non-fungible tokens explained

Non-fungible tokens preserve uniqueness and ownership in a digital world

The world of crypto assets was once a quiet place, populated by a relatively low number of cryptocurrencies like Bitcoin, Litecoin and Ether, minted as rewards for the miners supporting their respective blockchain platforms. This all changed in November, 2015, when the ERC-20 token standard was released on Ethereum.

ERC-20 allowed for a whole new array of projects to emerge on Ethereum. Suddenly, a blockchain start-up – anyone, really – had the means to create their own token running on Ethereum. The concept of asset tokenization was born.

Still, ERC-20 wasn’t enough to unlock the full potential of blockchain-based digitalization. To address that, a new token standard was introduced in 2017 – Ethereum’s ERC-721, which opened the door for non-fungible tokens, also known as NFTs.

Fungible vs non-fungible tokens

A common characteristic of the tokens issued under ERC-20 is that they are fungible, meaning that the units of a token are mutually interchangeable – just like a one-dollar bill can be replaced by any other one-dollar bill in circulation. This type of tokenization paved the way for a host of new blockchain applications to enter the scene. Concepts like utility tokens, token offerings, stablecoins and DeFi have greatly benefited from the introduction of the ERC-20 standard.

Unlike ERC-20 coins, tokens that are issued under ERC-721 are not mutually interchangeable, hence the name non-fingable tokens. This stems from the fact that while two NFTs may look identical to each other, they both hold unique information. Non-fungible tokens also lack another trait of their ERC-20 counterparts – they are not divisible, which means that you cannot own a portion of an NFT.

Considering all this, it seems reasonable to assume that NFTs lack the utility of fungible tokens. But while such an assumption might be fair, it misses the main point about non-fungible tokens. They are not aimed at powering blockchain ecosystems or funding startups. Rather, they seek to tap blockchain’s ability to protect identity and preserve uniqueness in digital form. That’s why NFTs are not interchangeable or divisible – you cannot replace a painting with an equivalent piece, nor can you own a piece of a painting (well, technically you can, but it doesn’t make much sense, does it?).

How do non-fungible tokens work?

It’s no coincidence that Ethereum, the first blockchain platform to support complex smart contracts, also popularized asset tokenization. Issuing a token requires writing a smart contract to specify under what conditions that token is issued. Ethereum, with its Turing-complete programming language Solidity, is perfect for building and executing smart contracts. However, over the past couple of years, other blockchain platforms, such as EOS, TRON and NEO, have introduced NFT standards of their own.

While both fungible and non-fungible tokens require smart contracts, NFT smart contracts allow for much more detailed information to be recorded. This can include metadata that describes what makes a particular NFT unique, information about the owner, file links and so on.

It should be noted that non-fungible digital assets have existed long before the arrival of blockchain. Domain names, digital art and other types of digital content fit the criteria perfectly and have been around for years and even decades. What NFTs essentially aim to do is not to create new asset types, but to allow for existing asset types to take advantage of the core strengths of blockchain technology to preserve ownership, prove authenticity, etc. Tokenization also makes digital assets more easily transferable.

Use cases and leading NFT projects

One of early successes of the NFT trend was CryptoKitties, an Ethereum-based game that allowed players to buy, collect, breed and sell virtual cats. Released in November, 2017, CryptoKitties quickly gained popularity and for a while was the hottest dApp on the Ethereum.

The success of CryptoKitties served as a proof of concept for the case of digital collectables on the blockchain and sparked a wave of launches of similar projects. This in turn led to the creation of marketplaces for digital collectables.

Sorare, a fantasy football game, is one of the most popular NFT digital collectable projects today. Some of the popular digital collectable marketplaces include OpenSea and Rarible. Meanwhile, other popular NTF marketplaces like SuperRare and Nifty Gateway point to another use case for non-fungible tokens – digital art.

Another area where NFTs are likely to gain traction is the broader video game sector. Video games, especially those in the so called “live services” category, rely on selling in-game items such as weapon and character skins to bolster their revenues. Such items could be represented with non-fungible tokens to protect ownership and to make them more easily transferable.

Digital collectables, art and video games are all great, but what about something more practical? Well, remember our earlier example about domain names? The Ethereum Name Service offers .ETH domains tokenized as NFTs. Another service called Unstoppable Domains has employed a similar approach.

Non-fungible tokens can also be used in real estate. In fact, games like Decentraland allow people to buy NFTs representing parcels of virtual land. And the same concept can be easily applied to real-world properties, where an NFT is used to prove ownership over a piece of real estate.

This can also lead to many more real-world applications like preserving identities, professional qualifications, diplomas, medical records, intellectual property rights and others.

Big players taking notice

While still in its infancy, the NFT sector is already drawing interest from some major players in the world of sports and entertainment. An example for this is the NBA Top Shot, a joint venture between the best basketball league in the world and CryptoKitties developer Dapper Labs. The platform, currently in beta, is a marketplace for NBA video highlights that utilizes NFTs to ensure digital scarcity and ownership. Dapper Labs is building the project on its proprietary blockchain platform, Flow.

Watch this space

The NFT sector is still a fledgeling industry, but it is one that deserves attention. Non-fungible tokens might not have the same investment draw as their fungible siblings, but they appeal to the human tendency of placing higher value on items based on their scarcity, uniqueness and authenticity. NFTs might not fuel the digital economies of tomorrow, but they could populate their digital storefronts. They will not allow you to buy a fraction of a building, but they are more than capable of digitizing and transferring the rights to a unique piece of property. Given their diverse set of potential use cases, non-fungible tokens are poised to play a key role in realizing blockchain’s full potential.

 

 

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ABOUT THE AUTHOR

Dimitar Bogdanov