Why Everyone Is Talking About Non-Fungible Tokens (NFTs)

Voltron, the first in my LEGO set collection

My Saturday morning routine when I was 7 years old was simple. I woke up and before long, I was in front of the television watching reruns of the 1980s cartoon, Voltron: Defender of the Universe. Voltron left such an impression on my younger self that many years later, I referenced it in my wedding vows.

When the LEGO Group released a Voltron set in 2018, I bought two sets – one to build, and the other to keep for posterity. That kickstarted my brick collection; I now buy LEGO sets with the purpose of keeping them in mint unboxed condition. LEGO collectibles occupy the intersection of childhood nostalgia, pop culture, and rarity which I find fascinating. Consider how the LEGO minifigure of Barb, a minor character in Netflix’s original series Stranger Things, is now worth £400 apiece – a result of artificial scarcity and high demand due to the character’s popularity (#JusticeforBarb).

Non-fungible tokens (NFTs) are like LEGO in two main ways:

  1. NFT’s most popular use case is that of digital collectibles.
  2. Metaphorically, NFTs are the new building blocks of the bourgeoning Metaverse (a persistent virtual world).

What is NFT good for?

NFTs are crypto-tokens issued on the blockchain. They are non-fungible, in that they are not interchangeable. To put it simply, contrast it to a £1 coin – £1 coins are fungible; they are identical and represent something of the same value. We don’t think twice about which £1 coin to use when exchanging it for goods and services.

Due to their non-fungible nature, NFTs are used to represent something unique. They are typically used as digital proof of ownership. Examples of interesting use cases are as follows:

  • Digital collectibles 🐱 – The most notable example is CryptoKitties, a game in which players purchase, breed, and sell virtual cats. CryptoKitties was the first widely used decentralised app (dApp) on the Ethereum blockchain. In late 2017, transactions generated by the dApp clogged up the Ethereum network due to CryptoKitties’ popularity and Ethereum’s low throughput. The most expensive CryptoKitty ever sold was for 600 Ether (valued at c. US$170,000 then). Technically, a CryptoKitty is nothing more than a text record on the Ethereum blockchain; its value is derived from game-imposed scarcity and collectors’ demand for certain “cattributes” and “mewtations”.
  • Digital representation of real-world assets ⌚️– Tokenisation of non-fungible physical assets such as properties, vintage watches, sneakers etc. opens up a slew of possibilities. It enables fractional ownership and increases tradability and liquidity. More interestingly, tokenisation enables programmability; for example, a smart contract can be coded such that the holder of a NFT, representing ownership in a property, receives rental income automatically.
  • Digital artwork 🖼 – Artists can now create NFTs to represent their digital art pieces, and sell them on digital art marketplaces. In November 2020, virtual influencer (as in she’s not a real person), @lilmiquela sold a one-of-a-kind digital artwork, Rebirth of Venus, on SuperRare (a digital art marketplace) for 159.5 Ether (valued at c. US$82,000 then). It’ll be an interesting day if and when Banksy jumps on the digital art bandwagon.
  • Video game items 🗡 – The main problem of in-game items is that they are not truly owned by the gamers. To sell a rare item, for instance, a gamer has to sell his/her entire account. A number of games have emerged that use NFTs to represent in-game assets, allowing gamers to trade these assets in marketplaces not operated by the game developers, or use them in another compatible game (for example, the aforementioned CryptoKitties can be used in a number of third party games).
  • Virtual real estate 🏰 – Ambitious projects such as Decentraland and CryptoVoxels are building persistent virtual worlds. NFTs are used to represent finite parcels of land which users can buy to build on, or to flip for a profit. The graphics quality and the mechanics of these nascent virtual worlds are primitive but it’s too early to write them off.

Old systems, identities and rules no longer need to bind us. If we decide something has value or a story meaning, then it does.

@lilmiquela, Rebirth of Venus

Building block of the Metaverse

Our cavemen instinct craves face-to-face interaction with our fellow human beings. That innate nature was upended in 2020; the COVID-19 pandemic has accelerated the virtualisation and digitalisation of things. The mass adoption of digital tools like Zoom for remote working and learning is just the beginning of a long-term trend towards a persistent virtual world, or the Metaverse. Hitherto the domain of science fiction, the Metaverse is becoming a reality.

The Metaverse is a collective virtual shared space, created by the convergence of virtually enhanced physical reality and physically persistent virtual space.

Wikipedia entry on the Metaverse

In an increasingly digital world, NFTs issued on the blockchain provide a way to prove ownership of all-things digital (digital native items and digital representation of physical items) that has never before been possible. Digital items are not new; the advantages offered by NFTs are:

1. Provable digital scarcity

Before the advent of blockchain, scarcity in the digital world was impossible. Digital commodities (e.g. software, digital content etc.) have zero marginal cost – they can be reproduced endlessly and be made widely available at close to zero cost.

Blockchain is a foundational technology that enables digital scarcity. The Bitcoin blockchain, for example, stipulates the number of Bitcoin that will ever exist, and provides a decentralised, immutable, and globally synchronised record of who (or which wallet address) owns what.

Similarly, the supply and the provenance of a NFT is enshrined on the blockchain. NFTs are kept in non-custodial wallets such that token holders have full control and true ownership.

2. Tradability

Like crypto-currencies, NFTs can be bought and sold on global marketplaces 24/7. When used to represent traditionally illiquid assets, NFTs could potentially improve liquidity.

A notable example is the trading of insurance policies. NFT has been used to implement Decentralised Finance (DeFi) smart contract risk insurance policies. NFT’s non-fungible nature lends well to this use case as each insurance policy has a number of unique attributes (e.g. amount insured, contract length etc.). The tradability of NFTs has created a secondary market for these insurance policies, allowing DeFi users to quickly acquire or sell protection without interacting with an insurer.

3. Programmability

If DeFi is programmable money, NFT is programmable ownership. DeFi apps are implemented using smart contracts i.e. software code deployed on the blockchain that automatically executes an action when certain conditions are triggered. Similarly, smart contracts can be coded to give NFTs utility.

My example above of a NFT which automatically pays rental income to token holders is a rather unimaginative use case. No one can really predict the applications which innovative and technically-able developers could manifest into existence.

Dreaming of LEGO NFTs

More than two years of LEGO collecting later, boxes are piled high in my garage, taking up space. Keeping LEGO sets in mint unboxed condition comes with a variety of troublesome chores. Would I rather be collecting digital version of LEGO sets to lighten my chores and brighten my day? Absolutely.

I dream of a LEGO NFT that’s a digital representation of physical LEGO sets. This would make keeping track of and trading my collection easier. While I’m dreaming, I want a LEGO NFT that works in a virtual reality environment so that I could enjoy building the set without needing to unbox the physical set. Knowing the innovative and creative force that is the LEGO Group, a LEGO NFT has to be on their Kanban board.

For further reading on NFTs, OpenSea’s guide is a good start.

The bottom line: Non-fungible tokens (NFTs) are crypto-tokens which represent something unique. Use cases include digital collectibles, digital representation of physical assets, digital artwork etc. A NFT provides digital proof of ownership and increases the tradability of the item it represents. More interestingly, NFTs are programmable, opening up a slew of possibilities.