26 July 2022
|— NFTs are unique digital assets that hold value – but can you tell the difference between fundamentals and hype?
— The NFT space is driven by communities, and it’s known for its FOMO, which can obscure our ability to truly understand what’s in a token.
— NFTs are composed of several different key elements, all of which affect their usefulness.
— Here we explain the anatomy of an NFT so you can perform your own basic NFT analysis – and potential new additions.
If you think fundamental analysis is something that only applies to finance – think again. NFTs are an emerging asset, but they must be assessed with traditional objectivity. Here we explain the components of NFT analysis, and how you can do this yourself.
NFTs changed the parameters of the digital space in profound ways, by enabling parts of our digital environment to be meaningfully owned – just like real life. This created a limitless new economy, with NFT sales volume totaling $25 billion in 2021, skyrocketing from just $94.9 million the previous year.
The stories that brought NFTS into the public consciousness tend to involve sensational tales of digital artists becoming millionaires, cartoon cats selling for obscene fortunes, or unlikely projects hitting the big time for no apparent reason—and all that hype can make it difficult to assess the value of individual NFTs objectively, without getting caught up in FOMO and sensationalism.
To truly understand the NFT economy and the individual tokens within it, we need to look past the hype and consider token attributes instead.
The anatomy of an NFT
NFTs are not just one “thing”, but rather a cluster of different components that all have an impact on how and where they can be used. So in this article, we’re going to take non-fungibles apart – identifying each component in turn and explaining its function and impact, so you can size tokens with a clear head.
Are you ready for a crash course on NFT fundamental analysis?!
Let’s start from the baseline – the blockchain your NFT sits on.
The largest and most established ecosystem for NFTs is Ethereum. And it stands to reason: CryptoKitties, the project that fired the starting gun on NFTs, launched on Ethereum, as well as the vast majority of major projects since then.
But it is far from the only blockchain that can host non-fungible substances. You can also buy NFTs on alternative chains such as Solana, Tezos, BSC, Polygon among others.
Coming later to the game, these networks offer a less developed NFT ecosystem and a much smaller global marketplace, and that’s something to factor in when considering your options. But there are also other considerations.
- Transaction costs (consensus mechanisms at play)
Transaction costs are a key tension in the crypto space, and they are determined in part by your blockchain. The Ethereum blockchain can host a huge ecosystem — but it’s notoriously slow and expensive, a knock-on effect of the proof-of-work consensus protocol.
Meanwhile, most alternative blockchains use proof-of-stake, and are therefore significantly cheaper (and faster), costing only a few cents per transaction.
All of these different blockchains have their own requirements, such as different marketplaces and wallets.
For example, MetaMask is the best option if you want to interact with Ethereum apps, but Phantom is the most popular choice for using applications on Solana. If you want to use Tezo’s blockchain, use Temple wallet and Trust Wallet will be the best option to interact with dApps on the BSC network.
These chains have further created their own specific applications and NFT marketplaces: the giant OpenSea is mainly built on Ethereum, for example, while the NFT marketplaces Solanart and SolSea are native to the Solana blockchain, and Objkt caters to Tezos.
All this to say that while the underlying blockchain may seem like one of the less exciting aspects of your NFT, it determines some important things – and should be kept in mind when deciding what an NFT is worth to you.
Internal smart contract
They say it’s what’s on the inside that counts, and nowhere is this more true than with NFTs – each one programmed with behavior and parameters via its internal smart contract.
While the blockchain is the foundation, it is the smart contracts that do all the work when your token interacts with platforms or other tokens, via terms written directly into the code.
Smart contracts control things like NFT royalty, rarity and whether the token is part of a collection – they also allow provenance to be embedded and track the transaction history of the token.
Impact on NFT
These smart contracts ultimately determine exactly how you can spend your NFT and how much of the resale value you get. Not to mention, you can always check them for the provenance of the NFT if it’s a work of art or fashion, and build a profile of the token by looking at its purchase and sale history, all documented by the smart contract.
Being able to read a smart contract is one of the most valuable weapons you have when sizing an NFT. So getting to know platforms like EtherScan, which allows you to read a smart contract, is a no-brainer for anyone exploring space.
OK, we’ve dealt with the inside of your NFT – what about the bit you can see now?
The metadata of an NFT is its digital content – the image, sound or video clip you purchased the token for. In BAYC for example, the metadata is the unique Ape image of the token.
What’s interesting about NFT metadata is that it usually is not stored on the chain with your ERC721 token. Blockchains are designed to handle transactional data, not managing large files like images and storing them on chain is both impractical and extremely expensive (check out our article for more on that). And while you can find some collections that are completely on the chain (On-Chain Monkey is the best example), these are quite rare.
So where is your NFT picture?
Your NFT token itself contains something called a Universal Resource Identifier (URI) which is sort of like digital coordinates pointing to the location where your media file (for example your Ape, Punk or World of Women avatar) actually resides is stored. This is normally off-chain, on a server or via IPFS, both of which have some important implications for your token.
The effect of off-chain storage
Your ERC721 token can be on an immutable, decentralized blockchain – but if the metadata is stored off-chain, this part of the token will not have blockchain-level security.
For example, your image may be stored on a centralized server, meaning you are dependent on a third party to maintain the file – this creates a centralized point of failure. If the server does not maintain your files, the URI in your NFT will simply be a dead link.
Systems like IPFS offer a decentralized (and more secure) approach to data storage, increasing the security of your NFT image files. But the main point to remember is that the vast majority of NFT images are simply NOT as secure as the token itself, so when sizing a prospect, it’s worth checking where the image is to understand the vulnerabilities of your token.
NFT commercial rights
OK, so we’ve covered the ins and outs of an NFT – now let’s talk business.
Just because you own an NFT does not mean you have the right to use it commercially yourself; the original creator of the artwork will likely retain some degree of intellectual property rights so you cannot profit from their work.
Broadly speaking, we see three main categories of commercial NFT rights emerging in today’s ecosystem (all of which are determined by the creator of the artwork):
- Rights reserved to creators: this is a complete moratorium on using your NFT image (yes, even if the token is yours) to make money
- Rights reserved for token holders: each token holder has the right to use their own NFT image for commercial purposes only.
- No rights reserved (CC0): anyone, even non-token holders, can use the project’s artwork for commercial purposes.
Why is this important to you when considering an NFT? Because it determines the scope of what you can use that token for. NFT holders are increasingly creative with their tokens, even creating their own brands from their token artwork. But if the token you’re looking at has commercial rights reserved, that option is off the table for you.
Before buying an NFT, check out its commercial rights. These are determined entirely off-chain by the project or creator, and vary from one NFT to another. You can usually find the commercial rights for your own NFTs on the project terms page of the website.
The private key
So you’ve sized your blockchain, checked out the smart contract terms, double-checked where your image will be stored and how secure it is, and done some research on what level of commercial rights you want over your token artwork. There’s just one last thing to deal with – and it may be the most important.
Your ownership of your NFT is defined by whether you have its private key, so it’s important to know how to protect and store it.
When it comes to your private keys, your most important vulnerabilities exist online. Hackers can target your connected device via malware distributed on bad links – for online wallets this means “bye bye NFTs!”, as we’ve already seen in too many cases.
A disconnected key is the only key
An offline key is the only key you should use, and this also applies to NFTs. It requires a security system that keeps your private keys completely offline and out of the reach of hackers. This is the whole purpose of a Ledger Nano, which is to secure your private crypto and NFT keys in an environment completely isolated from online threats.
Hardware wallets like the Ledger Nano ensure that the private key of your NFT is offline at all times. And with the NFT experience in Ledger Live constantly evolving, storing your private keys is both the safest option and the most fun and intuitive system for viewing and managing your collection.
Your tokens deserve a closer look
It’s hard to stay on top of all the exciting happenings in the NFT space, but the magic formula for knowing the truth about what you’re buying is knowing what items to look for and how to evaluate them. Now you have the tools to do it yourself.
You should now feel confident to look past the hype and see NFTs for their true value and potential – so go ahead, explore and cast a discerning eye over everything you buy! You have a superpower, start using it.
Protect your NFTs
If you know – you know. Keep these keys offline!! If you only do one thing, it should be this.