A Quick Guide to NFTs

Welcome back to our ongoing series of guides explaining different aspects of the crypto economy in  a quick and easy way. Our last instalment was on DeFi (decentralised finance). You can check that article out here. This time we’re going to focus on the NFT craze that’s currently taking the world by storm. Let’s jump right in!

Fungibility Explained
Fungibility is when a unit of something can be interchanged with any other unit of the same thing. For example, a US dollar bill is the same as any other US dollar bill and they’re all valued the same. This goes for equities like Apple stock. Any share of Apple is interchangeable with any other share of Apple stock. Most financial markets facilitate the trade of fungible assets like the above. In commodities markets, contracts for oil, wheat, or even pork bellies, are standardised to an agreed upon quality grade so that the units of each are considered interchangeable.

Non-Fungibility Explained
An asset that’s non-fungible is considered unique and thus not interchangeable with anything else. An original Picasso painting, for example, is not considered interchangeable with an original Van Gogh, or even with any other Picasso. The same goes for that limited edition, signed, psychedelic rock record from the 1960s that your mother handed down to you. Your home is also considered a non-fungible asset, even though it may be located in an apartment block of identical flats, they are not all exactly the same. So, assets can either be fungible, or non-fungible, and most of the financial markets we’re aware of (FX, stocks, precious metals, energy, agricultural commodities etc.) are markets in fungible assets.

What is an NFT?
NFT stands for non-fungible token, it’s basically a cryptocurrency that’s unique. What’s the use of non-fungibility in crypto? Well, a non-fungible token can be used to verify the authenticity of some unique object in the real world. For example, a work of art, a property, a vehicle, or even an obligation such as a mortgage, sales contract, or pending invoice. It can also represent a unique asset that only exists in the digital world, such as a piece of digital art, music, or in-game items like skins or trophies. The idea is that just like Bitcoin was the first provably scarce digital asset that’s fungible, NFTs are now attempting to do the same thing for assets (both real and digital) that are considered unique and thus non-fungible.

What NFTs Can Do
Imagine you’re an artist who wants to digitise your work so it can be sold online. NFTs not only allow you to do this, they also provide the buyer with a cryptographic guarantee that what they purchased is provably authentic. In addition, they provide you with certain benefits that you couldn’t hope to recreate in the “real” world. For instance, in the traditional art world, every time your artwork is re-sold to another collector for more money, it’s the current owner and the art dealers that get to see this extra profit. You as the artist don’t participate in or have access to any of the extra value that your work continues to create. With NFTs, you, your next of kin (or even their descendants) can theoretically receive a cut of the resale value of your work every single time it changes hands. It also gives you access to much larger markets of potential buyers that operate around the clock.

NFTs will allow assets that have been historically difficult to quantify, to enjoy the same sort of price discovery mechanisms that fungible assets do. Imagine you’re a small to medium enterprise that’s just secured a million dollar contract with a Fortune 500 company. Historically, you would have to wait for that contract to be completed in order to have access to that capital. NFTs allow the future value of that contract to be transformed into a unique asset that can then be traded on the open market, or used as collateral, allowing your business to unlock much-needed capital that it can use to grow its operations today.

Are NFTs A Bubble?
The short answer is YES! Just like the ICO (initial coin offering) craze of 2017, NFTs have sparked a speculative mania where everyone is throwing money at them expecting to get rich. This is partly because people are only just realising the implications of how NFTs could potentially change the way we do many things, from digital rights, to contract law. For now, though, most of the NFT space is dominated by silly memes achieving hugely inflated prices purely based upon this idea of uniqueness.

The best counterargument to this goes as follows: just because something’s unique, it doesn’t mean it’s worth anything. This holds just as true in the digital world as it does in the physical world. For example, your neighbour Bob fancies himself as an artist even though he has no talent and nobody cares about his work. Each piece of “art” he creates is just as unique and non-fungible as an original Picasso, right? So, should it be valued anywhere near an original Picasso, or closer to zero? Okay, so you get the point.

To discuss this or any of the other articles in this series, or to suggest future articles you would like to see, please get in touch. We’d love to hear from you.