What Are NFTs?

A beginner's guide to non-fungible tokens

The Concept Of Fungibility

To understand what exactly makes a non-fungible token (NFT), we need to start from the concept of fungibility – the quality of being able to be replaced by an identical entity. The simplest explanation would be through money.

Imagine I deposited $5 into your bank account, and you now have a grand total of $100. Can you identify amongst the $100, which dollars came from me? Probably not, and the fact that every dollar is identical, equal, and interchangeable is the fungibility of the dollars.

In comparison, a non-fungible entity is truly unique, irreplaceable, and non-interchangeable. That's to say, one object does not have its exact equivalent in this world.

Non-Fungible Items In Our Physical World

What are some examples of non-fungible items?

A natural diamond is non-fungible and no two are alike. Even if they are cut in the exact same size and shape, there will be unique properties and the slightest of inclusions can appear on different spots within each diamond.

Likewise, a piece of original traditional art is non-fungible. Of course, it can be copied but the copies will never be able to replace the original. Even if the same artist were to attempt to paint a replica, there will be subtle differences between the two pieces. In a way, assets like jewellery, artwork, collectible cards that are collected by people are all non-fungible, and there are ways to identify the authentic version.

Cryptocurrencies And NFTs

NFTs are a specific use case of cryptocurrencies. They are digital products turned into unique tokens that reside on the blockchain. It can be an image, a song, a body of text, a video, a Tweet – basically any digital file. By tokenising it, the digital file leverages on the verifiability and immutability of cryptocurrencies to create a unique mark.

Cryptocurrencies started with Bitcoin, which was designed to be a "peer-to-peer electronic cash system". As a cash, or currency, Bitcoin was meant to be fungible, so your 1 BTC is interchangeable with and is equal to my 1 BTC.

The earliest ideas of NFTs came about when early adopters thought of ascribing a unique value to each coin. For example, if they were to label them as BTC #001 and BTC #002, they will be unique. This is the concept of coloured tokens, where you "colour" each piece with a unique trait. NFTs is essentially "colouring" it with an attached digital file. Note: This is an oversimplified example, because BTC can be broken down further into Satoshis. For coloured tokens (and NFTs), we should "colour" the smallest unit available i.e. 1 Sat.

Bitcoin and blockchain technology created an online, verifiable, and immutable ledger. As all transaction records are stored and publicly available on the blockchain, anyone in the world can see exactly when a token was first created, by whom did it originate from, and all subsequent transactions relating to that token. Even if someone were to create a visually identical replica, if it did not come from the original source, its authenticity can easily be verified.

Despite the practical use case, NFTs did not take off until 2017 when the rise of Ethereum (ETH) and smart contracts made it a whole lot easier for anyone to create their unique tokens. ETH-based projects took off and Initial Coin Offerings (ICOs) stole the limelight back in 2017/2018. That was also when some of the OGs of NFTs started to appear, with the likes of CryptoPunks, CryptoKitties, and EtherRocks drawing some attention but quickly faded to oblivion with the burst of the ICO and crypto bubble. That was also the longest crypto slumber, commonly dubbed the "Crypto Winter".

It wasn't until the latest crypto bull run did NFTs and cryptocurrencies start to gain traction again.

Renaissance Of NFTs In 2020/2021

During the Crypto Winter, prices of cryptocurrencies were stagnant but many projects and companies continued to build. I argue that the rise of DeFi (Decentralised Finance) applications, together with the wrapped tokens that led to more staking and leveraging were what kickstarted the 2020 crypto bull run. At the same time, early signs of a NFT run started to appear towards the end of 2020 with NBA Top Shot, Punks, and Beeple, starting to sell for never-before-seen valuations.

In March 2021, Beeple's $69M sale epitomised the peak of this NFT mania, but the NFT community was still mostly a thing for the crypto people – oh, the difficulty of buying ETH, setting up your crypto wallet, pasting the right public address, and not to mention the ATH (all-time high) prices of most cryptocurrencies that price newcomers out. While the NFT market suffered a blip in May 2021, alongside the major correction of the crypto market, it has since continued on its trend with NFT marketplaces clocking record sales volume in August 2021.

Beeple's sensational sale drew in the next group of NFT people, myself included. Artists started to create art to "throw onto" the NFT marketplaces, people attempted to create their own Avatars to match the likes of Punks, and the curious, programming-savvy ones deployed their own generative NFTs. On the demand side, people who are on the back of the bull run have bags of cryptocurrencies for long-term HODL, and are looking for ways to spend and/or utilise their cryptocurrencies.

Therein, we now have a wave of NFT creators, too much of them in fact, and most will likely go to zero. We also have a new group of NFT collectors, who are usually crypto-rich or have a lot of money to spare. Within the space, NFT types have also proliferated and there are more than just Avatars and Art; gaming NFTs are increasingly popular, while fractional NFTs are also on the rise. All of them promise some form of utility or access, if not collectors' value, and the sentiments are reminiscent of the ICO days when one can attempt to pick the winners in the long run.

A note of caution: Just like in the previous ICO bubble, many of these projects will fade, and chances of your NFT collection becoming worthless is high.

The Significance Of NFTs

NFTs rely on the consensus mechanism and immutability of blockchain to enact a use case. Even if you manage to grasp the significance of that, it's hard to imagine what exactly is so valuable about proving ownership of a particular token.

Why would people pay exorbitant figures to own an NFT? Is it just a social flex, as described by Arthur Hayes and Packy McCormick?

Even though I agree largely with their perspectives, and believe the ability to manifest social value makes NFTs incredibly valuable, it's still hard for me to put a dollar value behind an NFT. It's no wonder why sceptics think of NFTs as a bubble, a scam, or even a Ponzi scheme where the last person who gets out will be a sucker with a worthless bag of tokens.

On the other hand, there are people who appreciate the social value that comes with ownership, and are prepared to pay top prices be it through cryptocurrencies or dollars. With Christie's and Sotheby's including BAYC (Bored Ape Yacht Club) and Punks into their auction, it legitimises that social value and NFTs have also since become even more inaccessible to plebs. Will the prices of these legacy NFTs come down if the crypto market were to crash? That's something I can't wait to find out.

Documenting And Recording My NFT Journey

I've been an advocate of cryptocurrencies since 2017 so the technical difficulties never bothered me. What got me started with NFTs was first trying to mint my own NFT – I had to do the research, formulate hypotheses on what made people part with their ETH, and looking at countless projects that attempted to use NFTs in their unique ways.

In the process, I came across NFT projects to get behind, and many others I choose to just observe. I've also gained a much deeper appreciation for the term "community", beyond the mere description of what a community entailed. There are projects that have no substance but are exceptional at storytelling, and there are also seemingly simple and dumb projects but with a great deal of thoughts behind it. It's this multitude of complexities and exciting opportunities that led me to creating this blog, to document my observations and the changes that are developing faster than one can even write about them.

The primary purpose of this blog is to articulate my thesis surrounding a NFT portfolio (or collection), and in doing so, I hope to share my findings and ideas for anyone who might be interested to jump into this rabbit hole. Join me on this journey, and I'll love to have a discussion with you someday.

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