Disclaimer: I work for a company that operates in the crypto currency space, which uses blockchain technology. This article talks about blockchains and mentions how it works with crypto currency.
What is an NFT? That acronym has been going around over the last few weeks, with NBA Top Shots bringing it a bit into the mainstream. NFT stands for “non-fungible token.” An NFT is an attempt to create scarcity and value on digital goods. What does this all mean? Let’s dig in.
For the purposes of this explanation, we are going to think of NFT in the vein of trading cards. I’m not the first person to use this comparison as an example, but it fits, its easy, and the NBA example makes this a simple comparison to make. The trading card market has been around for a very long time, with an entire industry around appraisal, buying, and selling trading cards. Trading cards can have value because there are a finite number of them, and preserving them in good condition usually increases value, especially for marquee or star players in whatever sport the trading cards are for. But it starts at the scarcity. Because there are a finite number of cards produced, there is a limited supply.
In the digital world, scarcity does not exist. Data is infinitely copyable, which has reduced or eliminated the value of a physical good in many industries. The music industry has gone through a complete transformation since the late 90’s when digital music started to become popular, and the movie industry is undergoing a similar transformation. This can be applied to any digital good, and the “value” of them is very very different.
Along comes the blockchain. Describing what a blockchain is in perfect detail goes beyond the scope of what I want to get into here, but at an overly simplistic description of what a blockchain is is a public ledger distributed across the internet. How it is used in crypto currency is as a way to verify ownership. Every single transaction is tracked and logged, and those transactions are public. And because the ledger is distributed across the entire internet, it is virtually impossible to edit or forge the blockchain. Because of this, it can be verified who owns the specific item in the transaction, which is why crypto currency can have value. If I own one Bitcoin, and I decide to sell it, it can be verified that I sold it, and who I sold it to. And because there are a finite number of Bitcoins, there is value there.
Blockchains have more use than crypto currency. Basically anything that needs to have ownership proved, or a chain of custody, can benefit from a blockchain. Shipping companies are beginning to use blockchains to track the products and items they ship. If you consider any time a package being shipped changes hands as a transaction, a blockchain can be used to track an item as it makes its way from origin to destination. That is another use of blockchain.
That brings us to NFTs. NFT’s take the idea of tracking digital currency over blockchain, but applies it to something else. Going back to the trading cards example, a “digital trading card” can be created, and using a blockchain, the creator can specify that the item is one of a kind, or say that there can be 100 authorized copies of that digital card. Each copy is tracked across a blockchain, which means that it can be verified who owns the copy of that card. When or if a copy is sold, that is tracked, and ownership can be verified.
Because ownership can be verified and the number of copies of said digital good can be limited, NFT’s aim to provide the same scarcity as a physical good. That’s why the trading card is an easy example to use, because it makes the idea of a virtual hockey card, or virtual baseball card, something that can be worth something.
NFT’s do have some interesting differences that may or may not be a good thing compared to a physical good. Because the entire chain of ownership can be tracked, NFT’s allow for continued monetization by the creator. Again with the hockey card. Let’s say that the NHL partners with a company to license a Connor McDavid virtual hockey card. Just like a physical trading card, the NHL gets a fee for that card to be created. But with an NFT, the NHL can decide that it will get a percentage of any sale of that card down the line. So if I buy a Connor McDavid NFT hockey card today and then decide to sell it 15 years from now, the NHL will get a percentage of that sale. That’ll be controversial, and no one knows what kind of effect a perpetual percentage of every sale will have on long term value of these digital goods.
NFTs will also find other uses digital goods. There are examples of bands selling albums as NFTs, some as “special edition” versions of albums. Artists are experimenting with NFTs for creating unique artwork. And I’m sure there will be more and more potential uses of NFTs that haven’t yet been throught of. The idea of making a digital good scarce and limited could have a profound impact on how we think about buying and selling products that are not physical. There will be posivite impacts, and I’m sure there will be negative impacts.
Will NFTs actually take off and become an important part of a digital economy? I'll go out on a big limb and say I have no idea. I’m not ready to buy my first virtual hockey card yet, but I’m definitely going to be watching this space closely.