What are NFTs and why are they so popular?

The $69m sale of a digital artwork backed by a cryptographic token known as an “NFT” hit the headlines recently. But what are NFTs and why are they suddenly so popular? Saloni Sardana investigates.

The crypto world has been making headlines again, not because bitcoin hit a new record high, but because of Christie’s auction of a piece of digital art for $69.3m. 

The artwork, called “Everydays: The First 5,000 Days”, was created by Mike Winkelmann, a graphic designer better known in the online art world as “Beeple”. It is a collage of 5,000 pieces of digital art that Beeple has produced every day since 2007.

It is the first time Christie’s has listed an entirely digital piece of work in its 250-year history, and is the latest milestone in the incredible rise of “non-fungible tokens”, or NFTs. 

So what are NFTs and why are they becoming so popular?

What is an NFT? 

NFTs are cryptographic tokens  – much like a cryptocurrency – that are recorded on a blockchain and can be used to prove the authenticity, ownership and provenance of anything – physical or non-physical – such as artwork, collectable cards, or real estate, for example, in much the same way as a blockchain can be used to settle financial transactions or track elements in a supply chain. “Non-fungible” simply means that the token is unique and cannot be duplicated or swapped for anything else. 

When someone buys an artwork that is authenticated by an NFT, they are not actually buying the digital asset per se, but rather they are purchasing a digitally authenticated note stating that there is only one owner. Anybody can download a copy of the file or link relating to whatever asset the NFT is tokenising, but only the NFT owner holds the contract stating their ownership rights. The NFT declares you as the official owner.

NFTs were introduced  to solve the problem of how to create scarcity for an object that can easily be reproduced (unlike a traditional painting or sculpture, digital artwork is trivially easy to duplicate – it’s just a matter of downloading a copy). Using NFTs provides proof of authenticity, in the same way that the blockchain prevents any single bitcoin from being “owned” by more than one person. 

In contrast to physical pieces of art which can be broken, lost or destroyed, NFTs cannot be destroyed as they are recorded on a blockchain (which as I’m sure you know by now is an immutable record of transactions – but if you need to know more about blockchain, take a look at my colleague Dominic’s explanation here) in the same way as cryptocurrency transactions are. Most NFTs use the Ethereum blockchain, but there are others.

The rise of NFTs 

NFTs can also act as smart contracts. In the case of “Everydays”, the NFT gives the originator of the token a cut of future sales, with Beeple receiving 10%. This can help artists secure a reliable source of income at a time where the pandemic has caused much uncertainty for those who rely on physical shows to make an income. 

“A bunch of people like me have seen their work go completely”, Beeple tells The Art Newspaper. “I’ve gone from doing big shows, with Justin Bieber filling 70,000 people in a stadium, to nothing for the second year running. So NFTs have been a godsend for us in terms of being able to make money again”. 

NFTs are not entirely new. The first type of NFTs to hit the market were “Coloured Coins” in 2012, which are bitcoin tokens with extra functionality that allowed them to represent other assets on the blockchain. 

In 2017 (notably, another boom/bubble period for crypto generally), NFTs and digital art came together to create “Cryptokitties” – digitally-created cartoon cats that can be bought and sold with NFTs verifying ownership. Crypokitties were created "to explore the concept of digital scarcity, implement a non-fungible token within smart contracts”, says their creator. 

But a renewed interest in cryptocurrencies and a boom in digital art have thrust NFTs into mainstream consciousness. It’s not just obscure digital artists getting in on the act – visual artist and musical performer Grimes, better known today perhaps as Elon Musk’s partner, recently made $6m in minutes, from selling digital art backed by NFTs.

Twitter co-founder and chief executive, Jack Dorsey, also got involved by auctioning off his (and Twitter’s) first Tweet. The highest bid received for the tweet so far is reportedly $2.5m. The winner of the auction is set to receive a “digital certificate” of Dorsey’s first ever tweet, reveals the FAQ section on NFT auction site Valuables. What does that actually mean? Good question. The tweet will remain publicly available on the platform under Dorsey’s account. The “owner”, as certified by the NFT, won’t be able to delete it or do anything with it. They will merely have been recorded as being the owner. 

It is perhaps this which has left many people scratching their head – the vast amounts of money trading hands simply to have the knowledge that you are the owner, with perhaps millions of identical copies of the digital file in existence. Some proponents compare it to owning the Mona Lisa versus owning a student poster of said masterpiece, but unsurprisingly, that’s not an argument to convince the sceptics. 

The future of NFTs 

The biggest risk to NFTs is whether the bubble bursts. NFTs may be the white-hot phenomenon of the moment, but, as with any new technology, they still have some way to go before they are widely accepted and become truly mainstream. 

Despite the eye-watering sums changing hands in headline-grabbing transactions, they are still very much a niche product, and may well turn out to be a passing fancy - digital tulips, perhaps (or Cryptokitties, even). Holders of tokens could end up sitting on a surplus of NFTs with little buying interest if there is a slump in their popularity, in the same way as numerous bubbles have burst over the last several years. 

However, as with the wider use of the blockchain, it does seem clear that because of NFTs’ usefulness as records of ownership in business, they could well be here to stay in one form or another.

Dominic Frisby has put together a downloadable Beginner’s Guide to Bitcoin for MoneyWeek subscribers, which includes a bonus section on other cryptocurrencies. If you’re not already a subscriber, sign up now to get the report plus your first six issues free.

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