Non-Fungible Tokens(NFTs)

Shermin Voshmgir: March 15, 2021

This article is partially based on texts that have already been published in my book Token Economy and my blog post from a few years ago on NFTs.

Recently, I have been contacted by a number of media outlets asking me to give interviews or write about NFTs. The wording is always: “NFTs seem to be the new hot shit.” NFTs are definitely not new, but due to some recent events in the art world and beyond, mainstream media is finally moving past Bitcoin price reporting to the wide array of more interesting things we can represent with tokens — and in this particular case — with NFTs. But why the sudden hype? Here s brief summary of recent events:

Web3 tokens allow artists to sign a specific digital file (artistic content) with their private key, thereby creating uniqueness for that file. The client-server architecture upon which the current Internet operates does not allow us to distinguish original files from their copies. A data packet is a data packet. You can only use DRM to limit access to that data packet and use legislation to enforce your property rights and sanction pirating of files or IP. Web3 tokens allow us to create a hash of an original file and sign it with the private key of the content creator, which means that the hash of this file can be collectively managed by a blockchain network. Uniqueness of digital art and the fact that files can be copied for free does not necessarily have to exclude each other. Creating a digital signature allows us to build complex behaviour into the token contract that could create interesting new dynamics in the art world and beyond.

Wether or not it makes sense to create artificial scarcity for a digital file is probably a matter of taste and subject to specific use cases. I personally don’t see an added value in paying 2,5 million USD for a digitally signed tweet by Jack Dorsey or paying 69 million USD for a an Instagram picture by Beeple. Other seem to think different. But there are many other NFT use cases that I find interesting and which we will discuss in a bit, but first let’s try and answer following question:

As opposed to Bitcoin and similar crypto assets, Non-fungible tokens (NFTs) are unique in nature, with varying properties that allow us to distinguish one token from another. NFTs can represent digital, unique, and thus scarce assets, such as art, other collectibles or even real estate. NFTs can also represent identities and anything that is tied to a physical identity such as voting rights, access rights and management rights: Examples are certificates, such as licenses, degrees, keys, passes, voting rights, tickets, loyalty tokens, copyrights, proof of authorship (of books, scientific papers and any kind of audio-visual content) as well as warranties, software licenses, medical data, wills (the transfer of assets), and certificates of any kind, such as supply chain or art certificates.

Web3 tokens are programmable rights management tools that can have much more complex properties than fungible currency tokens. They can represent any asset, access right, voting right or management right. Here is a broad overview of the different range of properties a token can have: (i) technical perspective; (ii) rights perspective; (iii) fungibility perspective; (iv) transferability perspective; (v) durability perspective; (vi) regulatory perspective; (vii) incentive perspective; (viii) supply perspective; and (ix) token flow perspective, (x) privacy perspective.

In my book Token Economy I described all the above mentioned perspectives, in this post, however, i would like to focus only on the fungibility perspective.

From an asset perspective, fungibility refers to the interchangeability of a unit of an asset with other units of the same asset. Examples thereof could be any durable goods, such as precious metals or currencies. Fungible assets have two key properties: (i) Only quantity matters, which means that units of fungible assets of the same kind are indistinguishable. (ii) Any amount can be merged or divided into a larger or smaller amount of it, making it indistinguishable from the rest. If you were to lend 10 EUR to someone, for example, it would not matter if that person returns the exact same 10 EUR bill or another one, or various bills and coins that amount to the value of 10 EUR. The same applies to one barrel of crude oil. Flour is another example of a fungible asset, and is also one of the reasons why it was used as a commodity currency in the past. Fungibility is an important property of any currency or commodity to serve as a store of value, medium of exchange, and a unit of account.

While some of these use cases are slowly showing some traction, they are not new. NFTs haven been around the crypto scene for a while, but we are still in the early stages of figuring out appropriate standards and similar patterns for pervasive use cases.

The first Web3 tokens were the native tokens of public and permissionless blockchain networks. In 2013, “Colored Coins” was one of the first projects that attempted to attach unique properties to a token. The idea was to use Bitcoin tokens to represent real-world assets like stocks, bonds, commodities, or the deed for a house. “Counterparty” was another project that built on this idea, but went one step further. It enabled users to create their own virtual assets on top of the Bitcoin network.

With the advent of Ethereum, tokens have moved up the technology stack and can now be issued on the application layer. Such application tokens can have simple or complex behaviors attached to them. As opposed to Counterparty and colored Coines, Ethereum made it particularly easy to issue tokens with a few lines of code. Standardized smart contracts like the “ERC-20” standard define a common list of rules for Ethereum tokens, including how the tokens are transferred from one Ethereum address to another and how data within each token is accessed. These token contracts manage the logic and maintain a list of all issued tokens, and can represent any asset that has features of a fungible commodity. A majority of early tokens issued on the Ethereum network were ERC-20 compliant fungible tokens.

Over the last years, however, more complex token standards have emerged that can represent any asset or access rights with special properties, including identities and voting rights. “ERC-721” introduced a free and open standard that describes how to issue so-called “non-fungible tokens” on the Ethereum network and introduced the era of building more complex features into tokens.

From a tech perspective, the ERC-721 token standard allows for more detailed attributes that make a token special, beyond the attributes that can be found in ERC-20 tokens. It allows the inclusion of metadata about an asset and information about ownership. When validated, such additional information can add value, guaranteeing the provenance of art, collectibles, or along the supply chain of other goods and services.

Ethereum based NFTs started to attract attention in 2017 when the ERC-721 token standard was introduced, especially following the success of “Crypto Kitties,” a game on the Ethereum network where players can collect and breed digital cats, and where each cat’s unique digital “genetic code” is stored on Ethereum’s ledger.

However many more complex token standards have emerged that allow us to attach more complex attributes and behaviours to a token. The success of ERC-721 also triggered many other blockchain networks to develop their own non-fungible token standards.

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