration with both virtual and real worlds is unlimited. Going forward, it is likely that more people will start realizing the value of crypto collectibles across various industries. Unsurprisingly, this is already in motion with highly compatible niches like gaming and digital art.

The next NFT adoption phase will probably mark an integration with real-world assets like real estate and physical art - this will likely be achieved through tokenization. Once recorded on a blockchain, tokenized assets can be traded across the globe without limitations. Basically, NFTs could revolutionize today's financial and commodities markets by taking them on-chain.