What are Non-Fungible Tokens?

Jason Yanowitz
Sep 10, 2018 · 7 min read

Non-fungible tokens, aka digital collectibles, are one of the most exciting applications of blockchain that we have seen thus far.

Eventually, digital collectibles and the games they enable will become the first big consumer use case for blockchain.

Remember CryptoKitties?

These digitized cats became so popular in Q1 2018 that they single-handedly slowed the Ethereum blockchain to a crawl because of their high transaction volume. They also raised a $12 million series A from the likes of Andreeson Horowitz, Union Square Ventures, Naval Ravikant, Fred Ehrsam and more.

But what do these seemingly glorified Beanie Babies have to do with the future of blockchain?

CryptoKitties were the first use case for blockchains (beyond digital money) that created value for users and enabled an entire ecoystem to be built.

CryptoKitties work because humans have a unique interest in scarce items. In fact, collectible goods served as precursors to money.

Because of our desire to collect rare goods, trillions of dollars are stored in physical collectibles.

A CryptoKitty is just a collectible, but digitized.

These digitized collectibles on the blockchain have come to be known as non-fungible token (NFT).

What is a Non-Fungible Token?

The term “non-fungible token” was developed by Dieter Shirley, the creator of CryptoKitties.

Breaking that down, the term fungible means that one unit of a particular product is perfectly interchangeable with another.

As Gerald Nash, a Coinbase engineer, states, “Fungibility is, essentially, a characteristic of an asset, or token in this case, that determines whether items or quantities of the same or similar type can be completely interchangeable during exchange or utility.”

For example, our system of money requires that each dollar be completely interchangeable with any other dollar.

This is obvious.

You can use a $10 bill to purchase a sandwich from a store. The bill has value and can be used to purchase items with the same amount of value. However, if you went to purchase the same sandwich and instead handed the clerk a baseball card, they wouldn’t accept it.

Dollars are fungible. Baseball cards are non-fungible.

Bitcoins are also fungible; every bitcoin is interchangeable, much like a dollar bill. None of them are special or distinguishable from other dollar bills in any way that would create more or less value.

NFTs are the opposite; they are distinguishable from one another because each one has different characteristics.

Unlike ERC-20 tokens (security and utility tokens), which have been made popular by the ICO craze, NFTs use Ethereum’s ERC-721 standard.

What’s Wrong with Digital Collectibles Today?

Right now, owners of digital goods face many risks, the biggest of which is a trust risk (remember, blockchains are good for solving trust issues).

For those who aren’t aware, digital goods often refers to any good in a video game.

At over $100 billion in market value, the gaming market is huge.

Activision Blizzard raked in over $4 billion on in-game purchases alone in 2017.

Digital goods are issue by central authorities (the video game companies). The three big risks include:

1. They manage custody of the digital goods (can take them away at any time)

2. Can inflate the supply at will (lowering the value of the good)

3. Limiting the trade-ability of the items (won’t let you take the digital good out of their ecosystem)

Why are Non-Fungible Tokens Valuable?

For the first time ever, we have digital goods that have all five of the following characteristics.

1. Unique: Each NFT is unique and can’t be replaced, unlike ERC-20 tokens (the popular standard used for utility and security token in ICOs)

2. Scarce: NFTs can be capped in numbers in the code so everyone knows how many there are and how to distinguish them

3. Accessible: NFTs are publicly available on the blockchain and therefore accessible to all

4. Durable: NFTs exist as long as the blockchain is alive. Even if the creators of CryptoKitties disappear, they cats will continue to exist on the blockchain

5. Extensible: They can be combined to create new assets and new experiences. For example, a CryptoKitty can be dressed with KittyHats and raced in a KittyRace. In essence, CryptoKitties has become a developer platform on which anyone can build.

All of these properties combined with digital money and public blockchains has created a rich innovative ecosystem where data is democratized and where everyone is building on top of each other without the need for permission.

To learn more about how to invest in this new ecosystem, read our breakdown of the Fat Protocol Thesis.

Just as bitcoin creates sound money, NFTs create sound digital goods.

Back to the CryptoKitties

Now that you understand NFTs, CryptoKitties should make more sense.

In CryptoKitties, players can buy, sell, trade, and breed digital cats. No two cats are the same, which is what makes them extremely collectible.

This is what the Union Square CryptoKitty looks like:

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And this is what the CryptoKitty that sold for $110,707 looks like:

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Which is crazy, until you realize that this 1909 Honus Wagner baseball card sold for

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Remember that NFTs are extensible, and that they enable games to become platforms for others to build on?

After CryptoKitties came CryptoHats, which was started by a team that decided they needed to dress up their cats.

Because of the nature of blockchain, the CryptoHats team was able to build an entire product on top of CryptoKitties, but without the fear that CryptoKitties could ever rip out the API from under them (as Facebook, Instagram, and other popular apps are infamous for doing).

Once a user buys a token from CryptoHats and assigns it to their cat, the cat then owns the hat.

The user owns the cat but the cat owns the hat. So, if you sell your cat, the hat goes with it. The hat is the property of the cat forever.

The ability to develop like this then strengthens the CryptoKitty ecosystem.

Today there’s over 100 CryptoKitties variants of NFT systems that have since been created (see all of them here: https://dappradar.com/).

NFTs allow us to create experiences on top of experiences on top of experiences.

Non-Fungible Tokens’ Impact on Gaming

As mentioned above, the gaming market is worth over $100B and growing rapidly.

NFTs will not only penetrate existing games, but they’ll introduce new types of games that could never been have been possible before blockchain.

As users demand ownership over their digital goods, over a long enough time horizon, every in-game item will be an NFT.

Successful adoption of NFTs in games could not only increase the size of the gaming market, but will most likely lead the way to mainstream crypto adoption.

Game based collectibles are just the beginning though. These in-game skins, items, kitties, etc. will help develop the infrastructure needed to store digital proxies of real-world assets on blockchains.

One of the platforms leading the way is WAX. WAX is a decentralized platform that enables anyone to operate a fully functioning virtual marketplace with zero investment in security, infrastructure, or payment processing. Developed by the founders of OPSkins, the world’s leading marketplace for online video game assets, WAX is designed to serve the 400+ million online players who already collect, buy and sell in-game items.

The Future of Non-Fungible Tokens

I’ll leave you with this Olaf Carlson-Weed quote and an idea for NFTs…

“What I care about are novel use cases that are beyond what was possible before. I don’t care about incrementally faster bank settlements. What I care about are the paradigm shifts that we’re seeing.”

Picture this:

You go to a Kanye concert and you get a cryptographically verified token that only people who went to that concert get. You share that token on social media and it becomes a social symbol.

Then, after going to ten Kanye concerts, those ten tokens that you’ve accumulated turn into one gold token.

Again, you share this rare collectible on social media as it’s become a status symbol.

Then, Kanye decides that for his most avid fans, he’s giving away prizes.

How does he decide who are his biggest fans? By their tokens, of course.

Anyone with a gold token gets sent his new album a week before it’s released on Spotify.

Anyone with three gold tokens gets a free box seat at the album premier.

And anyone with five gold tokens (fifty concerts) gets to have dinner with him.

Ultimately, what we’re seeing is that the value of permissionless, decentralized apps is not about replacing app X but about finding value in new and creative ways that previously weren’t imaginable or possible.

The possibilities are endless.

BlockWorks Group

Bridging the Gap Between Finance and Digital Assets

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