Like many of us, I was a crypto sceptic when Bitcoin was first introduced. At worst, it felt like a ponzi scheme. At best, it felt like a way for people to store value in an alternate currency free from the centralised manipulations of fiat. That skepticism further grew with reports of Bitcoin establishing itself as a common currency for facilitating cybercrime and terrorism.
My interest in the crypto space renewed in 2017 while in the US. Greater adoption of Ethereum networks led to usage of smart contracts for multiple applications. Banking giants started leveraging it for distributed ledger systems for reducing fraud and transaction costs. Some of them started using it for TradeFi applications such as facilitating SMB transactions and giving them easy access to credit. Goldman & Google started pumping massive amounts of capital into blockchain companies. However, even at that point in time, it seemed like a promising technology which was still a few years away from common usage.
The Pandemic changed all of that. After my return to India in 2020, I started actively looking at investing, with crypto being one of the areas. What began as research on alt-coins soon evolved into readings on protocols, staking, DAOs, collectibles….you get the drift. These foundational readings woke me up to the world of blockchain’s everyday possibilities, and made me appreciate its fundamental ability to change the way we live.
So what are these possibilities? To understand that, we need to first build a foundational understanding of cryptocurrency & block-chain technology, and why was it necessary in the first place. I have structured this essay into 4 broad subject areas
At a very basic level, money acts as a medium of exchange of goods & services between people. Barter system doesn’t achieve that, since what one person might want to sell may not coincide with what the other person might want to buy, and vice versa. This is called double coincidence of wants. Another issue that comes up with the barter system is trust - how can one trust the quality of goods being bartered by the other person? A third party might help brokering this issue, but this just increases the cost of trade and makes scaling up of the barter system next to impossible. With money (or currency), these issues are done away with, since goods & services have an agreed upon value.
There are some basic properties that money must have to function as an effective medium of exchange. Let’s look at each of these below
Durability: Money doesn’t get easily worn out. These can be used over and over again for a long period of time, unlike many goods that might be used in a barter system. Durability was a big reason why metals are still used for minting coins, which can survive even generations.
Fungibility: Each unit of money is the same (one Rs. 10 note is exactly the same as another), and can be replaced with another same unit of money. This ensures money just has ‘transaction’ value, instead of a ‘possession’ value (which certain collectibles might have, which are limited/unique).
Divisibility: We can divide a Rs.100 note into a Rs.50, 20, 10, 5, 2, 1 notes. Further, especially with the advent of digital finance, even Re.1 can be divided further ad-infinitum. This helps us easily buy products of different values
Portability: Money should be light-weight, which would allow people to carry large sums from one place to another without major hassles.
Wide acceptance: It is important that people agree upon the value of money. Generally, it was enforced by a powerful monarch in the yesteryears. Now, it is enforced by the government through a central authority (in case of India, it’s RBI), which in turn backs the value of money by issuing promissory notes
Scarcity: Money needs to be of limited supply to be considered valuable. Usually the central banking authority regulates its supply so that value is retained over time.
Creation of money with the above characteristics helped us across a bunch of use cases apart from commerce such as wealth transfer (passing assets down from one generation to another), credit lending (take money now to repay at a later date), enforcing penalties in a more humane manner and providing collateral (borrowing money in lieu of valuable assets).
So, if money was able to solve our commerce issues (and so much more) so well, why were people dissatisfied with it? The answer lies in trust and security. Over a period of time, the central banking authorities have become extremely powerful, with the ability to access and monitor every transaction of individuals. Ensuring all transactions are scrupulous requires banks to ask customers for more private information than they would generally need. This has severe privacy implications, since this information can be often used to manipulate individuals by freezing their accounts, or even stealing from them by Kleptocratic regimes. Further, digitization has led to storing of information in central databases, which can be quite vulnerable to ransomware attacks. This is where decentralisation comes into the picture, where two parties can transact with each other without the need of a trusted/authoritative third party (leading to centralisation of trust). Effective decentralisation requires effective implementation of cryptography, which can be used to encrypt transactions as per certain transparent rules.
Now that we have an overview of currency, let’s look at the ‘crypto’ aspect of cryptocurrency
Encryption in its modern form was used largely by intelligence agencies for stealth communication and storing classified files. It was restricted from public usage, and definitely from exporting to other countries. However, these bans were becoming an issue for financial institutions that were required to use encryption for international wire transfers. This resulted in creation of standards for civil encryption usage called Data Encryption Standard (DES). As an academic subject, it was soon realised by researchers that DES can be used for building decentralised systems where each person holds keys to their privacy information (called the Diffie-Hellman algorithm), thus facilitating easy exchange of information over public networks without these networks knowing the content of these messages. This was further brought into the public domain by Phil Zimmerman, who implemented public key cryptography for PCs called PGP (this protocol is central to today’s email systems).
However, encryption was still controlled to a large extent by the US government, with stringent rules of key sizes (in the 1970s, NSA used 128 bit-encryption, but only allowed for 48-bit encryption keys for public domains). Further, the US moved off the gold standard in 1971 to fiat currency, which made central banks very powerful. They had a complete history of all transactions made, leading to a complete lack of privacy. They could be easily arm twisted by the government to gain information on individuals and coerce them. This was completely unacceptable to a group of people called Cypherpunks, who felt the need for an uncensorable digital money that allowed for a sovereign economy. This is what gave rise to the idea of digital money.
Although digital currency was very much possible, a major roadblock to it was the double spend problem. This implies that though money spent digitally can be verified, what prevents the sender from sending the same digital currency to two different recipients? This is where a central party is necessary, to verify the authenticity of the transaction. The Cypherpunks wanted to put power in the hands of the individuals rather than the government or corporations. Hence, their goal here was to create an uncensorable digital currency, where personal privacy was paramount. Many attempts were made to find a way, but it largely proved to be a cumbersome process.
David Chaum, who was the father of the Cypherpunk movement, laid the technical roots for the movement. He was the first person to propose a blockchain protocol in 1982. As part of the proposal, he talked about eCash, an anonymous cryptographic electronic money. Based on his ideas, he founded Digicash in 1990, where he wanted to eliminate the need of credit cards by allowing users to transact anonymously using the money held in the bank account. Although it worked (eCash was implemented in a few banks), making transactions was complicated for the lay user. They simply did not care much about privacy, but loss of convenience being provided by credit cards was a much bigger issue to them.
The solution lay in creating a decentralised system for verification which improved efficiency, where reliance is not on a central server to distribute resources required for computation. Basically, multiple computers (called nodes) coordinate with each other to achieve a common objective.
How does a decentralised architecture exactly work? Let’s take a deeper look into it.
As discussed earlier, a decentralised architecture comprises nodes which work together to achieve a common objective. The nodes should have the capability to operate simultaneously, but execute these processes independently of each other. However, it’s important to understand what each of these nodes is doing for effective coordination between them to achieve the unified objective. This is where the concept of events comes into the picture. When a node executes a process, it broadcasts the event to other nodes. The other nodes receive and store these events, which helps in determining the order of events at a network level. Basically, to be able to coordinate so as to achieve a common objective, all the nodes have to agree that
This process is called ‘achieving consensus’, and is at the heart of the functioning of any distributed system.
Achieving consensus: To achieve consensus, typically all the nodes are required to have the same initial state, i.e, the initial state is replicated across all the nodes of the network. If a particular transaction is valid, it will lead to a state change. For a state change to happen across a network, all the participating nodes must agree on two things
This requires maintenance of a consistent transaction log across every node of the system.
There are multiple processes by which consensus can be achieved in a network. At a very basic level, these can be defined thus
One nuance in decision making is the timescale within which consensus is to be achieved. Under ideal circumstances, nodes should receive the proposal synchronously (all at the same time), but this rarely happens in reality. To overcome this, consensus algorithms specify a timeout, i.e the max time within which the voting on the outcome is to be communicated to the leader. However, this works only in case of crash-fault tolerance. If nodes are wilfully not responding/changing response to subvert the process, these consensus algorithms dont work.
Further, there are a set of nodes called learners, who don’t participate actively in the consensus building process, but learn the final values once they have been decided upon and execute state change based on consensus.
While theoretically this might sound simple, actually building and maintaining such open and permissionless systems (called peer-to-peer, or P2P) were practically not possible for a long time owing to multiple modes of failures. The major modes of failure include Crash-fail (nodes fail to process), Omission (processes are computed, but messages aren’t received/sent) and Byzantine (nodes behave arbitrarily/dishonestly with the stated objectives). Further, even if such failure modes were somehow taken care of, synchronicity between nodes can never be guaranteed since there is no single global clock that determines sequence of events across nodes (even if clock in all nodes were set the same at the beginning of the process, over time they will begin to differ by something called a clock drift). Considering all these issues, how does one ensure enough nodes agree in order to be able to make decisions at a scalable level?
The most accepted base protocol to ensure this is the Nakamoto consensus. The basic premise states that most nodes don’t have to agree that the event happened (or it’s associated value), but merely on its probability. Here, rather than electing a leader and coordinating with all nodes, consensus happens based on which node solves a computational puzzle the fastest. This node gets to add the new block to the chain, with more nodes further adding this block. The longest chain is the one with the most computational effort - and probabilistically speaking is the correct one. Hence as long as the majority of the nodes in the system are honest, this can be considered the canonical chain. As the chain increases in size, it becomes more and more difficult for dishonest nodes to mutate it. Although technically it is possible for fewer dishonest nodes to create alternate chains faster than those by honest nodes, it would require massive computational power and expenditure, which makes taking such actions impractical. We will see further how this provided a practical basis for the launch of Bitcoin.
So, now that we have some basic perspective on the nature of money, cryptography and decentralised systems, let’s return to the central point of our essay - what is a blockchain? To answer this question, we will dive deeper into two technologies which have made blockchain ubiquitous - Bitcoin & Ethereum
In Satoshi Nakamoto’s paper on Bitcoin, he defines it as ‘A purely peer-to-peer version of electronic cash [that] would allow online payments to be sent directly from one party to another without going through a financial institution.’ While this electronic cash is secured by digital signatures, where this paper proved to be path-breaking was its solution to the double spending problem using a P2P network. Recall that double spending problem refers to authenticating that the sender sent cash to only one receiver, and not multiple ones (this is where typically trusted 3P such as banks are required). The transaction needs to be authenticated in a decentralised manner, and Nakamoto consensus lies at the heart of this. So, how does this work? Let’s first understand how a block and the corresponding chain is produced.
Nodes in a network work to produce blocks. As discussed earlier, the leader is elected based on solving a computational puzzle the fastest. Once that is done, the leader proceeds to validate an event/transaction, which is time-stamped and hashed onto an ongoing chain, which represents ‘Proof of Work’. Now, what does ‘work’ imply here? Work implies hashing the transaction onto the block-chain, which involves integrating hash from the previous block on the chain, the current transaction being validated & and a value called nonce. A hashed transaction creates a block, which is on top of previous blocks that have been added by other nodes. Having proof of work requires creating a block on the chain, which can be assessed by other nodes in the network who can validate it and add it to the chain. Let’s look at what goes into building a block.
Below is a pictorial representation from Nakamoto’s paper of what a typical block looks like
As can be seen above, a block comprises of following broad components
Information on the current transaction itself
A hash consisting of information from the previous transaction and the current owner’s public key (to whom the transaction is made from the previous owner). The public key can be thought of as the owner’s digital address, which the owner decides to share publicly (a simple analogy here would be an email address if the owner wants someone else to send them an email).
The previous owner’s signature, which is used to sign the current transaction so as to give it validity from the previous owner who has made the transaction. This signature is verified from the previous owner’s public key which is part of the previous transaction.
A block typically consists of multiple of such transactions. To complete creation of a block, two additional components are required - timestamp and nonce. Let’s talk about them, and why are the necessary
Timestamp: Each of the blocks is hashed and time-stamped, which is then broadcasted to all the nodes in the network. The hash of each block contains information on timestamp of the previous hash as well, which allows nodes to verify timestamps of previous blocks as well. Essentially, this enables all nodes to verify the time of all the blocks (and hence all the transactions) on the chain and thus create a chronology of events/transactions that happened.If attempts are made to repeat the same transaction (double spend) again, it can be easily verified by nodes that this transaction has already been made earlier and thus invalidated.
Nonce: To create a hash of a particular block, the last component is a number called a nonce (0 bits). Nodes will keep incrementing this nonce value until one of them produces a hash that has the required number of zero bits in front. This is done to basically ensure all hashes are of a specific length as per hashing protocols used (the most common of which is SHA-256) Adding these values further increases the complexity of computations, hence contributing further to immutability of chains.
As we can see from the above, creating a block requires satisfying proof of work, which in turn requires a massive amount of computational work. The chain consisting of maximum such blocks serves as proof that the chain comes from a network of nodes with highest computational power, and hence is accepted by other nodes in the network as well on top of which other such blocks can be built. This acceptance is critical for an open and permissionless to scale, since now nodes can easily exit and join back a network, simply accepting the longest chain as authentic proof-of-work. Additionally, this requirement for computational work leads to prevention of proxy-decision making by a minority. If there was one IP address controlling the majority of nodes, decision making could be biased by one able to allocate multiple IPs. As Nakamoto says, ‘Proof-of-work is essentially one CPU-one vote’. Considering the heavy energy expenditure involved in this process, how to convince miners to create new blocks? This is where the Bitcoin incentive mechanism comes into the picture
Incentive mechanism: Each block holds a certain number of the transactions. The first of these transactions is called Coinbase, which is the same for all blocks. This further generates additional bitcoins, which are assigned to the miner who mines that block by creating the desired hash.These bitcoins are called block rewards.These rewards were 50 bitcoins at its inception. Further, miners are also rewarded a transaction fees (also called gas fees) for their energy & labor expenditure. To maintain scarcity, the algorithm halves the block rewards for every 210K blocks created. The block reward was halved for the first time to 25 BTC in 2012. In 2020, it was halved for the third time to 6.25 TC in 2020. At a future date, all the bitcoins that could have been mined would have been mined (expected to be ~2040). Hence, no new BTCs would come into circulation and all miners would be incentivised only via transaction fees. Capping of bitcoins is an important paradigm, since the production is predictable, and hence there are no sources of primary inflation (unlike fiat, where production is centralised and prone to inflation according to the policies of the central banking authority).
This mechanism also disincentives dishonest nodes from attacking the network. For example, if a dishonest node somehow gathers majority of CPU power and attempts to validate double spending, the entire network would be invalidated and the value of BTCs earned by the attacker would become null. Hence, nodes would rather mine honest blocks and get block rewards rather than invalidate their own network earnings.
We now have a foundational understanding of what Bitcoin and block chain is. We have seen how bitcoin solved the issue of creating a true digital currency which did not rely on a trusted third party for validation. Further, it was able to solve the double-spending problem in a practical manner. However, Bitcoin’s use of blockchain severely limits the type of applications that can be written on it. The Bitcoin script wasn’t Turing complete, i.e, it could perform only a few applications, and couldn’t be used for complex information transactions. For example, it doesn’t enable loops, limiting the types of algorithms it could execute to linear or tree-like instructions. Further, it takes roughly 10 minutes to produce a block, which limits the scalability of the network. That’s the basic reason why blockchain’s adoption was really slow during the initial Bitcoin days. These issues were mitigated to a large extent by the introduction of Ethereum.
While Bitcoin provided for a specific use-case around P2P electronic transfers, Ethereum aimed at creating a platform where developers could build and deploy applications. Buterin Vitalik, one of the founders of Ethereum, writes in his whitepaper “Rather than being a closed-ended, single purpose protocol intended for a specific array of applications in data storage, gambling or finance, Ethereum is open ended by design, and we believe that it is extremely well-suited to serving as a foundational layer for a very large number of both financial and non-financial protocols in the years to come.” The most important aspect of ETH protocol is its universality. Turing complete applications could be created on top of Ethereum block-chain, which are known as smart contracts. These contracts could be written to implement any type of workflow, and were not limited to industries or use-cases. Hence, a very generalised framework was used which was open for all. Any programmer could write smart contracts, and the regulatory framework used wasn’t restrictive in nature (except for cases which could harm the network).To facilitate creation & scalability of these applications, the block creation rates of Ethereum are significantly higher (1 block per ~15 seconds as compared to 10 mins for Bitcoin). Overall, Ethereum has been designed as an open system, faster and scalable platform on top of which multiple applications (called DApps - short for decentralised applications) could be built.
Let’s look at a few aspects of Ethereum, which will give us a better understanding of the value Ethereum brings to the table
Smart Contracts: Smart contracts are pretty central to Ethereum’s value proposition. These are essentially blocks of code which execute a certain programmed function if certain initial conditions are met (for eg: certain events are fired within the network). In short, they are the engine which define and execute the core logic of an application. This is a significant improvement over functions/scripts which can be employed in Bitcoin, where only simple transactions such as sending Bitcoins from Owner A to Owner B can be executed. Using smart contracts, we can execute complex transactions such as ownership of real world assets (if certain conditions are met). This gives an unprecedented flexibility to developers to create applications for any use-case
Ethereum Virtual Machine (EVM): Smart contracts reside and execute within an environment called Ethereum Virtual Machine. EVMs include a Turing complete scripting language (called Solidity), which ensures it is in a position to solve any computations defined by smart contracts. EVMs provide the necessary infrastructure support to coordinate communications of smart contracts with the rest of the network.
Incentivization structure: In Ethereum blockchain, miners mine for Ether (ETH) instead of Bitcoins. Miners are given 5 ETH for verifying transactions on the network. Because of the versatility of Ethereum blockchain, the function of ETH goes far beyond simple ETH ownership transactions or verifications. Developers writing smart contracts require computational and storage resources on top of the blockchain, which they pay using ETH (payment is in the form of transaction fees, typically known as gas fees). Whenever these applications are used by 3rd parties, a part of ETH generated via such transactions is given to the smart contract developers, hence incentivizing them to write quality applications. ETH is the base currency of Ethereum blockchain, which can be further traded just like Bitcoin. However, ETH differs from Bitcoin in its supply, with there being potentially no cap on its generation (Bitcoin has been set at a cap of 21 Million). The only constraint applied is the rate of generation of ETH, with its yearly cap being approximately 18 Million.
Consensus protocols: The consensus protocol is the same that is being used for Bitcoin Networks - Proof of Work (PoW). As mentioned in the Bitcoin section, the node earns the right to verify a transaction by solving a computationally difficult puzzle and broadcasting the results to all nodes within the network. If accepted by the majority of other nodes, the said node verifies the transactions and earns ETH. However, this leads to massive energy expenditure, which is both expensive and harmful to the environment. This has led to exploration of other effective consensus protocols, with Proof of Stake (PoS) emerging as the most favoured one.
So, what is PoS? In short, instead of group of nodes with the highest computation power verifying the contents of a blockchain, group of nodes with the highest stake in the network This process of generating consensus comprises of the following steps:
These protocols help Ethereum function as a ‘universal blockchain’, on top of which multiple applications can be built. But what are these applications? Let’s look at some of these in the final part of our essay.
Now that we understand the workings of the two major blockchain technologies, it’s time to finally look at the most important question - how are these technologies changing the way we do things for the better? What are these possibilities that we talked about at the beginning of this post? Blockchain has impacted 3 fundamental areas
Let’s look at these one by one
This application is as core to cryptocurrency as it can get. Bitcoin enables transfer of value without centralising trust and security. While Bitcoin only enabled currency transfer, Ethereum opened up the complete financial industry to blockchain technology, with its smart contracts facilitating any financial application we can think of. While the rise of fintech improved reach to retail investors & provided great UX by leveraging software, it still fundamentally relied on networks such as Visa, ACH and SWIFT. These are highly centralised modules requiring huge infrastructural spending. Further, cross-border payment requires presence of similar systems, but in different geographies, each requiring its own set of servers and maintenance. This siloed processing leads to high transaction times and coordination costs. DeFi overcomes all these deficiencies through its decentralised architecture.
DeFi apps use an underlying blockchain (the most prominent of which is Ethereum) to store ledger states of all transactions, deposits and withdrawals. The accounting functions are defined within the smart contracts, which provide the logic behind maintaining/changing ledger states. When a particular transaction is made, the associated processing, clearing and settling all happen at the same time (unlike traditional finance). Further, blockchain provides a unified global layer which preempts siloed infrastructure, especially for cross-border payments. Multiple applications can be built on top of each other, making it easy for them to access data from the same underlying blockchain.
Another major aspect of DeFi is its open-source and permissionless nature. Since the apps and underlying blockchain are open-source, they can be audited at any time. This includes the smart contracts (accounting functions), flow of money, trading volumes etc. This further reduces verification costs and timelines. This also helps to reduce new user onboarding times significantly. Typically onboarding involves in-person verification, credit checks, income verification etc. Apart from time, these lead to issues around lending discrimination, opening of credit lines without consent etc. In DeFi, all the user has to do is connect their wallet addresses to apps - no credit checks, no identity verifications. As long as there are funds inside the wallet, transactions can happen.
DeFi Ecosystem: DeFi apps can be built for tackling multiple applications such as lending & borrowing, asset management, options, insurance etc. A DeFi stack enables these applications through multiple layers built on top of an underlying blockchain
There are two basic infrastructural layers built on top of Ethereum base layer
Node infrastructure layer helps in querying for data from base layer faster, whereas Layer two (L2s) help in scaling up the blockchain. L2s are especially critical in moving blockchains to mass applications since capacity of base layers is limited. You can find more about various Ethereum L2 solutions here.
Further, DeFi apps can themselves build integrations with other specialised apps for wallets, analytics etc. instead of building them in-house. Some of these specialised apps are
To further make operating DeFi apps user friendly, there are specialised front end applications which enable users to interact seamlessly between multiple DeFi projects.
These underlying features of DeFi have led to some major advantages, which include
As we can see above, Opex of Lending Club is quite high (>50% of Opex is due to engineering and infrastructure management costs), leading to net losses. The corresponding figure for Maker DAO is significantly lower, thus leading to net overall profitability. Major banking institutions have understood this, and have moved many of their applications to a ledger distributed system. While in the short-term, integration with the fiat economy can lead to additional costs, these systems are far more efficient which will eventually bring down costs through economies of scale. No wonder financial organisations were the first to adopt blockchain at an institutional level.
Now that we have a basic sense of what DeFi is, let’s look at how blockchain can help us in building more inclusive organisations of the future.
As the name suggests, these are organisations where governance and decision making are massively de-centralised. These organisations have no single leader (usually a CEO in traditional organisations), instead being run by smart contracts(?!). Since these smart contracts are available on Ethereum blockchain, anyone can participate in the working of a DAO. DAOs can be set up to solve any user problem (just like a company), and over the past few months there has been a massive proliferation across areas such as media, investments and communities. As of March 2022, around 216 DAOs managing a cumulative of $10.6B has been listed on DeepDAO
So, how do DAOs exactly work? Let’s look at some of the aspects below
DAO Creation: Usually, a small group of people develop smart contracts which define the organisation’s objective, it’s functions and organisational processes. They put it out on a public blockchain (Ethereum being the most common), where anyone could buy tokens to own a part of DAO (these events are called ICOs - Initial Coin Offering). Hence, DAOs are typically community owned.
DAO Governance: Once DAOs are created, the stated functions and processes need to be operationalized. The rules and treasuries are encoded in smart contracts on the chain, and are automatically enforced if certain conditions are met. The core of DAO (or any organisations for that matter) is its decision making protocols. To enforce these protocols in order to make decisions, the community needs to build consensus. Consensus can be built across several levels, starting from organising polls in DAO-specific discord servers to voting mechanisms where token holders vote (typically people who have bought a certain number of tokens maybe allowed to vote here).
DAO projects: In traditional organisations, project proposals are drafted by specific departments (it’s their job!) which are then presented in front of senior management for inputs. Only after explicit approvals from a CXO/VP is the proposal implemented. In short, decision making is top-led. In DAOs, this process is inverted. A proposal is voluntarily drafted by specific members of a community (typically a DAO sub-committee), which is then proposed on the community forum (typically a Discord channel). Anyone can make suggestions which can lead to proposal modifications. The original proposal is continuously re-drafted till the majority of community members accept it.
Incentives: As you might have guessed by now, DAO members are incentivised by tokens. Creators are incentivised by granting them specific amounts of token for their work. Investors are granted tokens for their investments, and obviously have an interest in increasing the value of tokens by enabling good decision making. Community members who participate in proposal creation can be paid through tokens in case their proposals are accepted by the majority. Further, certain DAOs also pay members based on the coordination activities they do. Tokens are the fuel which runs DAO. Further, these tokens can be traded publicly in crypto exchanges, further providing access to the general public in investing in them without necessarily taking explicit part in governance/coordination/creative functions.
Overall, DAOs are the organisation of the future, and represent a natural succession to the traditional organisations human society has built over the years. These are disrupting our traditional modes of working, and are moving the workforce away from extraction to enablement; away from centralised management decision making to community-led decentralised decision making.
This brings us to the final area we will be looking at - how blockchain is disrupting the creator economy through Non-Fungible Tokens (NFTs)
NFTs are probably the most-hyped crypto use-case going around currently. In a very short period of time, NFTs have unlocked massive liquidity - in 2021 alone NFT transactions reached $41 Billion, with the majority of them happening on Opensea. Simplistically speaking, NFTs are tokens which have properties like any other token, i.e they transfer value and information on the blockchain. These tokens have owners, and can be traded on the network.
What differentiates it from other tokens is its non-fungibility, i.e, its uniqueness. Fungible tokens are interchangeable - a Bitcoin is a bitcoin irrespective of its current (or previous) owner, transaction history etc. However, NFTs are not interchangeable (think of the Monalisa painting - there’s just one original). Since NFTs are present on block-chain, ownership can be easily verified. Any kind of data can be stored within NFTs, such as music, images (jpegs anyone?), messages etc. Apart from the ability to verify its authenticity and ownership, what makes NFTs very powerful is its programmability. NFTs can be programmed to be part of any ecosystem (imagine a ‘digital Monalisa’ not being part of only a ‘digital Louvre’, but several other digital art museums). This programmability also enables creators to incorporate royalties as part of NFTs minted by them. Any transaction involving that NFT will not only lead to value generation for its current owner, but also its actual creator.
All the above properties have opened up a host of possibilities across industries. The infographic below presents a succinct view of major NFT categories
Let’s talk about each of the categories above
Cards & Collectibles: Unique and scarce items have long commanded premium prices from collectors. These include baseball cards, stamps, rare coins and limited edition toys. By representing them on the blockchain, these assets can be granted immutability and easy public verification of ownership. Popularity of these kinds of NFTs skyrocketed when Cryptopunks issued 10,000 NFTs (24x24 pixel art images - remember all those Twitter DPs?) which possess different attributes, hence making each of them unique. Each NFT was minted just once, and they possess different levels of rarity (for eg: there are only 24 cryptopunks in existence). Since, several cards & collectibles NFT startups have sprung up such as NBA Top Shots (trading platform for rare NBA video highlights that are sold as digital cards) and Sorare (fantasy football game that allows users to create virtual teams and compete in a league format; Sorare issues player cards as NFTs which users can buy to add to their existing teams), who have tied up with multiple sporting leagues to generate collectibles.
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Art**: This particular use-case has exploded in the past couple of years. Artists can mint their creations on blockchain, which can be bought by anyone. Further, programmable royalties ensure these artists get a cut of every transaction made on their art. Art NFTs gained massive prominence from the $69 Million sale made by the artist Beeple at Christie’s auction house (fun fact: the auction started at $100, since that was the maximum sale Beeple had ever done till then!). Opensea & Binance have NFT galleries where artists can showcase their art for a limited period. This has led to unprecedented access to artists all across the world to not only showcase their art in an open market, but also ensure they are compensated duly due to immutability and verifiability of their art on the blockchain.
Gaming: Gaming assets such as tools, avatars, skins etc can be bought by users as NFTs, thus making it a seamless use-case. Gaming companies such as Blockade allow developers to build games on blockchain, hence allowing developers to mint in-game assets as NFTs. Axie Infinity (a pokemon-type game) issues creatures called axes as NFTs which can be used for creating an ‘axie army’ for in-game battles. These axies have unique abilities based on their ‘genes’, and their combinations can produce millions of game plays. Axies can be bred too, which can be sold to other players in the platform as NFTs. Many gaming platforms allow users to trade their NFTs on in-house secondary platforms, which is a massive change from licence based web 2.0 games where such markets were deemed illegal (most such secondary sales were done in black markets).
Content & Media: Any type of media such as music, blogs, tweets, essays etc can be minted as a NFT. Although distribution of content isn’t expected to attract massive capital (unless you are famous), the NFT concept can be leveraged for crowdfunding creation of written and musical content. For example, Kings of Leon has released their album as an NFT, dropping three types of tokens - a special album package, live show perks such as lifetime front row seats and an exclusive audiovisual art. These NFTs can be treated as limited edition content/privileges available only to a few who decide to invest.
Apart from the above, NFTs can be used for multiple other applications such as selling event tickets, storing real estate contracts and buying domain names. The flexibility of NFTs has led to creation of a vibrant ecosystem, where not only the creator gains (through initial sale & royalties), but also owners (secondary sales) and NFT marketplaces (commision/transaction fees). And by all accounts, we are just getting started.
If you have made it this far, congratulations! Now you have a pretty good idea how blockchain works and its various applications. Feel free to DM me on Twitter here or to write to me at tilakpattnaik@gmail.com
Until next time!