An introduction to NFT technology
If you’re looking for tech or business news at least occasionally, chances are you’ve come across the infamous three-letter acronym loved by some and condemned by others: NFT.
In this three-part series, I will take you on a journey around this illusory concept. If you are a critic, I hope these articles will shed some light on why technology is not what it seems and inspire you to use it in new ways. Conversely, if you are a blind follower, I hope my approach will help bring your enthusiasm back down to earth before some terrible mistakes are made.
The first part of this series will focus on the technology behind NFTs, breaking down what they actually are and laying a solid foundation for part two on industrial applications that you probably haven’t considered before. Part three will conclude by walking through a case study of an NFT project I’m a part of, CryptoSwarm.ai, that shows how NFTs actually improve various steps in the business-to-customer pipeline. This three-pronged approach (technology, industry landscape, and a concrete example) will put you at the forefront of emerging industries and prepare you to integrate them into your own businesses.
What is an NFT?
NFT stands for non-fungible token, which simply means a symbol that is unique, just like a collectible baseball card. A fungible token, like a Bitcoin, is indistinguishable from other Bitcoins. Similarly, you wouldn’t care if you got one dollar bill against another if they are in the same condition.
An NFT is simply proof of ownership that lives on a blockchain, a distributed ledger that is not controlled by a single entity and cannot be easily tampered with. They are similar to deeds, but are made for digital assets such as photos, videos or documents rather than houses or cars. If you own an NFT, you can prove that you own the associated asset.
Most NFTs are built on the Ethereum blockchain. The entries written on Ethereum’s immutable, tamper-proof distributed ledger are not limited to the transfer of funds, but are actually much more open. Anyone can write a “smart contract” – a piece of code executed by every participant in the Ethereum network – and can interact with information stored on the blockchain.
As with any other program, smart contracts can build out any system – gaming, tracking ownership, brokering markets, or even training AI models (but I wouldn’t recommend this for reasons mentioned later). These programs can perform many processes that usually involve an intermediary, such as exchanging one cryptocurrency for another using a DeFi (decentralized finance) exchange, since the terms between the parties are set programmatically and the contract is self-executed. In Web3 parlance, ‘code is law’.
How do NFTs work?
Most NFTs are ERC721 tokens, which are based on the ERC721 standard smart contract that describes how to create and transfer a non-fungible token of that type. When you start an NFT project, you must write your own smart contract that mediates between you and the buyers, defining how much each token is sold for and their total supply. Copying code from other projects also works. ERC721 defines the basics, like checking ownership and transferability of ERC721 tokens, but you can add custom code to make your token do all kinds of things and connect to different smart contracts. Check out this BAYC smart contract overview to learn more.
There are other token standards such as ERC20, a fungible token similar to ETH or the US dollar, and ERC1155, a standard that allows the transfer of fungible and non-fungible tokens in a single transaction. Additionally, more and more NFTs are being built on top of Solana, a different blockchain known for having faster transaction speeds and lower gas fees than Ethereum.
NFTs on the Ethereum blockchain can be purchased with Ether or ETH, the chain’s native currency, which in turn can be purchased with fiat currency, such as euros or dollars, from cryptocurrency on-ramps, such as Coinbase. Much to the dismay of true Web3 ideologues, these ramps are regulated, Web2-esque companies and require your ID to create an account.
You can then transfer your purchased cryptocurrency to a software wallet like MetaMask, a Chrome extension that gives you custody of your Ethereum address while integrating into all kinds of Web3 apps. NFTs can then be purchased on marketplaces such as OpenSea. Caution: Transactions with ETH use up gas, or the cost of computation necessary to write data on the blockchain. In times of high market activity, gas taxes can increase dramatically. This is also why you don’t want to train a machine learning (ML) model on a blockchain…
NFT challenges
A major problem with NFTs is their legal aspect. In reality, an NFT shows that a given account owns an ID placed on the blockchain. This ID is then linked to an asset, whether it’s a JPEG or a pair of virtual sneakers. Even if you can indisputably prove ownership of the ID, you do not have direct control over the asset to which the ID is linked. The connection is made on a proprietary basis. To top it off, the copyright of the asset usually remains with the author unless explicitly outlined in the contract, which is why, as technical law and legal ownership expert João Marinotti points out, we need legal reform alongside NFTs.
Let’s say you buy an NFT that represents a plot of virtual land in The Sandbox. Your address is not directly linked to the actual file that is the virtual country, but rather to an ID or hyperlink that points to that file. This ID or link can be in the form of HTML, where the file itself is stored on a traditional web server owned by a company. If you don’t follow the terms of use, the company can disconnect the asset from the ID you own, leaving you with a useless string of characters and no asset. However, recognizing this problem, many platforms are already implementing decentralized storage solutions such as Filecoin and IPFS.
Despite gas and copyright issues, and the link/asset distinction, NFTs remain an effective tool. By adopting many of the useful properties of public, permissionless blockchains on which they are typically built, Ethereum or Solana, and by allowing easy transfer of ownership of digital assets, NFTs can be used for a variety of use cases beyond images of Bored Monkeys. If you want to learn about these use cases, stay tuned for part two of my NFT explainer series.
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