The Digital Twin of Everything — How Tokenized Assets Can Change the (Digital) World
Authored by Bernhard Kronfellner, Filip Sokolowski, Zosia Tippner, Tibor Mérey, Christian Schmid, Stephen Robnett, Joel Hazan, Kaj Burchardi, Dominik Beron, Walid Khemiri, Justin Davreau
The paper is co-authored by BCG and walt.id.
How Can Nonfungible Tokens (NFTs) Change the World?
The digitization of our world is accelerating, leaving no region or industry untouched. Enabled by technological innovations, such as blockchain technology and decentralized storage of sensitive data, digitization is creating a world in which everything is done online, especially in the wake of COVID-19.
In this new era, we are forced to rethink many traditional concepts through which we make sense of the world: money, equity, property rights, to name a few. Innovators are realizing that there are enormous opportunities in rebuilding these core concepts from first principles.
A digital world means that ownership should be modeled in a natively digital way. NFTs allow us to accomplish just that technologically (legally, however, there are property rights and ownership issues in some jurisdictions). Due to their unique properties, NFTs offer a way to encode ownership of any type of asset digitally, including physical assets and intangible things (e.g. natively digital assets, ideas). Moreover, NFTs are anchored in blockchains, an immutable registry of records that cannot be manipulated or controlled by any single entity or malicious actors. Anyone can trust that blockchains can reliably show the correct ownership distribution of assets.
Use cases for NFTs are abundant and can be found wherever there’s a need to digitally model ownership or property rights. Consequently, NFTs will likely be among the most important building blocks of the digital world, or even potentially a metaverse.
What Are NFTs?
In a nutshell, NFTs are nonfungible tokens that digitally represent ownership over something. Each NFT has at least three properties:
1. NFTs are nonfungible, which means that each NFT (or token) is unique — there is no other thing just like it. In other words, each NFT is one of a kind, just like there is only one real Mona Lisa painting. (A fungible token, on the other hand, is not unique. It would not make any difference if one exchanged a fungible token, such as Bitcoin, for another token of the same kind.)
2. Second, NFTs represent ownership. Because they are one-of-a-kind, an NFT is able to be treated as the actual thing that it stands for, so that by selling an NFT you are also selling “the real thing” that it represents.
3. Third, NFTs can be used to tokenize and represent anything, from physical things (e.g. houses) to natively digital assets (e.g. CryptoPunk) to intellectual property. (Note that in most jurisdictions the same property rights apply to NFT s as they do to other asset categories such as IP.)
Exhibit 1 compares NFTs with other tokenized assets and describes four archetypes.
The combination of these properties reveals why a growing number of people are excited about NFTs.
Until recently, the mainstream assumption was that digital assets are necessarily fungible, because any digital asset could simply be copied. Now, if digital assets are inherently abundant, they cannot be scarce, which means they cannot really be “owned” and hold value in the way that scarce physical things do.
NFTs have changed that paradigm by introducing digital scarcity. Digital assets that are represented as NFTs can not be copied in a way that is indistinguishable from the original; they are unique, which means that digital assets can be just as valuable as physical things. (Note that a NFT can be physically copied, but one can verify, through examining the metadata and the origin blockchain, which is the original and which is a copy.)
In this way, NFTs is a natively digital way to model ownership of any type of asset.
How Do NFTs Work?
To understand how NFTs work, one must consider two perspectives:
● The functional perspective, which is understanding the implications of NFTs for its adopters and the market, particularly what NFTs enable one to do that could not be done without NFTs.
● The technical perspective, which is understanding the technologies on which NFTs are built and the technical properties that give rise to NFTs’ functionalities.
Functional Perspective
NFTs allow us to have digital representations (of potentially anything) in a way that is unique, tradable, and trustworthy (or at least with a tamper-proof record of ownership). We can distinguish, as shown in the exhibit below, between the following roles or functionalities:
1. Creator: A person or entity who is the original creator of the smart contract holding all NFTs
2. Smart contract: NFTs and ownership information are stored in a list within the smart contract; each NFT points to a URL serving its metadata
3. Minter: A minter, who can also be the creator, mints (creates) new NFTs through an authorized account
4. Owner: An owner owns one or more NFTs via their blockchain accounts
5. Data storage: Metadata containing information about an NFT is stored off-chain in any location set by the minter
Technical Perspective
Understanding NFTs technologically requires understanding a few core concepts:
● Registries, typically blockchains, serve as shared and trusted records of information. They are a single source of truth.
● Cryptographic keys enable control over NFTs and enable other crucial functionalities such as authentication.
● Token IDs are used to distinguish NFTs on a blockchain such that each token ID is linked to metadata and a unique address (establishing a public key infrastructure). This way different parties can easily find and interact with each other, as well as benefit from blockchains’ unique properties, such as immutability.
● Metadata can be anything, ranging from a piece of digital art to a digital representation of a physical asset. Importantly, metadata can be stored on-chain or off-chain.
● Smart contracts can be conceived as the programs or apps that run on a blockchain and are responsible for minting NFTs.
● Wallets are used to store keys or metadata. They also enable NFTs to be managed and shared via easy-to-use applications.
Exhibit 3 illustrates the main technical concepts in an exemplary trade process where the seller (former owner) will sell it to the buyer (future owner).
One can think of these core concepts as building blocks that are available in different variations and can be combined in various ways. For example, different blockchains (or other distributed ledger technologies) can be used to establish registries (e.g., Ethereum, Polygon, Solana, Avalanche, Polkadot, Tezos, and IOTA). Similarly, NFT metadata can be stored in different ways such as on blockchains, other distributed data storage protocols (e.g., IPFS or filecoin) or even traditional databases. Similarly, different smart contract development standards with different strengths and weaknesses can be used (e.g., ERC-721 or ERC-1155 for EVM-compatible chains like Ethereum).
As a result, there are many different flavors of NFTs depending on what variations of building blocks are used and how they are put together.
Who Should Care about NFTs?
Adoption
Industry leaders, major brands, and household names, as well as influential individuals, such as creators and celebrities, are already adopting NFTs and reaping the benefits of this new innovation.
Examples can be found in almost every industry, including legendary consumer brands (Nike[1], Adidas[2], Louis Vuitton[3]), social media giants (Meta[4], Twitter[5]), payment and e‑commerce infrastructure providers (Visa[6], Mastercard[7], Shopify[8]), leaders in entertainment (Disney[9], Marvel[10], DC[11], Spotify[12]) and gaming (Atari[13], Ubisoft[14]), sports (FIFA[15], NBA[16]), automotive (Lamborghini[17], Porsche[18], Audi[19]), travel (Emirates[20]), marketplaces (OpenSea, Rarible, eBay[21]), and leading Web3 companies (Coinbase, FTX, Kraken, Metamask).
Many early adopters of NFTs share a legendary track record of harnessing innovations to drive business value and/or the ability to create unique brands with which their customers strongly identify. The way in which these businesses apply NFTs are just as diverse and colorful as the use cases they are building.
● Art: Digital art can be monetized — by being rented or sold — as unique digital assets with exclusive properties. In DeFi (decentralized finance), art NFTs can also be used as collateral for a loan.
● Music: In a similar way to digital art, musicians and singers can link their music to NFTs, which makes it possible to own a piece of a song or album and receive royalties from it.
● Ticketing: Event organizers can issue event tickets using NFT, as this method would avoid fraud by providing an easy way to verify tickets. Additionally, it would also allow for a better traceability of all resold tickets.
● Real estate: Property ownership documents can also be made (created and issued) via NFTs, which would represent a digital and immutable certificate of ownership of a physical property. Similarly, NFTs are also used to represent virtual properties.
● Gaming: Items in online games can now be truly owned by the players, which offers many new possibilities, such as selling and buying items outside of a game’s centralized marketplace as well as using those items in other digital environments (e.g. other games).
● Product authenticity: Similar to the property ownership documents for real estate, NFTs can also be used to prove the authenticity of any other physical products, such as clothing items, jewelry, and cars.
● Fundraising and crowdfunding: Foundations and charities have already started to raise money by selling their own NFT collections. Crowdfunding platforms are now challenged by NFTs, as it allows startups to raise funds in a peer-to-peer manner.
● Access management: Decoupling access to a product or service from a user’s identity is also possible, as access can be given to the owner of a specific NFT without knowing the identity of the owner in advance.
Unique Benefits
NFTs can create significant value for your organization by enabling the creation of natively digital assets that are scarce and the crafting of unique digital experiences. Similarly, NFTs can help you overcome major business challenges such as preventing fraud or minimizing high transaction costs of trading assets.
●Unlock natively digital assets: NFTs allow your company to create scarce and tradable assets that are natively digital and that can hold significant value for your customers. This is particularly true for creative and consumer-facing industries as well the creator economy.
●Craft unique brand experiences: NFTs enable your company to create unique experiences for different customer segments, thereby driving customer affiliation, affection, and identification with your brand. You can do this by providing customers with limited editions of NFTs that come with access rights to physical or digital experiences (e.g., events) or other benefits (e.g., discounts).
●Combat fraud: NFTs can help your company combat fraudulent practices such as counterfeiting or illegal reselling that devalue and/or negatively impact the customer experience and, by extension, your brand. This is especially salient for event and ticketing industries as well as fashion and luxury goods.
●Reduce transaction costs: NFTs enable you to tokenize assets and trade these assets digitally by cutting out middlemen, thus reducing transaction costs.
● Supercharge apps: NFTs can infuse your existing apps with the ability to manage and trade digital assets, creating significant value for your users. This can be particularly interesting for apps that are already used to manage valuable assets, such as apps in banking and financial services, payments and crypto, art and real estate.
●Fractionalization of assets: A fractional NFT refers to a set of fungible tokens tied to a single or a set of NFTs. As the name suggests, it represents fractional — or proportionally shared — ownership of an NFT. When an NFT is fractionalized, the original NFT is locked up in a digital vault, and someone issues a limited supply of fungible tokens that represent ownership over that NFT.
● Transparency and zero trust: NFTs are stored on a decentralized blockchain that is validated constantly. Especially in an environment of decreasing trust in cybersecurity, this storage and transparency of ownership distinguishes NFTs from the ownership of goods in the traditional world.
●Platform economy: The platform allows owners to trade and further monetize their assets/NFTs such as by collecting royalties, which is a percentage of sales or profit. The functionalities of these royalties are set in the minting process and are defined in the smart contracts.
Deep Dive: NFTs and Identity
Since NFTs are increasingly used to model digital identity, it’s important to clarify the issues with this approach. At their core, all issues are rooted in the fact that ownership and identity are two entirely different creatures.
Ownership versus Identity
When it comes to ownership, it’s fine to exclusively rely on decentralized systems such as blockchains, because all one needs is an immutable record of transactions. If there is such a record, one can simply view the history of all transactions to verify the state of ownership at any given point in time without having to trust anyone. Trust is only required in the technology (and incentive structures).
However, that’s not the case with identity. Having an immutable history of records is not enough, as the following example illustrates.
If I tell you my name is Luke Skywalker, you probably won’t believe me, regardless if there is a record of it on a blockchain. Even if you manage to find a couple (or even thousands) of people to confirm that I am Luke Skywalker, you cannot be sure that it’s true. To be sure, you would need to see an official identity document, such as my passport, which was issued by an authoritative entity or at least a source you trust.
Here’s the problem. You cannot rely on people to tell the truth about their identity, which means that identity must always be asserted or vouched for by someone else, typically a highly trusted authority — like a government for your core identity, or a university for your diploma.
A blockchain can only tell you about the ownership distribution of things anchored on it. It cannot tell you whether the things are, in a sense, “true.” This is why plagiarism is a problem for NFTs. While a blockchain can tell you that there is only one NFT and who owns it, it cannot tell you whether the NFT represents, for example, a real CryptoPunk or merely a copy. To find out, you need a trusted authority that can verify the CryptoPunk’s authenticity by, for example, checking if it has really been minted by the original artist.
Why You Should Not Use NFTs for Digital Identity
There are least four reasons why NFTs are typically not a good solution for identity use cases.
● Insufficiency: While NFTs are good for modeling ownership of assets, they are not sufficient for modeling digital identity in all its facets.
● Privacy: NFTs are typically anchored to public blockchains, which creates obvious privacy issues when it comes to identity data.
● Compliance: Using NFTs to model the identity of individuals typically violates data protection regulations considering the tensions between individual data rights (e.g., GDPR’s right to be forgotten) and blockchains’ inherent properties (e.g., immutability).
● Costs and scalability: The use of blockchains in the context of NFTs implies transaction costs and potential scalability issues.
In a nutshell, NFTs are good for modeling what you own but not for modeling who you are.
Identity Use Cases for NFTs
Even though NFTs are not the right solution for most identity use cases, there is at least one set of use cases that make sense: “ownership-based access management.” That means that access to information, services, products, or other benefits depend on what you own, not on who you are. Consider these exemplary applications:
● Content, such as articles, music, or podcasts, that can only be accessed by people who already hold NFTs from the respective creator.
● Special discounts for or early access to new products that can only be claimed by holders of NFTs from a special series.
● New maps or challenges in online games that can only be played by holders of NFTs that represent certain digital assets, like skins or trophies.
Additionally, there is an important difference between ownership-based and identity-based access management which completely changes use case dynamics.
In the first case (ownership), the right to have access and benefits is tradable, which is not possible if access rights are tied to one’s identity. In other words, NFTs allow us to model access rights as a commodity that exists independently of its owner’s identity and thus can be bought and sold.
Per the examples above, creators may choose to create unique experiences that can only be consumed by a limited number of people without having to determine who these people are in advance. Clearly, NFTs that come with special access rights can become incredibly valuable. Think about what someone would pay for the privilege of being one of a hundred people on this planet who can listen to a special song played by their favorite artist or playing a special map on their favorite online game.
Additionally, NFTs may be used for nonhuman identity, such as the digital identity of legal entities or machines (IoT). Since these use cases that do not involve individuals or their personal data, they do not trigger privacy and compliance issues. Even here, however, NFTs are usually not the best option considering the advantages of other approaches such a self-sovereign identity (SSI) which come with lower costs and higher scalability due to off-chain data storage and transactions.
What Steps Do You Need to Take to Get Started?
Industry leaders are already adopting NFTs across the world with global consumer brands leading the way. If you are not already exploring NFTs, the following steps will help you navigate the shift in your infrastructure strategy.
Identify Opportunities
Analyze your business with a focus on either finding opportunities for creating natively digital assets or unique digital experiences, or identifying existing challenges such as fraudulent practices and high transaction costs for selling or renting assets.
● Digital assets: Does your company have an opportunity to create natively digital assets that could be valuable for your customers, particularly if such assets could be scarce and tradable?
● Unique experiences: Does your company have an opportunity to create unique experiences for different customer segments that can potentially drive customer affiliation, affection, and identification with your brand? (Think particularly about use cases for ownership-based access management.)
● Fraud: Is your company battling fraudulent practices that devalue and/or negatively impact customer experiences and your brand, such as counterfeiting and forgery or illegal reselling?
● High transaction costs: Does your company sell or rent assets for which transaction costs are. high due to middlemen or other factors?
● Existing apps: Does your company have an app with a large consumer or enterprise user base that could benefit from integration capabilities to manage or trade NFTs or digital assets generally? This would increase trust and transparency on your brand or product, and constitute concrete added value for your users.
● Platform economics: Does your company trade ownership of virtual assets and facilitate economic and social activities on a digital platform?
Analyze and Select Use Cases
Prioritize use cases based on your organization’s goals, challenges, and product or service portfolio. Make sure to include risk assessments that evaluate the cost of doing nothing, such as risks related to security breaches, compliance penalties and related brand damage, or losing customers to competitors who adopt NFTs.
Build Pilots and Applications
Plan and implement proof of concepts to build up knowledge, evaluate feasibility, and establish the ROI (return on investment) of NFTs for your organization. If you decide to pursue further initiatives and build production systems, make sure to screen solutions for the following:
● Technology fit with the use case; the benefits and costs of going with a partner versus doing it in-house
● Support of different blockchains and Web3 ecosystems (e.g., ETH, Polygon, Tezos, and IOTA)
● Holistic functionality to enable end-to-end use cases and speed up implementation (e.g., minting NFTs, supporting different distribution mechanisms, verifying ownership and metadata, plus advanced functionality such as dynamic NFTs)
● Ease of integration with your infrastructure (e.g., backward compatibility with your existing identity and access management solutions; support of legacy authentication protocols such as OpenID Connect; support for multicloud and custom key stores/HSMs)
● Open source licenses (e.g., Apache 2)
Sources:
[1] https://www.cbsnews.com/news/nike-metaverse-rtfkt-nikeland-roblox-nft/
[2] https://www.theverge.com/2021/12/16/22822143/adidas-nft-launch-into-the-metaverse-price-release-date
[3] https://www.voguebusiness.com/technology/louis-vuitton-to-release-new-nfts
[4] https://www.coindesk.com/business/2021/10/28/facebooks-metaverse-will-support-nfts/
[5] https://www.coindesk.com/business/2022/01/20/twitter-launches-nft-profile-picture-verification/
[8] https://www.shopify.com/nft
[9] https://cryptonews.net/news/nft/2443425/
[10] https://www.marvel.com/articles/gear/first-ever-marvel-digital-comic-collectibles-nft-veve
[12] https://musically.com/2022/05/13/spotify-artists-promote-nfts/
[13] https://www.theverge.com/2021/4/1/22362707/atari-corporate-entity-centipede-nft-sale-pong-collection
[14] https://www.theverge.com/2021/12/7/22822410/ubisoft-nfts-quartz-digits-ghost-recon-breakpoint
[16] https://www.nba.com/bulls/nft
[17] https://nft.lamborghini.com/
[18] https://www.nft.porsche.com/
[19] https://www.ledgerinsights.com/audi-launches-novel-fractional-nft/
[20] https://www.emirates.com/media-centre/emirates-to-launch-nfts-and-experiences-in-the-metaverse/
