Glossary

What are NFTs? How Do They Work?

What are NFTs?

Wake up, read stories of young kids making millions by flipping NFTs, try to understand this space, give up and go back to sleep. Relatable much, eh? Well, the idea of this post is not to cock a snook at you but help you wrap your head around this rather novel use case of blockchain technology called NFTs. What is NFT? How does it work?

Honestly, you are not at fault completely. Any sane individual would be bewildered to see JPEGs of monkeys and pixelated characters being sold for millions of dollars. But hang on. Over the course of this article, you’ll realise that people have not aped into the JPEGs alone. There’s a lot to uncover to find the underlying value of NFTs.

But before that, if you are looking at NFTs from an investment lens, you should consider NFT Coin Set!

Now let’s get on with the article.

What are Non-Fungible Tokens (NFTs)?

To decipher the term non-fungible token, let us try to break it down further. What is fungibility, after all? Fungibility is the ability of a product or commodity to be replaced by another identical item. Say you have $1000 in your bank account. Each one of those 1000 dollars is exactly the same. You could very well take out a dollar and replace it with some other dollar and nothing changes. 

Similarly, if you have a $50 bill and I give you 5 bills of $10 in exchange for that, our overall net worth is unimpacted. 

However, if you own the infamous ‘Monalisa’ and I own ‘Starry Nights’, we can’t just barter it. Each of these paintings is priced differently because they are absolutely unique. 

Let us port this concept to the crypto realm. If you have 1 Bitcoin, it can be replaced by any Bitcoin out of the total 21M that there are in existence. However, any one of your 10,000 crypto punks (those pixelated dudes that are being sold for millions) is not interchangeable. Each of them has a unique characteristic. 

If that wasn’t hard for your brain, you are almost there. NFTs are blockchain-based tokens which have unique properties. Simply put, it is a blockchain proof that represents a particular asset. This could be an image, text, video, GIF etc. 

How Does NFT Work?

NFTs are a very interesting use case of blockchain technology. The origin of NFTs happened with the advent of the ERC-721 token standard on Ethereum blockchain. Think of it as a token (just like crypto tokens) with a totally new set of rules, that gives birth to this uniqueness. 

One big question is what do you get when you purchase an NFT? Think of NFT as an address with the name of the owner written against it. This address can represent an image, text or video, whatever. When you purchase an NFT, all you are doing is writing your name against a particular address. 

What makes it so valuable then? It is the fact that blockchains are immutable. No one can change it at will. You now have a provable source of ownership of a particular asset. 

So most of the time, when people buy an NFT, it’s the ownership that is valuable rather than the image. Moreover, this ownership equips you to be a part of the exclusive group of NFT holders. Imagine getting entry to a private concert just because you hold a particular NFT!

What Are the Features of NFT?

Now that we have covered some basics around the working of NFTs, let us dive deeper into some of the key features offered by NFTs. 

A. Unique

You saw this coming, didn’t you? NFTs are one of a kind. You can argue that anyone can copy-paste the image of a bored ape (one of the biggest NFT projects). However, even if you do that, you don’t become an owner of it. The original one lies with the buyer. All you have is a mere copy. In a traditional context, a lot of people have the painting of Monalisa in their house. But there is only one original kept at Louvre Museum in Paris. 

B. Non-interchangeable

Each NFT has an element of subjectivity involved. Since they are unique pieces of art, you cannot interchange them. Of course, you could get into a barter deal, but that does not mean both the NFTs will hold the same value in the future. 

C. Traceable

Another feature of NFTs is what makes them extremely powerful. You can always prove the ownership. Not only that, but you can also track all the past owners of an NFT. Imagine if someone tries to sell you a watch that was previously owned by David Beckham. There is no way to prove it. However, if the watch had an NFT attached to it, you could simply keep on transferring the ownership and the records will forever be stored in the blockchain.

In another example, you could trace the origin of any product if it is backed by NFTs. You could now trace if your favourite champagne is coming from France or verify that your clothes are not sourced through unethical labour. 

D. Programmable

NFTs could be programmed the way you want. For example, in the traditional setting, if you sell a painting, your ownership ends on the first transaction. However, if you want to get a royalty on every purchase, NFTs are your answer. You can program an NFT to fetch a percentage of royalty every time it changes hands in the market. 

NFTs could also be programmed to be redeemed against certain perks offered by the issuer. 

How Does NFT Differ From Cryptocurrency?

Comparing NFTs and Cryptocurrency is like comparing Email to Social Media. Both of them are individual use cases of the internet. Likewise, NFTs and Cryptocurrency are two different use cases of blockchain. 

The key difference between these assets is primarily fungibility. As mentioned above, it is easy to swap a Bitcoin for a Bitcoin OR an Ether for Ether. However, it is not possible to swap between two NFTs. By design, NFTs have unique digital signatures and cannot be interchanged. 

Secondly, cryptocurrencies (at least some of them) are used to exchange value. They plan to become borderless, fast and cheap modes of payment. NFTs, on the other hand, have a different set of use cases. They cannot and don’t intend to become a medium of exchange as they themselves are valued in a cryptocurrency like Ether or Solana. 

Third, the difference between cryptocurrency and NFT is economical. While Cryptocurrency derives its value from its utility as a currency, NFTs have both tangible and intangible value attached to them. They can either be a simple collectable or a complicated loyalty program. 

What Are the Use Cases of NFTs?

Now you might think that NFTs are limited to digital art alone. Well, that is just the tip of the iceberg. One of the first applications on the Apple App Store was called ‘Koi Pond’. The app was a simple screensaver that showed fishes roaming around in an aquarium. What we are trying to say is that initial use cases of any new technology are often futile and redundant. However, in principle, NFTs are an extremely powerful tool. Here is a list of use cases that can be implemented using NFTs. 

A. Proof of authenticity

Since blockchains store information backed up by immutability and permanence, NFTs built on them can be used as proof of authenticity. How? Let us get into industry-specific use cases of blockchain.

A.1: Fashion industry

Did you ever buy your favourite brand just to know that you have been defrauded by the roadside vendor? Turns out that it’s not only you. The fashion industry has been plagued with counterfeits. 

This problem can be solved using NFTs. If fashion companies issue a digital twin of their product which is somehow tagged to the original piece of clothing, anyone could verify the authenticity of the product on the blockchain. 

Say, Nike releases a pair of shoes and calls it a limited edition with only 101 copies in circulation. One could easily verify these copies by validating them on the blockchain. 

A.2: Luxury items

On a similar note, all luxury items can be tagged to digital twins a.k.a NFTs so that anyone can verify the authenticity and also see the history of ownership. For example, BlockBar has released a collection of marquee liquors on its platform. These rare scotch whiskeys are sold as NFTs to clients. In other words, the physical bottle is stored in the warehouse and only the digital version is changing hands. 

A holder of NFT at any given point can sell it or redeem it against the physical bottle, after which NFT will be burnt. This way, an average user can participate in the appreciation of price due to the ageing of liquor and doesn’t have to worry about the authenticity. 

B. Provenance

NFTs are an amazing tool to establish the source of an object. Since they lie on blockchain and cannot be tampered with, it is extremely powerful when it comes to provenance. This can be applied in different use cases. 

For example, the world recently tried to boycott Chinese-produced cotton as it was grown by exploiting the Uighur Muslim population. Similarly, there is a whole narrative around blood diamonds wherein child labour and other unethical practices are used to harvest diamonds. 

If there was a way to tag each of these articles to the source of origin, any end customer could do a simple scan and find out the source of the same. 

C. Real-estate

We believe that real estate and NFTs are a match made in heaven. If we are successful in implementing this use case, a lot of inefficiencies in the current system will just go away. How? Let us find out. 

Trust is a big problem when it comes to the real estate business these days. You are not sure if you would get the possession on time after the payment. Similarly, the seller is not sure if he gets paid on time after releasing the property.

So, we often escrow this trust to third parties like the government and banks. While they do a decent job, it does create a lot of friction and documentation. 

Now imagine if government systems could be replaced by NFTs. All you have to do is transfer an NFT to the intended buyer and voila. Since all of this is built on smart contracts, neither parties have to worry about getting defrauded in terms of ownership or payment. 

Apart from that, the deal could take place within minutes instead of days as in the conventional method. 

As an example, on 10th February 2022, a house in Florida was auctioned for 210 ETH (then $6,54,309.60). The winner of this auction was awarded an NFT which acted as proof of ownership of the property. Imagine the bureaucracy and paper trail it managed to cut through.

And finally, there is an extremely important use case of tokenization. You could divide any property into smaller pieces as digital NFTs. Each piece would represent a fraction of ownership. If the property price goes up, you benefit as the partial owner of the property. There is no way you could do this in a traditional setting. 

D. Ticketing

Sports and event tickets are often plagued with two common problems. Counterfeits and Hoarders. 

NFTs can solve both these problems. Unlike digital tickets that run a risk of being copied, blockchain-based NFT tickets are way more secure. You can simply mint NFTs instead of tickets and interested buyers can purchase them. With this option, you can also airdrop tickets to some ‘lucky winners’ and also run an auction for a certain type of ticket. 

Secondly, if you have purchased a ticket and cannot make it, it becomes super easy for you to list it on the open market to find prospective buyers. You can also command the price of your choice to sell those tickets. And finally, trust is not a problem anymore because blockchain transactions are trustless in nature. 

So now, even if hoarders purchase tickets in bulk, they could only sell them by legitimate means. Apart from that, wallet restrictions could be imposed as smart contracts to ensure there is no secondary black market generated for these tickets. 

E. Gaming

Wait, what? Gaming and NFTs? Indeed. Now imagine your favourite high-end game. And even if you are not into one, let’s assume that you play as this warrior character who is fighting the zombies. Now, this character unlocks different types of weapons as he progresses. As it turns out, you have spent some sleepless nights to earn a coveted sword that could slash 5 zombies at once. As you boost your ego and feel proud of this achievement, you realize a couple of problems. 

What if the game developers decide to remove this sword? Wouldn’t it be nice if you could somehow monetize the effort you have put in to win this sword?

NFTs can help you with both. Turns out that even if you have unlocked this sword, you still don’t own it. Gaming company does. But what if this sword was an NFT? You could now truly own it and also take it to other games (theoretically) to flaunt and perform better. 

Secondly, if required, you could now list this NFT to an in-game marketplace and sell it to a newbie who has money but lacks the patience to reach that level. 

F. Certificates

All key organizations could issue certificates as NFTs. This could lead to multiple benefits like:

  • No need to create, seal, ship and store the physical, fragile certificates. It is there on the blockchain for your perusal. Always.
  • Anyone who needs to validate your certifications (HR, Auditors, Universities) could simply access the blockchain and find out your achievements. They need not double-check it either because blockchain technology has your back.

G. Intellectual property

NFTs will unlock the creator economy like never before. Currently, if you are an artist (musician, painter, filmmaker etc) you need to find a producer to fund your project. He/she in turn seeks a hefty share of the profits. To top it all off, you don’t know if your artwork will perform enough in the market to cover the costs. 

To solve these problems, you can now issue rights to your future movie, song etc as NFT. Your fanbase could purchase this NFT (so you have already found an interested audience) and that money could fund your project. This way, the fans get to keep a share of your success and you have to shell out a much lesser share (it’s flexible) with lesser risk to create something. 

In another example, you may also choose to monetize your content as NFTs. Currently, you have to route your artwork through distributors who take a fair share of the pie. NFTs allow you to reach out directly to your buyers. You can simply issue them NFTs which act as a ticket of sorts to view and appreciate your artwork. 

Why Are NFTs Becoming Popular?

There is a short-term hype surrounding the NFT space. No one wants to miss the NFT train the way they missed Bitcoin. That is why even the NFTs with no roadmap or vision have been selling like hotcakes. For instance, someone purchased Jack Dorsey’s first tweet for a staggering $2.1M. When this guy came back to sell it in the open market a year later, he could fetch a maximum bid of ~$200. 

However, while these examples will always try to bring a bad name to the space, people have realized that NFTs can’t work without a utility. As a result, stronger use cases like community management, and loyalty programs using NFTs are emerging every day. 

In fact, Bored Apes, the company behind BAYC, has now entered the Metaverse. They have been a case study on how to run an NFT project. They have successfully tied up with Nike, Adidas and other major brands to benefit their community. 

And finally, the list of use cases is enormous. The technology is so exciting that you could very well create a plethora of applications on top of it. If you are as excited as the rest of the world about the future of NFTs, you might wanna consider riding the wave by investing in the NFT Coin Set on Mudrex. It is a basket of top NFT cryptos that could be ideal for investing in this cutting-edge use case of blockchain tech.

What Are Some Examples of NFTs?

We have quoted a few NFT projects throughout this article. It is time to officially acknowledge some of the blue-chip projects out there. 

A. CryptoKitties

The NFT that broke Ethereum. Cryptokitties was a simple game where you would raise kittens verifiable via blockchain. More than anything else, it was the adrenaline rush of the very first blockchain-based games that led to fans shell out a staggering $20M in Ether to buy and sell these kittens. 

As a result, one fine day, these kittens became so popular that they choked Ethereum blockchain. 

B. Bored Ape Yacht Club (BAYC)

BAYC is a collection of 10,000 apes. Each has its own set of unique characteristics. BAYC has a cult following. Probably the reason behind some of those selling to the north of $20 Million. A peculiar feature of BAYC is that it gives the owners of these NFTs legal rights to the IP of these monkeys. 

Apart from that, NFT also acts as gated access to the community-specific meet-ups. NFT holders were also given exclusive early access to $APE token and Metaverse land. 

C. Crypto Punks

Crypto Punks is one of the OG crypto projects. A total of 10,000 pixelated unique characters took over the web3 realm with a storm. The company behind this project, Larva labs actually coded these characters in the blockchain. Let me explain. Most of the NFT projects (as mentioned above) give you the ownership of an address that contains the media file. However, in the case of Cryptopunks, these characters were a part of the NFT code. That is why they are pixelated and low poly. 

Should You Invest in NFTs?

If cryptocurrency were mutual funds, then NFTs are alternate investment funds. NFT is a high-risk, high-return investment class. We say this because the fate of NFT projects lies in the hands of the roadmap and its implementation. The value of a project is in its utility. 

However, it is advised to keep a very small portion of your crypto investment portfolio in NFTs to ensure that you reap the benefits of mass adoption. You can use our NFT investment guide to navigate through this, read it here!

FAQs

1. Are NFTs a good investment?

Yes. From a long term perspective, NFTs are a good investment. However, one needs to conduct due diligence before buying them as more than 90% of the projects out there have no fundamentals, roadmap and are most likely to fail. 

2. How do you make money with NFTs?

There are multiple ways to make money with NFTs. You can hold them and reap the benefits of appreciation. You can also try to flip them for a profit as soon as you buy them. Some NFTs also allow staking so that you can earn an interest by holding them. 

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