NFT & Blockchain | The Core Concept Explained in Easy Words.
What are NFTs?
Non Fungible Tokens (NFT) have been all the hype from 2021 and especially the use cases for personal profile pictures (Cryptopunks, Bored Ape) and digital art (Beeple) made headlines in mainstream media. Many questions came up such as:
Can we simply print-screen an NFT without purchasing it and try selling it?
— Yes, but can we sell it at its original value while proving the right to do so?
Can we paint a copy of the 1930 Composition with Red, Blue, and Yellow by Mondrian? — Yes, but how easy would it be to find a collector for it? The internet is an excellent tool for exchanging information and bringing people together, but sharing copyright-sensitive materials has been a big flaw.
To understand Non-Fungible-Tokens easily, we can break down each term individually.
TOKEN → A token is a bearer instrument that can be exchanged for goods or services. They can be physical or digital. Physical tokens are casino coins that grant access to participate at a roulette table. Also, US dollar bills grant access to a market where the dollar is a legal tender, for instance in the USA.
An example of a digital token is an access code for a software license; once you enter it you can use the software. Another example, airline miles can be exchanged for goods or services. Bitcoin [BTC] is the first unique digital bearer token, for instance, a bitcoin cannot be copied like other digital bearer tokens. They can therefore be exchanged via the internet without third parties validating the transaction. This is done via the so-called consensus protocol of the bitcoin software.
FUNGIBLE → Interchangeable. Something that is fungible can be substituted for another thing of equal value in satisfying an obligation.
For example, a $1 bill is fungible, or equal to another $1 bill; just like 1 Bitcoin is fungible for another 1 Bitcoin. Technically speaking, each bill has a serial number just like each BTC has its unique identifier. Still, practically speaking, we do not really care which specific $1 bill in circulation we get when we are entitled to. Their values are the same, and therefore, these are exchangeable and not unique, and so are companies’ shares and bonds of equal value.
NON-FUNGIBLE TOKEN: When we add the NON to the phrase, it takes us to what we call uniqueness: non-exchangeable, non-comparable, irreplaceable. It has a single unique identifier, which cannot be interchanged with any other one, just like our fingerprints, or an NFT-Art, such as the famous first 5000 Days, -a digital work of art created by Mike Winkelmann, known professionally as Beeple. The work is a collage of 5000 digital images created by Winkelmann for his Everydays series.
The line between fungibility and non-fungibility may be a thin one such as an event ticket with or without a seat number assigned. If the seat has a special view or is next to a celebrity, the ticket is unique, and therefore non-fungible [desire driven by demand].
NFT can now be fractionalized, but we will discuss it in later articles together with all its currently possible use cases aside from art.
What is a Blockchain?
Now, these virtual coins, cryptocurrencies, and NFTs happen to be created and recorded on a Blockchain, but what is a Blockchain?
Just as the name suggests: a block of data, recorded chronologically one after another like an unbroken chain.
The main characteristics of a blockchain are:
- Timestamp append-only log: a blockchain protocol allows input data only, therefore, the information once entered can't be edited. It also happens chronologically, keeping the history of every transaction recorded one after another.
- Cryptographically secured: a random input being it just one word, a whole book, or a whole library of text and numbers is converted into a unique fixed-length string of numbers and letters. Even a change of a comma results in a completely new combination of letters and numbers. This is done by a so-called Hash function. The SHA-256 function is, for instance, a common cryptographic algorithm based on a combination of 256-bit (equivalent to 64 bytes in a hexadecimal string format). This amounts to the enormous number of 2 ^256 possible combinations, which means it is virtually impossible to find the input value to a given output as it would take. For example: the input `Non fungible` produces: dbe4f5ca2c5cb2a765608fd7f298d72cf894233891c201b7061e459bb44b486d and the input `Non-fungible` produces: Be125bf25663de6411e265c97711d2b2a144e68ae6f5edcb5016288cf618c22b
256 bits / 4 bits per character = 64 character
return BitConverter.ToString(bytes).Replace("-", string.Empty);- Consensus Algorithms: if a new NFT is minted, this information is communicated to the blockchain network and special participants called miners, (in the case of a Proof of Work — PoW, consensus like Bitcoin, or validators, (in a Proof of Stake — PoS, blockchain like Solana and recently Etherium, verify the transaction and update the blockchain against a reward, which is issued in the form of new Blockchain Tokens and/or fees. The information to be processed is distributed to many computers called nodes of the blockchain network, like Ethereum. The first miner, which solves the puzzle or the algorithmic combination is referred to as the miner, who mints the token. In this example, the miner mints an NFT art, therefore, he/she is entitled to gas fees and then sends a copy to all the other nodes to update their copy of the blockchain. Currently, there are 12,500 Ethereum nodes or participants which operate this tech beauty in our lifetime. In a few words, an NFT’s transaction history is automatically recorded on the blockchain like a certificate of authenticity or property right. And I call it immutable because an alteration to this record would require making the change to each and every participant node globally. Yes, there have been plenty of frauds in the virtual world, but not on the blockchain directly. Learn more: Scams Explained to Protect Yourself as Scammers See New Frontier
Blockchain & Real World impact
Beyond cryptocurrencies, blockchain technology has found applications in various industries
NFT Base Functionality & Terms
Among the base functionalities, some terms are key such as Minting, which comes from the basics of making a coin by stamping metal. However, virtually as explained above, it stands for the process of creating new tokens on the blockchain. There are a couple of methods such as PoW and PoS.
On the other hand, Burning is the opposite, basically taking tokens out of circulation. Crypto burning serves only one purpose — an increase in the value of each remaining token…“One example was Terra in 11.2021, burning 88.7 million LUNA tokens ($4.5 billion., at the time), and later, in 02.2022, 29 million ($2.57 billion)… Binance aims to eliminate 50% of its volume.” The act of burning an NFT does not destroy it or delete it; instead, it renders it useless in the future. Because burning an NFT is irrevocable, make sure you understand the risks.
Among other base-functionality are: Gas Fees, Royalties, Withdraws, Nesting, Deposits, and Metadata. Imagine the Gas Fee just like the cost of gas we need for a car to take us somewhere, which cost often fluctuates. A gas fee is a payment the miners receive for minting the tokens, which requires sophisticated hardware, software, energy, and knowledge. It is not a fixed amount, nor a percentage of the transaction cost. It varies every second based on the traffic congestion in the network, meaning the number of people making transactions at the same time, as well as the cost of Ethereum [EHT] at the time.
In regular practice, an artist sells his/her art and gets rewarded once. Royalties allow the original artist to receive a percentage of every transaction (resale or change of hand) ever after, as long as it is specified in the smart contract.
Withdraw: When minting, the data or information recorded on the blockchain is accessible to the general public (user) through a variety of layers such as platforms, wallets, and storage. When we download an NFT into our wallet, this action will burn or destroy the original version creating a new version in the new assigned wallet.
NFT Layers
It is easy to imagine that everything just happens on the platform, wallet, and blockchain, but here is a comprehensive graph of the stack of layers showing different solutions and their position in the ecosystem. For example, on a platform like OpenSea, we can list or mint NFTs. For the payments, we need a Wallet connected to it. To avoid high transaction fees (gas fees) we can choose Polygon, a second layer built on the Ethereum blockchain. Depending on the platform selected, the NFT images can be stored directly on-chain (decentralized) or off-chain (centralized), which comes with ups and downs discussed here. In addition, there are industry vertical applications such as art, game, sports, music, film, finance, etc.
5 Basic Steps for Buying | Selling NFTs:
As of today, OpenSea is the first and the largest marketplace for NFTs. However, selecting a platform can be influenced by many considerations such as the wallets they offer, formats allowed (.jpg .gif .mov …), or the type of art since some platforms are more oriented to sports, others to art, music, and the list goes on ↓. Some of them are open to anyone, some are curated and selective, and some decentralized or fully centralized. Extensive research is recommended before selecting one.
The image below depicts the basic steps to buying and selling an NFT
NFT Marketplaces
A comprehensive list of Marketplaces
Update: German Web3 Ecosystem Map
▸ #0 — A Journey into the NFT Space
▸ #1 — The Core Concept explained
▸ #2 — Scams Explained
▸ #3 — Centralized vs Decentralized
▸ #4 — Web3 & Climate Change
▸ #5 — A Deep-Dive into Earth’s Limits
▸ #6 — Una inmersión profunda en los límites de la Tierra
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