Introduction
The world of crypto and NFTs are exploding for the 4th and 1st times, respectively. I wrote this primer on the history and technical basics of NFTs for anyone with little or no background on the topic. The space moves quickly, so treat this piece as a cultural relic - have a read if you are building a systems-level understanding and take that understanding forward to explore the latest stuff! 😇
Definition of NFTs
A non-fungible token, or "NFT", is a unique digital asset. Consider "fungible" assets, like bitcoin or a US Dollar: all bitcoins and US Dollars are non-unique and interchangeable. In contrast, an example of a non-fungible asset would be a unique, one-of-a-kind piece of art (2).
NFTs can be used to register any digital assets on a blockchain. These assets could include, but are not limited to art, music, tickets, property, and more. What makes something an NFT is its encoding as part of the Ethereum blockchain. Most NFTs are today built on Ethereum, though some other blockchains implement their own versions of NFTs (1).
A Brief History of NFTs
2012-13 Colored Coins
One of the earliest attempts to use a cryptocurrency to denote and verify real-world assets on the blockchain was Colored Coins. Colored Coins are equivalent to small denominations of bitcoin, as small as a single satoshi (the smallest unit of a bitcoin). Colored Coins were mentioned in a few blog posts and papers in 2012-13 by various authors including Yoni Assia, Meni Rosenfeld, Vitalik Buterin, and Lior Hakim. Colored Coins could be used to represent property, coupons, issue shares of a company, and act as digital collectibles or access tokens. However, there was one main limitation: the Colored Coins only represented a certain value if everyone agreed to their worth. Thus, they may be thought of as one of the first explorations of putting real-world assets onto distributed ledgers, but was far from foolproof.
2014-17 Counterparty, Spells of Genesis, Force of Will trading cards, and Rare Pepes
Between 2014-16, Counterparty was founded as a peer-to-peer financial platform and distributed, open-source Internet protocol built on top of the Bitcoin blockchain, with use cases such as a trading card game. In 2016, popular trading card game, Force of Will, then the 4th largest trading card game (following behind Pokemon, Yu-Gi-Oh, and Magic: The Gathering in North American sales), launched their cards on the Counterparty platform. This was another leap forward in putting assets on a blockchain. Around the same time, Counterparty users began creating a collection of memes, called "rare pepes", featuring a frog character. These memes were traded on Counterparty, built on the blockchain protocol, as well as on the Ethereum blockchain through a project named "Peperium", created in March 2017.
2017 CryptoPunks
In June 2017, two individuals created a new NFT project on the Ethereum blockchain, "CryptoPunks": a collection of 10,000 unique characters generated through random combinations of visual features (e.g., beard, sunglasses, skin tone, hairstyles, and other attributes). CryptoPunks were initially offered to anyone with an Ethereum wallet to claim for free, and quickly gave rise to a secondary marketplace where people bought and sold them for hundreds, then thousands, and now, millions of dollars. The most valuable CryptoPunk as of late summer 2021 was CryptoPunk #7523 which was auctioned by Sotheby's in July 2021 and sold for $11.75M at the ETH-to-USD exchange rate of the time.
2017 ERC271 and CryptoKitties
CryptoKitties is a virtual game that allows players to adopt, raise, and trade virtual cats, all on the blockchain. CryptoKitties took another big leap in making NFTs mainstream because they were all over the news as a "digital cat" or "digital beanie babies" that you can buy and trade with cryptocurrency. Some virtual cats sold for over $100,000.
CryptoKitties were created by a Vancouver-based company called Axiom Zen and revealed at the ETH Waterloo Hackathon, the world's largest Ethereum hackathon. After the release of CryptoKitties, which coincided with the 2017 crypto bull market that saw bitcoin rise in value from $900 to $20,000 between December 2016 and December 2017. Axiom Zen spun out a company called Dapper Labs, which raised $15M from a16z and Google Ventures (and much more since then), and remains today as one of the leading players in the NFT space, as the company partnering with the NBA to launch NBA Top Shot collectible digital assets.
2018-19 Growing in the Background
The NFT ecosystem continued to grow slowly, with marketplaces like OpenSea, SuperRare, Rarible, Nifty Gateway, and many more online platforms used to buy and sell NFTs.
Web3 wallets like Metamask made it easier to purchase and own NFTs.
Some additional names from this era below courtesy of crypto newsletter The Block.
2020-21 Explosion in the Consumer Mainstage
NFT assets grew from $40.9M in 2018 to $338M in 2020, with 150,000 total individuals participating in the NFT market, according to enthusiast-started market information site Nonfungible.com, which also estimated the breakdown of NFT-related activities as follows: 25% metaverses, 24% art, 23% gaming, 13% sport, 11% collectibles, and 4% utility-based (6).
In September of 2021 alone, NFT asset sales totaled $2B in transaction volume.
Many more notable projects were launched during this time, which I won't describe in detail, including: Bored Ape Yacht Club (a profile picture & community project); Loot (a simple drop of text files that catalyzed hundreds of projects building on top of the concept); and RTFKT (a sneaker and metaverse brand).
For a more in-depth overview of the various categories of NFTs, I enjoyed this Beginner's Guide to NFTs, by Linda Xie of Scalar Capital.
Technical Background & Capabilities
Before I get to the business applications of NFTs, below is an overview of how the underlying blockchain technology works. Feel free to read, skim, or skip this section.
How Blockchains Work
NFTs historically, and most NFTs today, build upon the Ethereum blockchain. The Ethereum blockchain is a decentralized public ledger, similar to the Bitcoin blockchain. One of the important underlying mechanisms of the blockchain is the consensus algorithm, or the algorithm by which users are able to agree on the history of transactions and current state of a blockchain without reliance on a central authority (13).
Bitcoin was the first to solve this problem using a Proof-of-Work (PoW) system. Ethereum uses the same mechanism right now, though it is highly computationally intense and energy-inefficient, and Ethereum is soon transitioning to a more efficient Proof-of-Stake (PoS) method.
In order to maintain accuracy in a decentralized network, each time someone wants to make a transaction on a blockchain, other members of that blockchain ecosystem are asked to verify that transaction (more precisely, a group of transactions called a "block") as legitimate. One method is PoW, and relies on a consensus algorithm, where participating members ("miners") solve difficult math problems and publish the solutions with the goal of arriving at a consensus. These problems are computationally intensive and require real-world resources like computers and electricity. Miners are rewarded for arriving at the consensus solution and receive the currency (e.g., Bitcoin, Ethereum, or other currency of that Blockchain) generated in that block. This enables verification in a decentralized network because the only way to commit fraud would be to control enough total computing power that you can put forth your solution as the overwhelming consensus, implying that other users are misrepresenting the current state of the blockchain. Due to the magnitude of miners, PoW is expensive (in a real-world sense, due to high usage of electricity and computers) and controlling enough resources to outnumber enough other miners is expensively infeasible.
ERC-721 and NFT technologies
The ERC-721 is an Ethereum Standard for NFTs, meaning that these NFTs are built on the Ethereum blockchain. The main feature of ERC-721 is that each Token is unique and can have a different value from other Tokens from the same Smart Contract. Smart contracts are programs that live and run on the blockchain and create and govern NFTs or decentralized apps. Mechanically, all NFTs have a uint256 variable called tokenId and for any ERC-721 Contract, the pair contract address, tokenId must be globally unique. Then, a dApp can have a "converter" that uses the tokenId as input and outputs a range of media type, including an image, music, or more.
The ERC-721 standard is used widely for NFTs today and was originally proposed in January 2018 by William Entriken, Dieter Shirley, Jacob Evans, and Nastassia Sachs.
As NFTs have grown in popularity, some companies use private blockchains to power NFTs. In particular, Flow, operated by Dapper labs (and supporting NBA Top Shot) is devoted to NFT transactions and can be more efficient. (Though the very nature of private blockchains is somewhat counterculture to the original purpose of a decentralized network as a place where anyone can make transactions without oversight by any one institution).
Business Capabilities, and Why NFTs Represent a New Possibility Frontier in Crypto
Cryptocurrencies have always been traded, their value determined by supply and demand, as a currency. However, NFTs represent a difference in that the value of each token is not based on supply and demand for a commodity or currency, but rather, ownership (partial or fully) of an asset represented by each token.
NFTs in Collectibles
Clearly, we have already seen the possibilities of NFTs as collectibles - from the $100,000+ CryptoKitties to $11M+ CryptoPunk to a Top Shot 2019-2020 LeBron James dunk moment, to of course, Beeple's art collection sold for $69M (7). At the high end, this market seems likely to continue for as long as the crypto nouveau-riche have their riches - driven by a powerful combination of the pursuit of social status and financial investing. In addition, some believe that players like NBA Top Shot and Autograph are bringing in the non-crypto audience as well.
NFTs in Art
Art can be thought of as a subset of collectibles, or at least at the intersection of the Venn Diagram between collectibles and art in its purest form - an expression and appreciation of human creativity. Art "minted" as NFTs means that the art has a digital representation on the Ethereum blockchain ("minting" is the act of adding representation for that artwork on the Ethereum public ledger) (9).
Perhaps the significance of the NFT ecosystem for artwork is the ability to now buy and sell art - particularly digital art - with greater ease, confidence in its verification, and upside in its value thanks to the scarcity feature of NFTs and the thriving crypto wealth and ecosystem springing up around digital artwork.
NFTs have a feature that enable the original artist to receive a percentage of sales every time the NFT is sold, or resold. This could mean that artists, for the first time, can get tangible value from their artwork as it trades hands.
Just last week, a friend of mine posted on Twitter that an anonymous collector had purchased ALL ~two dozen of her paintings via NFT artwork marketplace, OpenSea. Without the NFT and crypto capital, it is hard to imagine where, to whom, or how she would have sold this artwork. However, now, her ability to earn income as an artist is significantly higher with an entire new world of crypto capital and digital patrons anywhere.
Even more interesting is the intersection of traditional art and digital, programmatically generated art. Cryptopunks fall in this category as each Cryptopunk was generated algorithmically based on a set of traits; each trait had a certain number of variations and varying levels of rarity. More recently, in 2021, the creators of Cryptopunks created Meebits, using the same method, a custom generative algorithm.
NFTs in Gaming
Certain early pioneers of mobile games, such as Machine Zone CEO Leydon, believe NFTs have huge potential in gaming (8). As one illustration, games traditionally make significant revenue from in-game purchases (e.g., of weapons, character customizations, or other benefits). However, when someone stops logging into a game, the items they bought no longer have value. Imagine if players could then sell their items and make money, or bring their items across games into another game. Moreover, the players of a game were beholden the game creators - players had to follow game rules and received none of the value or revenues generated by the game. In a world of NFTs, a game in which players can buy NFTs used in the game (e.g., plots of land) means that suddenly, the players become owners and investors in the game.
NFTs as Access Tokens
Another use case of NFTs is to give NFT-holders the ability to access certain experiences, products, or services - and transact that access. Imagine a celebrity wants to issue an NFT-based membership program to offer exclusive products, musical drops, or experiences to their fans. A fan could purchase an NFT access token and enjoy the offerings, as well as sell that NFT in the future when they no longer want to consume the offerings, or perhaps if the value of that artist's token has increased significantly and the fan wishes to sell the access token for a profit.
For example, one startup, Centerstage, is a digital events platform where seats are sold as NFTs. Users create online stadiums use the revenue from NFT seat sales to book artists to perform. NFT seat holders can then trade NFTs based on upcoming artists or hold onto their own seats and watch every show.
NFTs as Equity Ownership (in Music, Writing, and what's next?)
To me, one of the most consequential implications of NFTs is the paradigm shift they have brought about - where anything digital can be owned, accrue financial meaning and value, and therefore become a new financial asset.
As an example, Mirror.xyz (where I have published this article!) is a platform where writers can offer pieces of writing as NFTs. You can actually buy (and trade, and display!) fractional ownership in a piece of writing to indicate support of the writer, agreement with the ideas, or for any other reason. Patrons who purchase an NFT associated with a particular piece of writing then display those NFTs on their profile. Similarly, Royal.io is a music platform co-founded by DJ and early NFT enthusiast Justin Blau with serial entrepreneur JD Ross, where listeners can buy ownership in songs directly from artists and earn royalties alongside them. Thus, if a reader is a big fan of a certain piece of work or a creator, or a listener is a big fan of an artist, they now have a means of showcasing and supporting the work not only for the benefit of the creator, but also for the social and financial gain of the patron.
If the the prior generation of "Patreon"-style creator economy focused on giving fans a direct way of monetarily supporting creators, the new NFT economy represents a paradigm shift where anything can be turned into an asset and both user/fan/audience and creator can take part in the financial, equity ownership and financial appreciation of that asset.
Controversy & Criticism: The intangible nature of NFTs and The Climate Impact
NFTs don't actually come with rights to the artwork, just a digital representation
One of the earliest experimenters with NFTs recently warned that spammers have been taking copies of famous artwork and selling them as NFTs (10). NFTs don't come with the artwork itself - even when the artwork is fully digital, the NFT doesn't have enough space to store the full details of an image; instead, an NFT typically points to an https URI address (uniform resource identifier, similar to a URL) or an IPFS address (powered by the InterPlanetary File System, a blockchain-based file storage provider) or includes a mathematical compression of the work (e.g., a checksum) to prove the work's identity.
NFTS are accused of being environmentally unethical
One loud and growing criticism of NFTs are the environmental impacts. ArtStation, an online marketplace for digital artists, was met with fast backlash on Twitter hours after it announced plans to launch a platform for NFTs. Artists protested the "ecological nightmare" of NFTs and ArtStation scrapped its plans (11).
Some argue that the greater the demand for NFTs, the greater the motivation for miners to continue their energy-intensive mining activities. The crypto world seems to believe that the upcoming move of Ethereum 2.0, using a PoS instead of PoW method, could be a solution to this problem. In addition, innovators are exploring solutions such as alternate blockchains or private chains which already use PoS methods, side chains that verify NFT transactions without using the main, expensive Ethereum chain, and interchain operability allowing interactions across NFTs built on any blockchain.
It will be interesting to see where, across all these options, NFT creators, collectors, and consumers end up over time.
A Few Conclusions: NFTs as Equity Ownership of Anything, and Ushering in the Digital New World
NFTs have evolved gradually over the last many years and certainly exploded in the last 12 months. This was likely due to a combination of factors: the pandemic confining consumers much more so to digital experiences; the global macro environment, between financial heat-up in the stock markets and low interest rates, leading to significant capital seeking new assets to generate returns; the crypto ballooning in market size, from ~$200B to $800B+ from 2019 to 2021 in bitcoin alone (14).
Regardless of where the zealous interest and capital has come from, one thing is for sure: the popularity of NFTs has created a zeitgeist and permanent paradigm shift in business models. Namely:
- NFTs enable the creation of equity ownership in anything, while
- greatly reducing the friction and increasing the acceptance of valuing, owning, and trading digital assets.
Given the amount of interest and economy value the NFT economy has created, this paradigm is likely here to stay.
This piece was originally written for my Stanford independent research project. Thank you to my friends Josh and Hou who provided comments on my writing (both credited in the wallet split, in addition to a handful of other early sources of NFT-learning inspiration) and my Stanford faculty advisor Anne Chang Raimondi!
PS: welcome to my first Mirror post - and to Mirror, which gave me one of my first NFT-as-equity-in-anything Aha! moments.
- Sources
- https://www.theverge.com/22310188/nft-explainer-what-is-blockchain-crypto-art-faq
- https://medium.com/@Andrew.Steinwold/the-history-of-non-fungible-tokens-nfts-f362ca57ae10
- https://ethereum.org/en/developers/docs/standards/tokens/erc-721/
- https://eips.ethereum.org/EIPS/eip-721
- https://rarest.org/entertainment/cryptopunks
- https://nonfungible.com/blog/nft-yearly-report-2020
- https://hoopshype.com/lists/most-expensive-nba-top-shot-moments/
- https://venturebeat.com/2021/02/26/the-deanbeat-how-non-fungible-tokens-nfts-will-change-games/
- https://101blockchains.com/nft-minting/
- https://www.theatlantic.com/ideas/archive/2021/04/nfts-werent-supposed-end-like/618488/
- https://www.theverge.com/2021/3/15/22328203/nft-cryptoart-ethereum-blockchain-climate-change
- https://github.com/memo/eco-nft
- https://www.blockchain-council.org/blockchain/what-are-the-differences-between-proof-of-work-proof-of-stake/
- https://www.statista.com/statistics/377382/bitcoin-market-capitalization/
- https://whiterabbit1111.medium.com/the-origin-digital-antiquities-market-nfts-1ea9b69c03f9
- https://a16z.com/2020/05/15/the-crypto-price-innovation-cycle/
- https://linda.mirror.xyz/df649d61efb92c910464a4e74ae213c4cab150b9cbcc4b7fb6090fc77881a95d