The internet is full of funny images, including cartoon images of animals by digital artists from all over the world. The Bored Ape Yacht Club is one such group producing digital cartoons of apes in hats. They’re entertaining; they’re cute; and one sold for USD 3.4 million last year.

These monkey pictures are examples of NFTs: non-fungible tokens. To explain NFTs, let’s start with the concept of fungibility. Fungible assets are goods that can be readily interchanged for another of the same thing: a dollar bill is a dollar bill, regardless of its serial number.

That dollar bill is also four quarters or ten dimes, and so on. Its value remains the same. Stock operates in much the same way: One share of a company’s stock is worth the same as any other share of that same company. It doesn’t matter which one you personally own: The stocks are designed to be equivalent and interchangeable.

Go to any bookstore and buy a copy of any mass-market paperback. You now have a fungible copy of that text. But if you choose a first edition or a limited cover, things start to shift.

Now, you have something of a limited run, and its value often increases because of that. People may pay a premium to get that unique cover or the historical first edition: The book hasn’t actually got more to offer as a first edition. It’s generally the same text that you’d find in the mass-market paperback.

Bringing it back to art, you could purchase a print of one of Monet’s Water Lilies series for your wall; you could even print an image from the internet and hang that.

But an original Water Lilies piece costs so much more than a printer-paper copy or even the most skilled reproduction. You’re not just paying for the image, you’re paying for the history and the provenance, for the fact that it’s a Monet, an original.

Anything can be an NFT. The NFT isn’t a digital image itself, but the receipt that shows that you own it. A blockchain record verifies the purchase.

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If you want your item to be valuable, you often want it to be non-fungible. For physical items, non-fungibility makes sense. Certain things hold greater value than others even if they are fundamentally the same thing. Digital media, however, is infinitely reproducible.

My eBook copy of the mass-market paperback is identical to your copy, right down to the ones and the zeros. How can you have a collector’s edition of those ones and zeros? How can you have something special when creating an exact copy is as simple as Ctrl+C?

ENTER THE BLOCKCHAIN

Blockchain is the technology that’ll be powering everything, that new system we’ve all heard of yet barely anyone actually understands. Blockchain offers an immutable and tamper-proof ledger, where each record created forms a block, and each block is confirmed by the community among which the platform is shared before it can be paired up with the previous entry in the chain.

The blockchain is a shared database, validated by a wider community rather than a central authority, making it a public ledger that cannot be easily tampered with, as no one person can go back and change things.
If you purchase an NFT, you are the sole owner, and this fact is protected by the blockchain. No one can modify the record of ownership, and no one can copy/paste a new one into existence.

Smart contracts assign ownership and manage the transfer of NFTs. When someone creates an NFT, they execute code stored in the smart contracts that conform to different standards, with this information added to the blockchain to be tamper-free forever.

Think of an NFT as a template. Although 2021 saw digital art sweep the mainstream, anything can be an NFT. The NFT isn’t the asset itself, but a unit of data (or a digital asset) on the blockchain that confirms and represents ownership of the asset, whether that is digital or physical.

If you’re purchasing a piece of digital art that has been listed as an NFT, the NFT is the string of numbers on the blockchain that says, “Yes, you own this now.” It’s like a digital receipt that no one can argue with.

An NFT could represent digital art, from GIFs to videos, and real-world items such as the deeds to a house, legal documents, tickets to a real-life event and so on. As the Ethereum website says, “It’s not hard to imagine a world where your Ethereum wallet becomes the key to your car or home — your door being unlocked by the cryptographic proof of ownership.”

WHERE IS THE MONEY?

As with any good where only a limited number exist, you can often expect its value to increase over time. Bragging rights command a high price. The NFTs created by Bored Ape Yacht Club, a team of developers who created the 10,000 Bored Apes sitting in the digital repositories of such celebrities as Justin Bieber, Paris Hilton and Jimmy Fallon, also serve as tickets to an exclusive social club. And they’re all sold out.

At the same time, there’s money to be made anywhere people are willing to pay for something.

Some people want to support their favorite creators by buying a “premium” version of a piece. Some people just want to own a piece of digital art.

There’s also the concept of royalties, which is new to this marketplace, but powerful. Some NFTs have smart contracts that will automatically pay out royalties to their creators when they’re sold.

As their work is sold from person to person — as that NFT changes hands — creators can earn royalties automatically.

And the potential for those royalties could be rapidly growing. Andrea Baronchelli, reader of mathematics at City University of London, reports on what he describes as the “NFT revolution.”

Some NFTs have language built into the smart contract that automatically pays out royalties to the NFT creators when the asset is resold.

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He investigated data concerning 6.1 million trades of 4.7 million NFTs between June 23, 2017, and April 27, 2021, and says the NFT market experienced a 150-fold growth in just eight months at the end of 2020 and into 2021.

“Following an initial rapid growth in late 2017, when the CryptoKitties collection gained worldwide popularity, the size of the NFT market remained substantially stable until mid 2020, with an average of around USD 60,000 traded daily,” Baronchelli says. “Starting in July 2020, the market experienced dramatic growth, with the total volume exchanged daily surpassing USD 10 million in March 2021.”

How valuable is an NFT, really? Usman Chohan, economist at the University of New South Wales, says an NFT is just “as valuable as people express a willingness to pay for it.”

Same as anything, then.

IT’S NOT PERFECT — YET

The blockchain itself is immutable; your information and your assets are safe when they’re on there. But with multiple NFT marketplaces and multiple individual blockchains, it’s feasible to screenshot an NFT from one platform and list it as something brand new and unique on a different platform.

Once it’s on that blockchain, have fun trying to delete it. Ultimately here, the fungibility applies to the specific blockchain instance of the thing, not the thing itself.

Chohan says this is part of what raises eyebrows among casual observers of NFT markets. “Anyone could, in theory, upload artwork onto an NFT, without proving that they are the original creator of the work,” he says. “This creates an evident real-world risk that fraudulent actors will upload NFTs to auction markets by posing as the original owners, or creators, of objects of value.”

“In theory,” he continues, “there can be multiple NFTs created over an asset, claiming to be the ‘true’ token representing an idea, image or object.”
There are contracts that can help mitigate this. If you want to buy an NFT, you can ask a smart contract to run a ”node,” a piece of software that checks everything on a blockchain for fakes. This contract needs to be smart enough to find fakes, but if it does, you’ll realize the NFT is a copy and you can pull out of the purchase.

The whole system works because blockchain technology is decentralized and secure, but this comes at a cost. It takes a lot of computing power to create new blocks in the blockchain, and blocks are created constantly to keep everything tamper-proof. Even if blocks aren’t storing new data, the more blocks, the more secure the chain.

The computing power to run NFT exchanges can be energy-intensive. Each new block in the blockchain required to prevent tampering with the record requires uninterrupted computer power.

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However, this means that uninterrupted computing power is required and that is energy-intensive, to say the least. According to the New York Times, mining bitcoin uses more electricity than some countries.

“The process of creating bitcoin to spend or trade consumes around 91 terawatt-hours of electricity annually, more than is used by Finland,” the paper reports. Blockchain companies like Ethereum are committing to making the process greener, but it’s likely that blockchain technology’s energy consumption will remain volatile.

THE ‘ART’ IN FRAUD ARTIST

Nothing is immune from exploitation and NFTs are no different. For those looking to launder money, the art world has long been a draw: Art typically commands a high price, and the industry allows large cash deals.

Many valuable artworks are housed in ”freeports,” high-security storage spaces for safekeeping. They are auctioned and purchased using dirty money, then anonymously sold on without ever leaving their place in the freeport. The new buyer can retrieve their new artwork from the same freeport, and the original buyer, turned seller, has money from a seemingly legitimate business deal. NFTs could make this even easier.

There is nothing stopping you listing any asset as an NFT for huge amounts of money. An anonymous user who totally isn’t you then buys that NFT, and you receive some nice clean cryptocurrency. The anonymity of the whole affair is the key here: When your government wants to know where you got all your money, you can point to the transaction where an anonymous user paid for your NFT.

IT’S ALL A BIT TENUOUS

When you buy an NFT, you buy the certificate of authenticity that proves you own the NFT, not the thing itself, and a link pointing to that thing. That thing could be the original image, that Bored Ape you’ve wanted for so long.

But that link is only as good as the service keeping that link active. It’s all very fragile and maintains value only as long as the people using it insist it has value. But then, that’s how all money works, really.

As Baronchelli points out: “The NFT market is less than four years old. Overall, NFTs are a new tool that satisfies some of the needs of creators, users and collectors of a large class of digital and non-digital objects.

Have you bought THE Mona Lisa or A Mona Lisa? The value of your asset often depends on the exclusivity of the purchase.

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As such, they are probably here to stay or, at least, they represent a first step towards new tools to deal with property and provenance of such assets.” Ultimately, NFTs are a way to emulate physical uniqueness for digital assets. Even if there are a million other identical copies out there, the NFT says that you own the original one.

This is all secured using blockchain technology, which is the same method that digital currencies use to ensure that you can’t make a million copies of your bitcoin.

There are countless copies of the Mona Lisa out there, but there’s only one Mona Lisa.