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What are NFTs and How Do They Work?

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Illustration of an auction house to illustrate the topic of what are nfts.

If you’ve been on the internet these past few weeks, you’ve likely seen or heard mentions of NFTs. NFTs have become an increasingly popular buzzword lately – but what are NFTs exactly, and how do they work?

In this article, we’ll be going over what NFTs are, how exactly they work, as well as their current and potential applications in the future. 

Understanding NFTs

First and foremost, let’s get a working definition of what exactly is an NFT. 

What are NFTs?

By definition, an NFT (Non-Fungible Token), is a type of digital asset like Bitcoin and Ethereum that can represent a unique tangible, or intangible digital property and/or goods. Similar to cryptocurrencies, NFTs exist on a decentralized network of computers called a blockchain. 

What differentiates NFTs and cryptocurrencies is the non-fungible aspect of NFTs, hence the name. Non-fungible means that NFTs are individually unique and cannot be directly exchanged for one another. 

Each NFT contains information that allows it to be easily verifiable and can be traced back to the original creator. Another way to think of NFTs are like digital signatures that can serve as a way to prove authenticity and ownership of a digital asset. 

What gives NFTs their value?

As with any commodity, the value of an NFT is determined by supply and demand. In the current market, NFTs are still relatively scarce while the demand from collectors and investors is high. This means people are willing to pay high prices for them. 

Dragon the CryptoKitty. Source: CryptoKitty.

An NFT can also have a unique valuation that is dependent on the digital properties they represent, which can vary depending on the highest bidder. For example, one of the most notable NFTs was for a CryptoKitty named Dragon that was valued at 600 ETH. 

How do NFTs work?

As we prefaced above, NFTs represent a unique digital property that provides the owner proof of ownership. They can represent works of art, items in a video game, a tweet, or literally any digital property you can think of. 

In the current market, the majority of NFTs are built using the Ethereum-based token standards known as ERC-721 or ERC-1155. 

These tokens enable developers to easily launch NFTs on the Ethereum blockchain as well as ensure their compatibility with the ecosystem of dApps (decentralized apps) that can interact with the NFT. 

In many ways, NFTs work and function similar to cryptocurrencies – they are run on a blockchain and are validated by the digital ledgers on the network. This gives them the same properties that are synonymous with cryptocurrencies, such as privacy, accessibility, and security.

Additionally, NFTs are characterized by the following features:

Verifiable

Historical ownership of NFTs are validated and stored on the underlying blockchain that they run on. This allows any NFT to be authenticated without having the need for third parties.

Indestructible

The environment in which NFTs are stored in – on blockchain networks via smart contracts – means that the tokens are virtually impervious to replication or disintegration. Their ownership is also immutable, meaning that users actually own the NFT as opposed to the companies or entities that created them. 

Indivisible

NFTs exist exclusively as a single, whole item and cannot be split into smaller denominations like Bitcoin satoshis, or Ethereum gweis. 

Why are NFTs important?

The prospect of being able to authenticate a digital property has many potential groundbreaking applications in the future. 

The advent of NFTs opens up the possibility of commodifying digital properties, ranging from artwork, photographs, tweets, video game items, or any digital creations you can think of. 

Imagine having a digitally signed autograph of your favorite artist, or a one-of-a-kind digital artwork from Banksy – NFTs can be crafted to represent these items, and provide proof of immutable ownership within the token through a cryptographic hash function. 

For digital creators, being able to create artwork and sell directly to a global audience without having to rely on galleries or third parties is a game changer. This means they’ll be able to keep larger portions of any sales they make compared to having to cut a percentage of their profit to third parties. 

This works the same way for digital properties with royalties. The artist can have a specific set of conditions programmed into the NFT so that they automatically receive a percentage of profit whenever those conditions are met. 

What are some notable NFT examples?

Some of the most notable applications of NFTs is the CryptoKitty, Dragon we mentioned earlier that was valued at 600 ETH. 

Another one is the NFT of Twitter CEO, Jack Dorsey’s first tweet that sold for USD $2.9 million from March 21st, 2006. The NFT was sold to Sina Estavi, the CEO of a Malaysian blockchain service called the Bridge Oracle, and was paid for with Ether.  

Other notable NFT examples include:

  • The most expensive NFT to date is Beeple’s The First 5,000 Days that was sold for USD $69 million at Christie’s auction house.
  • The famous internet Nyan Cat GIF was also sold recently for USD $587,000 through the crypto art platform Foundation. 
  • NFT Yourself album by American rock band Kings of Leon that was sold as an NFT, making them the first band to do so.
Nyan Cat GIF
Nyan Cat GIF that was recently sold as an NFT. Source: GIPHY

With that said, NFTs are an exciting new development that shares its roots with cryptocurrency and blockchain technology that can have groundbreaking potential use cases in the real-world. 

We look forward to sharing more NFT updates as the technology and applications continue to expand in the near future!

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