Cryptocurrencies, utility tokens, security tokens and more…digital assets and their classifications are evolving right alongside cryptographic and blockchain technology. Non-fungible tokens, or NFTs are another example of the fast-paced change in the industry. In this guide we explore what they, how they work, and how they're being used.
What are non-fungible tokens?
Non-fungible tokens contain identifying information recorded in their smart contracts. It’s this information that makes each different and as such, they cannot be directly replaced by another token. They cannot be swapped like for like, as no two are alike. Banknotes, in contrast, can be simply exchanged one for another, if they are the same value, there is no difference to the holder.
Bitcoin meanwhile, is a fungible token. You can send someone one Bitcoin and they can send one back, it would still be one Bitcoin. The value might change depending on the time between exchanging Bitcoin, but it's essentially the same. You can also send or receive any part of a Bitcoin, measured in Satoshi, as fungible tokens are divisible.
Non-fungible tokens are not divisible, in the same way as you cannot send someone part of a concert ticket. Part of a concert ticket wouldn’t be worth anything on its own and would not be redeemable.
CryptoKitties collectibles were some of the first non-fungible tokens. Each blockchain-based cat is unique, if you sent someone a CryptoKitty it would be a completely different one if you were sent one in return, unless they returned the exact same one.
The unique information of a non-fungible token, like a CryptoKitty, is stored in its smart contract and immutably recorded on the token’s blockchain. CryptoKitties are Ethereum ERC-721 tokens, they use Ethereum’s protocols and the Ethereum blockchain.
Did you know?
In late 2018, one player was so desperate to move to a "better location" in the virtual game Decentraland that they were ready to say goodbye to 2,800,000 MANA in order to purchase a land piece in-game. At the time of the deal, that was equivalent to over Ξ1000 or $215,200.
What makes NFTs so special?
Non-fungible tokens have unique attributes, they are usually linked to a specific asset. They can be used to prove the ownership of digital items like game skins right through to the ownership of physical assets.
Other tokens are fungible, in the same way as coins or banknotes. Fungible tokens are identical, they have the same attributes and value when exchanged.
How are non-fungible tokens used?
As well as for crypto-collectibles like CryptoKitties, non-fungible tokens can be used for digital assets that need to be differentiated from each other in order to prove their value, or scarcity.
Another example of a non-fungible token is Decentraland’s LAND token. Decentraland is a blockchain-based virtual world, similar to Second Life. Each LAND token represents a parcel of virtual land in Decentraland identified by its virtual world coordinates.
SuperRare is another blockchain project creating non-fungible tokens that allow digital artists to link a token to an image or GIF they have created. A token represents ownership of the digital art and allows the creator to also retain and record their copyright and IP. The tokens, and hence the art, can be bought and sold just like physical artwork.
Non-fungible tokens are not traded on standard cryptocurrency exchanges, instead they are bought or sold on digital marketplaces like Openbazaar or Decentraland’s LAND marketplace.
How do NFTs work?
Tokens like Bitcoin and Ethereum-based ERC-20 tokens are fungible. Ethereum’s non-fungible token standard, as used by CryptoKitties and Decentraland, is ERC-721. Non-fungible tokens can also be created on other smart-contract enabled blockchains with non-fungible token tools and support. Though Ethereum was the first to be widely used, NEO, EOS, and TRON, now have NFT standards.
Non-fungible tokens and their smart contracts allow for detailed attributes to be added, like the identity of the owner, rich metadata or secure file links. The potent of non-fungible tokens to immutably prove digital ownership is an important progression for an increasingly digital world. They could see blockchain’s promise of trustless security applied to the ownership or exchange of almost any asset.
As is the challenge of blockchain to date, non-fungible tokens, their protocols and smart contract technology is still being developed. Creating decentralized applications and platforms for the management and creation of non-fungible tokens is still relatively complicated. There is also the challenge of creating a standard. Blockchain development is fragmented, many developers are working on their own projects. To be successful there may need to be unified protocols and interoperability.
Predominantly, non-fungible tokens are being implemented in gaming and crypto collectibles. For gaming, non-fungible tokens could be used to represent in-game items like skins, potentially allowing them to be ported to new games or traded with other players.
Their potential however is much wider with possible application to copyright and intellectual property rights, ticketing and the sales and trading of video games.
Non-fungible tokens add potential to the creation of security tokens, the tokenization of both digital and real-world assets. Physical assets like property could be tokenized for fractional, or shared, ownership. If these security tokens are non-fungible the assets ownership is completely traceable and clear, even if only tokens representing part ownership are sold.
Further application of non-fungible tokens could be certification such as for qualifications, software licensing, warranties, and even birth and death certificates. The smart contract of a non-fungible token immutably proves the identity of the recipient or owner and could be stored in a digital wallet for ease of access and representation. One day, our digital wallets could contain proof of every certificate, license, and asset, we own.