Complete Guide to Non-Fungible Tokens (NFTs)

Complete Guide to Non-Fungible Tokens (NFTs)

Complete Guide to Non-Fungible Tokens (NFTs)

Regardless of whether you’re invested in cryptocurrencies, you’ve likely heard of Bitcoin. Of all the cryptocurrencies that exist, Bitcoin is the most familiar and the most prominent—despite the fact that it is still not considered legal tender in Canada.

That said, there are dozens of other virtual currency options out there, which have been rising steadily in popularity. Among them are NFTs, or non-fungible tokens. On a basic level, NFTs are their own type of blockchain technology—specifically Ethereum blockchain—and they’re making digital artwork more valuable. In fact, investing in NFTs is most commonly compared to collection fine art.

If you’re brand new to the concept of NFTs, stick around. You’re about to get the lowdown on the virtual currency that’s redefining the value of digital art.

How Do NFTs Work?

At a very high level, most NFTs are part of the Ethereum blockchain. Ethereum is a cryptocurrency, like Bitcoin; however, its blockchain also supports NFTs, which store extra information that makes them work differently from, say, a bitcoin. It is worth noting that other blockchains can implement their own versions of NFTs. Due to its additional storage, an NFT can take the form of art, music, videos—even tweets! These may all be stored in a variety of file types.

Let’s break that down a bit: if you don’t already know, blockchain is essentially a virtual database that logs and stores each transaction in chronological order. It’s the online equivalent of bookkeeping or keeping ledgers or records of in-store transactions.

NFTs are units of data stored via blockchain; what separates them from cryptocurrencies is their unique identification codes. These codes have their own metadata that sets individual tokens apart, providing the ability to transfer tokens between owners as well as verify ownership.

Owners of NFTs—artists, for instance—may also include their signature in an NFT’s metadata to accompany artwork traded via a token. In some cases, this signature may increase value.

Advantages of NFTs

Purchasing NFTs is compared to collecting art because those who buy them are, in fact, collecting digital art. Because each token is unique and cannot be replicated—nor can ownership be amended—the owner of an NFT is the sole owner until that token is traded or sold.

This concept of sole ownership, or scarcity, is what makes NFTs highly valuable. Whoever creates a token can set the conditions for how it may exist, and once those conditions are set, they cannot be altered. For example, if there is only one NFT for a specific asset, that NFT cannot be replicated—even if it is recreated. The recreated version would still be a different NFT, making the original art rare and valuable.

In light of this, one of the primary advantages of NFTs is value. Think of a rare work of art or a first edition manuscript. No matter how many copies are made and sold, only the original—or originals—have a high value. 

Adding to this, there are a few other benefits of owning or trading NFTs:

  • Both the artist and the owner benefit from an NFT transaction
  • They are limited, and therefore scarce (and rare)
  • They are indivisible, or unable to be broken into smaller and less valuable units
  • They are easily sold, traded, and transferred

Disadvantages of NFTs

As with cryptocurrencies, one of the biggest disadvantages of NFTs is that they are new, not widely accepted, and therefore volatile. No one can predict whether NFTs will grow in value or even maintain their value. This means that investors have to accept a good deal of risk when buying a non-fungible token.

Generally, the major disadvantages of NFT investment are:

  • Occasional risk of fraud (due to hackers)
  • The asset or content may not be perfectly preserved (i.e., quality may decline, file formats may become unusable, digital wallets may be lost or become inaccessible)
  • The value may decline after the original purchase
  • Subject to capital gains taxes

In short, NFTs can be a risky splurge due to factors such as uncertain value, unstable preservation, and potential exposure to fraud and hacking.

What Makes NFTs Valuable?

We touched on this a bit earlier, but if investors and collectors are pouring millions of dollars into NFTs, the value of these tokens is worth exploring in more detail.

Because NFTs are scarce and therefore rare, the buyer holds a unique form of digital art after making a purchase, which drives up the value. The creator, meanwhile, makes a profit—their work has been purchased instead of being copied or forwarded, as is often the case with digital artwork.

Unlike other collectible items, the scarcity—and therefore value—of an NFT is guaranteed because it has been hardwired into the token itself. Moreover, the way NFTs are created makes authentication more than just possible, it makes authentication reliable. The owner of an NFT will always be able to prove that their asset is real, which is a great quality when buying or selling any rare item. 

Of course, “value” is often immeasurable and completely intangible. It is typically ascribed to items that are high in demand, low in supply (again, scarcity), and beautiful, meaningful or useful. Thus, the true value of an NFT is subjective, much like any other art form.

When Are NFTs Used?

NFTs are most commonly used for buying and selling digital art. This cryptocurrency gives artists another means of profiting from their work without having to partner with galleries or auction houses. Plus, the “middle man” typically takes a cut from the final sale as commission, but NFTs eliminate that third party, allowing artists to sell their work directly to investors.

And NFTs get even better for artists. An artist can program royalties into a token so that they will continue profiting from their art even as it is sold and resold by the original buyer. This is a particularly beneficial aspect of non-fungible tokens for artists, since they usually do not receive future royalties after their work is first purchased.

While trading, transferring, and owning digital artwork is one of the main purposes of NFTs, they are also used outside of the art realm. For instance, Nyan Cat—a 2011 gif sensation—recently sold as an NFT for about $600,000; meanwhile, the first tweet of Twitter CEO Jack Dorsey was sold earlier this year for $2.9M. Music groups are even jumping on the bandwagon, with Kings of Leon being the first-ever band to release an album as an NFT. 

While art NFTs are the most common and popular forms, there is really no limit to when and how NFTs can be used.

Why Are NFTs Important?

Among other things, NFTs are important because they are revolutionizing the way art is sold and collected.

In March 2021, the artist Beeple made $69.4M from his digital art entitled “Everydays: the First 5,000 Days.” It sold at Christie’s, a bricks-and-mortar auction house, but it is one of the most remarkable examples of the efficacy and influence of non-fungible tokens.

Thousands of other pieces of digital art have also been purchased via NFTs, providing tremendous value to artists and buyers alike. This is because:

  • Artists now have access to an additional source of revenue—one that doesn’t require a portion of their sales for presenting their art
  • Buyers can invest not only in the art they collect but in a new asset class

Non-Fungible Tokens vs. Cryptocurrency

Though non-fungible tokens and cryptocurrency, such as Bitcoin or Ethereum, are relatives of sorts, they are not the same thing. Both are forms of virtual currency that use similar programming (blockchain technology), but the main difference lies in an NFT’s unique value compared to another NFT.

Crypto, for example, is “fungible,” meaning that it can be traded or exchanged for money. Moreover, one crypto unit, such as a bitcoin, is always equal to another bitcoin. This is not the case for NFTs, which are not equivocal in value. Each is ascribed its own value because each NFT represents a different and unequal image, design, video, etc. 

While cryptocurrencies can be bought and traded through apps such as Coinbase, NFTs are purchased separately, through platforms and online marketplaces such as:

  • OpenSea
  • Rarible
  • Foundation 

Buyers should note that it is important to do some research prior to investing. OpenSea and Rarible, for example, do not require verification or a certificate of authenticity for their listings, so it’s a good idea to get as much information as possible before buying. This is true not only for NFTs, but for any major purchase.

Conclusion & Recommendations

Non-fungible tokens are among the latest of virtual currencies and are amounting to some serious value for both artists and investors. While they can be a volatile investment, NFTs have also become a valuable outlet for artists and collectors alike. However, like any major purchase, buyers should be prepared to do some research prior to purchasing a high-value NFT, as they can be purchased through a variety of online marketplaces and platforms which do not all practice the same level of due diligence.