The Secret to NFTs: Call Them “AL”
Lesson 18: Understanding How NFTs Work
Yet again, I’m stretching analogies and metaphors in this educational series on blockchain and cryptocurrencies for The Art of the Bubble. If you’ve been with me through all 17 lessons so far, then you’ve probably come to expect strange rhetorical twists. This article is no exception.
On the topic of NFTs, one of the things that really gets people confused is their ambiguous acronym. Telling people the acronym stands for “non-fungible token” does not help much.
What in blazes is “non-fungible”?
What really is a token?
The secret to unravelling this enigma is to forget the technical monicker altogether. Let’s just call NFTs by the name “Al”. Why?
So the story goes that when Paul Simon wrote the song “You Can Call Me Al,” he explained that its motivation was a memory of when he and first wife Peggy Harper when to a party in NYC. The host did not know their names, and just introduced them as “Betty and Al.”
So the rhetorical play here is to forget about non-fungibility and tokens — i.e. we can’t see the forest due to the trees. Instead, we’ll focus on “Al”, whom we don’t know. So let’s see what he’s about.
Al Goes to a Party . . .
Al goes to a party dressed in the style of his day — a black turtleneck and a tan corduroy jacket. There are ten other guys dressed exactly like him.
Is Al unique or just a “carbon copy”?
Well, he’s not unique in one sense. He’s of a certain type, or perhaps even types.
- He’s a male human.
- He’s a male human from Queens.
On the other hand, Al is unique.
There is no other human male like Al. In that sense, we’d also probably say that if we were somehow pressed to replace Al (because he left the party and we wanted someone exactly like him), we’d throw up our arms and say like a French deconstructionist philosopher, “Impossible!”
In other words, in being non-exchangeable, Al is also irreplaceable. He is non-fungible. Or, we can phrase this yet another way:
In being a particular human being named “Al” with unique characteristics, we can say Al is a token of the type “human”.
Token in this sense means an instance of a type.
Philosophical caveat: But oddly, tokens are not necessarily particulars of a general concept. This is because, to quote my metaphysics colleague, “you can have a token universal (redness) of a type universal (colouredness).” Thanks, Graeme Forbes!
Philosophy aside, we can see how this matters if we’re speaking of humans. But can we really say the same about things, especially if they are digital — like NFTs?
What Is Fungibility?
Fungibility, or exchangeability, is a pervasive factor in our daily lives. Without being able to exchange and replace things, we’d have to labor to create each thing we wanted since we would not be able to barter or use money to make a trade.
There are more significant (philosophical) questions about the nature of fungibility, but for our purposes, we need only know that when things are fungible, they are not unique. Something of similar standing can replace the item in question. For example, one dollar bill can be replaced by another dollar bill with no loss in value.
What Is Non-fungibility?
In contrast, non-fungibility means an item cannot be replaced by something of similar kind, quality, or value. There are two ways one can think about non-fungibility: metaphysically and economically.
- Metaphysically, one could argue that each and every thing is unique and so in essence nothing is fungible. (There are other metaphysical views, as well.)
- Economically, one can say each thing may be unique, but humans come to an agreement about equivalences between things. In this sense, money is the ultimate tool in making things fungible because we can see a range of items in terms of a common value or price. And just to note metaphysically, Marx disagreed with this power of money.
So given our world is largely governed by economic fungibility (sorry Marx!), what purpose does non-fungibility serve and how can one ensure items are non-fungible?
Non-fungibility is key wherever the uniqueness of an item is essential to its value. Think of artwork, contracts, and personal identity.
But this quality seems a bit stretched when applied to digital items and representations. The quality of being digital often means being replicable and replaceable. One digital recording of an original performance of “You Can Call Me Al” will be the same as another.
In fact, this is where the innovation of the blockchain emerges. If you haven’t done Lesson 1 about the blockchain, then you might have forgotten that one of the specific features of blockchain technology is that it provides a permanent record of an event. So although digital, a recorded event will have a unique block.
In other words, securing uniqueness and non-fungibility can be done through a permanent “signature”. So in essence, the coded record of an event on the blockchain is the signature or proof of uniqueness. And whoever possesses that portion of the code is the possessor of the event.
Just events?
Well, yes. Although the code is representative of a thing — such as, coins, a work of art, a contract, etc. — what is actually on the blockchain is the code representing that thing at a specific moment on the chain.
From Al to NFTs
I think we are now ready to wrap our heads around NFTs, or dare I say “non-fungible tokens”.
The unique code specific to a NFT is what makes it non-fungible. Remember, this is its signature. No other code can replace it. (Interestingly, this does not hold for other unique codes. The reason for this is because, per above, we agree “economically” that that is not the case.)
What the code represents is the token. In the case of NFTs, that is usually a digital avatar or image.
When buying a NFT, you are paying for the proof of possession of the code underlying the token, image, etc. We often say “ownership” in this context. For example: “I own a Chumpazoids NFT.”
But in reality, since the blockchain is a permanent record, as a NFT “owner” what one actually is doing is possessing the code. (No one owns the code in a truly decentralized system!) So while the item is unique by virtue of its blockchain code or signature, possession of the code can transfer between human agents.
In short, when you buy a NFT, what you are buying is possession of the coded signature.
Types of NFTs
There are different types of NFTs. Let’s distinguish between “first-order” and “second-order” NFTs.
First-order NFTs are those where the code is the item or thing in question. It does not represent something else, like an already existing artwork (e.g. the Mona Lisa) or a person’s identity (e.g. I may have an avatar but that avatar is not me entirely or existentially).
Most people will recognize NFTs according to Cryptopunks and BAYC digital art.
The image above is a digital copy of a NFT, while the original is probably in someone’s wallet which contains access to the respective blockchain code. First-order NFTs can be one-off creations which are referred to as “1/1”. Or, as with BAYC, they can consist of a collection of pieces generated by an algorithmic process of creation.
A second-order NFT is one where the code represents some actual thing in the non-digital world. Contracts, personal identities, shares in a company, vesting vouchers, and much more are digital representations of agreements, personal information, ownership or equity rights, and values. You’ll often hear of the phrase “tokenization” as the process by which something is made into an NFT.
Moreover, NFTs can be split up so that there can be multiple people possessing a respective share of the original NFT. This process is called fractionalization. Although not unique to the blockchain, the digital process of NFT tokenization theoretically makes it easier to divide an asset due to lack of constraints relating to physical and in-person requirements. NFT tokenization will have its own way to confirm authenticity and ownership.
One example of this is a NFT version of a Real Estate Investment Trust, or REIT. Participants in a REIT often invest in a wide range of real properties–from mortgages to actual locations, without having to buy or finance property. Any digital asset can be tokenized–or made into a NFT; and hence any digital asset that is a NFT can be fractionalized. So it’s easy to imagine a NFT of a property that is then split up, or fractionalized, so that it can be owned by several investors.
So If Non-fungible, Why Are NFTs Tradeable?
If you go to a platform like OpenSea or Magic Eden, you will see that NFTs in the form of digital art and avatars are trading at often very lucrative values for the respective owners. Leaving aside the question of how such NFTs can command value, the fact that they are tradeable seems to go against the idea that they are non-fungible.
Splitting hairs . . . the item itself is unreplaceable. Yet, as an unreplaceable item, it can be sold or transferred to someone who wants it. In fact, its unreplaceability or non-fungibility makes it even more valuable. So trading NFTs is not replacing them, but taking some other thing or things as an agreement of transfer. Another similar example of this is land: each plot of land is unique with specific qualities and features; but as we know, plots of land can usually be bought and sold.
And just as in the “real” world of physical things, where buying a unique item requires due diligence in comfirming authenticity, NFT traders have to do the same by following the code to ensure its creator and creation date are not fraudulent.
The Nuts & Bolts of Trading NFTs
If that’s not too much, then the hearty reader might like to know how NFTs are bought and sold. Usually with some form of cryptocurrency. We’ll take the Ethereum network as an example since Ethereum is the one network with the lion’s share of applications and utility — including NFT trading.
In short, if you want to buy a NFT, you’ll have to use the protocol’s native currency. You can’t use US dollars, and so would have to convert USD to a cryptocurrency that is compatible with the Ethereum network. These types of coins are called ERC-20 coins.
As a point of reference ERC stands for “Ethereum request for comment”. Think of it as a kind of memorandum within a process. In this case, the process involves developing something within the Ethereum community based on technical requirements and protocols. If the memorandum passes muster, then it becomes an ERC.
ERC-20 refers to the specific project pertaining to fungible tokens. ERC-20 was proposed by Fabian Vogelsteller in November 2015. According to Ethereum,
“It is a Token Standard that implements an API [Application Programming Interface] for tokens within Smart Contracts.
Example functionalities ERC-20 provides:
- transfer tokens from one account to another
- get the current token balance of an account
- get the total supply of the token available on the network
- approve whether an amount of token from an account can be spent by a third-party account”
Examples of ERC-20 tokens include USDT, USDC, SHIB, DAI, BNB, and many more.
In general, whenever developers can think of improving on specific token standards or introducing new standards for specific utilities, an ERC will emerge.
ERC-721 is the non-fungible version of ERC-20. It is intended to allow for NFT transactions. ERC-721 was proposed by Dieter Shirle in January 2018. Since then, it is the backbone of NFT creation and commerce, as one would find with a Bored Ape Yacht Club asset.
According to Geeks for Geeks:
All the ERC-721 tokens hold a different value.
The ERC-721 standard tokens are created the same way as other kinds of tokens and can be created as many as the user wishes but the only difference is that the tokens have a unique value and unique metadata.
It provides many functionalities such as transferring tokens from one account to another, obtaining the current token balance of an account, the owner of a specific token, and also finding out the total supply of the token available on the network.
ERC-721 is a more complex standard than other token standards, with multiple optional extensions.
In addition, it is split across a number of contracts.
ERC-1155 was proposed by Witek Radomski, Andrew Cooke, Philippe Castonguay, James Therien, Eric Binet, and Ronan Sandford proposed in June 2018 to bridge ERC-20 and ERC-721. Because ERC-20 is fungible and ERC-721 is non-fungible, they cannot be wrapped into the same smart contract. For example, if you had a BAYC NFT and USDT, you could not send the two items in one transaction and would have to do at least two transactions.
ERC-1155 not only allows such transfers to happen in one transaction, but it can accommodate a host of assets. For this reason, ERC-1155 has been extremely popular on gaming platforms where players will often transfer and trade items like gems, heroes, weapons, crests, badges, spaceships, castles, etc.
According to Decrypt, ERC-1155 also supports semi-fungible tokens which have a expiration on fungibility (e.g. like a concert ticket); and “[i]t has a safe transfer function that allows tokens to be reclaimed if they are sent to the wrong address.”
How This Can Be Applied
Hopefully, this will make the person new to blockchain technology a little less weary of the idea of NFTs and more curious about how the process of digital tokenization and fractionalization might be applied in new ways.
A unique digital signature that can confirm whole or partial ownership is a huge thing, especially when the record of that coded signature is stored permanently and publicly.
Property, identity, time stamps . . . the possibilities change how we might hear the ad slogan “What’s in your wallet?” and think (at least IMHO) of subtle yet significant differences between ownership and possession.
Stayed tuned for part 2 on NFTs in the gaming universe.
This article is a part of the Crypto Industry Essentials educational program presented by The Art of the Bubble.
Though this article is credited to me, it contains some written material by Sebastian Purcell, PhD from his The Art of the Bubble education series on cryptocurrencies.
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