Non-Fungible Token | What is NFT and How Does it Work?

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Non-Fungible Token (NFT) Explained | How Do NFTs Work?

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5 Min Read    |    April 09, 2021

According to CNBC,

Jack Dorsey, CEO of Twitter and Square, sold his first tweet as an NFT, or nonfungible token, for over $2.9 million on Monday when the bidding ended on the “Valuables” platform, which is run by Cent, a blockchain-powered social media network. 

Apart from that, on March 11, 2021, Beeple, a digital artist, sold his art to Vignesh Sundaresan for $69 million.

What exactly is NFT?

Why did it get this craze all of a sudden?

Here’s everything about NFT and how it became the red-hot digital art market. Read on to find out.

What is NFT?

NFT stands for Non-Fungible (un-interchangeable) Token, meaning something that cannot be changed for something else.

For example, the Taj Mahal. You cannot swap the Taj Mahal with anything because it is a one-of-a-kind asset.

In this context, fungible means something that is interchangeable.

For example, swapping the currency, i.e., you can swap a Rs. 100 note for another Rs.100 or two Rs 50 notes. Here, there is no change in the value. 

NFT is like the registration of ownership of a digital object on a blockchain, a digital ledger that records all transactions from the time they were created to the time they last exchanged. It is a new method of buying and selling art and other media in a digital mode.

You might come to know about NFTs (Non-Fungible Token) after the news of sales that are worth thousands of dollars around the artwork. Though a lot of the current NFT market is roaming around art, NFTs can be anything digital such as drawings, music, GIFs, etc.

As mentioned above, in NFT, there is no tangible form of an asset but a unique code assigned to anything digital. This digital code is stored on the Ethereum blockchain which one cannot erase or modify the data once it is entered.

In simple terms, NFTs transform digital artwork into one-of-a-kind assets that can easily be bought and sold on the blockchain.

While buying this digital artwork, the buyer of the NFT gets a token that proves they own the original work.

NFTs That Have Been Sold

In recent weeks, some NFTs (non-fungible tokens) have sold for hundreds of thousands of dollars. One such trade has taken place between Beeple and Vignesh Sundaresan. The deal is worth more than $69 million at an auction. 

Beeple, an American digital artist, sold his digital collage titled “Everydays: The First 5,000 Days' to Vignesh Sundaresan.

According to Business Insider,

'I honestly, like, I never thought I could sell my work,' Beeple said in an interview at his home in South Carolina. 'Kind of late September, early October, people kept hitting me on being like, 'Oh, you got to look at this NFT thing.''
In March, Christie's, a 225-year-old auction house that previously only sold physical art, auctioned an entirely digital piece by Beeple. It sold for $69,346,250.

Another such NFT activity is Twitter co-founder, Jack Dorsey’s first-ever tweet for sale with bids hitting $2.9 million.

Chris Torres sold an animated Gif of Nyan Cat for $561,000.

Three years ago, the NFT market value was around $41 million. Now it is around $338 million i.e., it has grown by 705%.

Growth of NFTs

As all transactions are stored in a blockchain, Ethereum, it is easy to verify the owner of the NFT. The creators of the art can retain the ownership rights over their work and can even claim the royalties.

NFT Returns

Now that we have talked about what NFTs are and how they work, let us now compare the returns from NFTs with other forms of investment.

People are very much excited about blockchain and cryptocurrency these days. They are looking for new investment avenues, unlike the traditional investment platforms. 

Like any other speculative investment avenue, NFTs also work like speculative assets. One can buy any digital art and can wait for an increase in its value to sell it for a profit.

On average, one can get the returns from art are 7.5%.

If we look at the annual returns of other investment avenues i.e., the Indian stock market, government bonds, and fixed deposits, they are giving 14%, 8% and 7% returns respectively.

The risk in this crypto art is so huge that Beeple, just after his record-breaking auction, said that the NFT market is in a bubble right now and will go to zero and doesn't inspire confidence for longer-term investors. So, most of the time, NFT valuations go through the classic hype cycle.

For 7.5% returns, it is not acceptable to take such a huge risk.

So, one needs to be even more sceptical, while investing in NFTs.

NFT returns vs other investment returns

There are over 70 million cryptocurrency owners worldwide but the buyers and sellers of NFTs are very few.

In 2020, the buyers and sellers of NFTs are 74,529 and 31,504 respectively.

Segments of the NFT industry

  • Metaverses

Metaverse enables players to create virtual space and design games of their own. With NFTs, users can own the assets to design and can sell in the market.

  • Art

Artists these days are looking up to NFTs and online platforms. With NFTs, artists can solve one of the biggest challenges i.e., copyright infringement.

NFTs provide proof of ownership and eliminate fraudulent activities.

  • Gaming

The concept of virtual reality and currencies is not a whole new world to gamers or the gaming industry.

If you are a gamer, now you can hold and own in-game items. With NFTs, these items can be tokenized and you can even trade these in-game items in the market.

  • Sport

The collection of sports memorabilia is ineradicable in the sports industry. And NFTs are the biggest opportunity to create, collect and trade memorable moments.

NBA Top Shot is the renowned forum to buy and sell sports (Basketball) collectibles.

       Collectibles

Collectibles are currently one of the most popular segments of NFTs. CryptoPunks were launched in June 2017 at American Game Studio Larva Labs.

These are 24×24-pixel art images, one of the first collectible NFTs on Ethereum, and have sold for thousands of dollars.

You may also have heard of CryptoKitties, virtual cat images. This application reached a volume of over $38 million recently.

       Utilities

According to the NFT yearly report, utilities can be NFT domain names, tickets, and assets that can grant access or specific rights to their owner. It can be individuals with unique avatars.

NFT Sales Volume by Category

NFT Sales Volume by Category

How to Sell NFTs

There are various market avenues there to buy and sell NFTs.

To sell the arts or assets as NFTs, creators, artists or digital art sellers need to register with a marketplace and mint their tokens. For this process, they need to share and verify their information or data on a blockchain, in this case, Ethereum.

After the verification, the creator can put the asset and ask the buyers to bid. The deal takes place at which both seller and buyer agreed upon.

How to Buy NFTs

For this, first, you need to decide the marketplace from which you intend to buy the NFTs.

There are so many marketplaces available to buy NFTs such as Nifty Gateway, MakersPlace, SuperRare, OpenSea, Decentraland, Rarible, etc.

Then you need to download the wallet and decide the cryptocurrency that supports the marketplace or platform to complete the trade.

Pros of NFTs

  • The primary advantage of NFT is that sellers can access a global market to sell their products.

  • The seller can get royalty after every time his product is sold in the market.

  • One can identify the original owner of art as every transaction is stored or recorded in the Ethereum blockchain ledger. It also ensures safety.

Cons of NFTs

  • NFTs take a lot of energy that on average as a single NFT takes up around 340kWh i.e., a carbon footprint of 211kg.

  • There are instances where some people enter into the NFTs as original owners which turn out to be false claims. Even after complaints made by original owners, no marketplace took charge to resolve the problem.

  • Another problem with NFT is its dependency on third parties such as the ethereum blockchain, internet, etc.

Should You Invest in NFTs?

NFTs are on a craze in the first place is because it establishes authenticity and chain of ownership for a digital piece. So, can this be the reason to make it a good investment tool?

Considering this as a reason, the NFT ecosystem has gone into a historic boom during 2020. After a huge trade volume, people considering the NFT industry is not just speculative but also a value generative.

But, the most important thing we should talk about while discussing the investments in NFTs is, “IT IS VERY NEW”.

There will be a high amount of risk and the NFT market is still going through so many ups and downs, it chooses different cycles. So, investing in NFTs (non-fungible tokens) is quite a risky task.

 

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