NFTs Probably Aren’t What You Think
Why nobody is paying millions for a jpeg, and why you can’t actually right-click-save an NFT.
There’s a bit of a meme about “explaining NFTs” to people unsolicited. But given the space I work in I’m actually asked about them pretty often, and I thought it might be useful to get those answers into a single place. Much of the content of this comes from private conversations I’ve had with people, but I thought there might be value to sharing those discussions and expand on some of them.
WTF is an NFT, BTW
An NFT is a Non Fungible Token. Non-Fungible something means that it isn’t… fungible. Ok, tautologies are fun. An example of a fungible thing would be money. A dollar is worth a dollar. “Which one” isn’t a meaningful question.
To clarify there are nit-picky exceptions. A US dollar or a Hong Kong dollar are not the same thing. And some misprinted silver dollar might be worth thousands. Not the point. We’re talking currency value here, not the object.
A non-fungible token, therefore, is in fact “different” for each… thing. They’re not equal. They have independent values, store independent data, and need to be tracked individually.
To contrast again with money, your bank balance is just a number. It goes up and down. (Sadly mostly it goes down). The point being you don’t have to track each dollar, that isn’t meaningful.
NFTs, on the other hand, you do. Each one is an individual and unique item. It has its own properties. These might be stored on the token in a smart contract, but more often the contract contains a key or hash for an external lookup, typically something like IPFS.
What is most important about these things is that they can be transferred. The transfer process can only be done by the owner and it is tracked and public. Essentially if you have the keys to the account you can prove ownership.
Hype and Counter-Hype
The rise of NFTs is a cultural phenomenon that goes outside the crypto space. This is in part because the Gartner Hype Cycle applies, but interestingly the hype and the backlash are occurring simultaneously. There will likely follow the same pattern of moving to a less hyped, pragmatic case.
In the meantime we have a heavily loaded space where many people are proclaiming NFTs as the big thing, while an even larger number take the opposite view, seeing nothing but speculative nonsense.
JPEGs aren’t an NFT
People will often joke about “saving an NFT”. But that’s not how it works. The JPEG is not the NFT. This isn’t just ceci n’est pas une pomme. The token is an instance of a contract, typically an ERC-721 contract. This contract contains a number of properties, which include the current owner, and usually a URI, which links to the asset being commoditised. Most often this is an IPFS link which may directly to the art asset, or to a metadata file which contains further links.
It’s important to distinguish that the asset isn’t the NFT, the deployed token instance is the NFT. And it’s this that can’t be duplicated, it’s this that stores and maintains ownership.
Let’s Talk about Use-cases
When it comes to high profile stuff lately with art especially that’s… interesting. There is a distinction to be made here between the possession and the ownership. You can possess a jpeg without owning it. By contrast, in the real world you could own art without possessing it.
The buzz around NFTs, as many think of these things, is flawed because that distinction between ownership and possession isn’t particularly obvious or meaningful.
A better use-case would be a digital ticket. Say a concert ticket, or a plane ticket. That’s mine. I own it. But they’re not all the same. I have a specific seat, a specific class. There is a right conveyed — the right to get on the plane. An NFT-based ticketing system could let the owner transfer the ticket. Not copy. Not duplicate. Not share. But potentially could give, or sell. In that case, the new owner has the ticket, they now have the right. Unlike the jpeg, the ticket conveys a meaningful right.
Other good use-cases include gaming items. Your Staff of Leprosy might be a rare item you can trade on an open market. And if implemented using the standard, it genuinely could.
The purchase of that staff then conveys the ownership. The game accepts and adopts that ownership as a fact. The right and the possession are identical, without the semantics and ambiguity of cryptoart.
Digital Art vs Generated Digital Assets
Things like the Bored Ape and countless equivalents like CryptoPunks or Invisible Friends are essentially generated content, where various traits are picked from a collection. This means there is a large potential number of possible apes, punks or friends.
These are typically referred to as digital art but I don’t think that really applies. They are programmed, combinatorially generated from a pool of options.
The value of these is complex. Certainly it’s difficult for “outsiders” to see, but frankly from my own point of view I really struggle to see why a specific combination of traits is worth 11 million dollars. With that said, it’s worth that the instant someone pays that for it. That’s how it works.
This is what an NFT is to most people. But this isn’t the extent of what can be done with NFTs in the art space. There are people doing genuinely innovative things in the blockchain and art space. A year ago Grimes released an art collection called WarNymph, to an amount of around $6 million. Beeple sold a work of art through Christies for $69 million. Nice. Some might query the value of digital art, but this isn’t that conversation.
The above distinction between generated art and otherwise is difficult to defend.
Misconceptions and the Dark Side
This is a controversial topic. NFTs are currently the subject of massive amounts of hype, and a corresponding pushback against it. Like any technology there are downsides as well as benefits. And more particularly there are use-cases that make sense, and others that don’t.
In particular it’s important when talking about NFTs in contexts like this that we be clear that we’re talking about the underlying technology. Not the implementation. Just because the airline ticket is an interesting use-case for NFTs doesn’t mean British Airways is about to implement it. Technology options and business requirements aren’t always aligned.
Circling back to art, there is an interesting and barely spoken fact about these high value NFT transactions. Some of them are straight up money laundering schemes.
This can be to launder money directly, or to launder crypto obtained from illegal activity such as ransomware.
It should be acknowledged, though, that the same criticism has been levelled at the fine art world for many years. Ultimately art and its value, whether digital or not, is highly subjective, and may legitimately be extremely high. This lack of objective value is a prime candidate for exploitation by deliberately inflating prices for the purpose of money laundering.
There is also the issue (see more in the link above) of wash trading. Wash trades are trades with the same (or a colluding) party on both sides of the trade. These trades can be done for a number of reasons, including bumping up the ostensible value of a commodity, or for tax reasons. This is illegal in securities trading, but as we all know, crypto can be an unregulated wild west.
There is another issue often brought up with NFTs, and that is the environmental cost. The process of minting NFTs (or any other transaction) on blockchains consumes electricity. Massive amounts of electricity are burned by the Proof of Work consensus mechanisms of the main blockchain networks.
Bitcoin uses the most, as much as 707 kWh for each transaction, with the whole network using as much as 160 TWh a year. However, Bitcoin isn’t relevant — it doesn’t do NFTs.
Ethereum is the most important network for NFTs, burning approximately 74.6 TWh a year. The total electricity generation for the world is about 24,000 TWh, so as a percentage that’s surprisingly high. Around 0.32% of total electricity generation for the planet. That isn’t just for NFTs, either, that’s the whole network.
Not every NFT is on Ethereum, however. The top NFT by volume at time of writing is WIN NFT HORSE, something to do with trading racing horses. It’s on Binance Smart Chain, which has a massively lower power usage. But the next 44 top projects are all Ethereum.
Still power usage doesn’t tell the whole story. A good example is that people in Iceland use about four times as much electricity as the US per capita. But Iceland’s electricity generation is 99.95% renewables.
Mining companies are incentivised to use cheaper power, which is often renewable. They also regularly have arrangements whereby they drop off their usage during heavy load periods. It is difficult to tell exactly what impact blockchain mining companies actually have on power. But it’s too much.
This will get better. Bitcoin’s contribution isn’t going away, but from an NFT point of view, Ethereum gives hope. The movement from a Proof of Work to a Proof of Stake for Ethereum 2.0 should hopefully drop energy usage by a predicted 99.95%. Unfortunately Eth 2.0 was supposed to be released in 2019, and has continually slipped since.
Conclusions, or the TL;DR
The key takeaway here is that NFT is a useful and valid mechanism for the conveyance of rights, including ownership of digital assets. Where it has less value is when the specific right being exercised isn’t clear, and unfortunately many current high profile examples of NFTs are in this category.
The asset isn’t the NFT, and can’t be duplicated, but the current use-cases don’t make that very clear or meaningful. The environmental cost is a very real thing, but extremely difficult to quantify. Hopefully that will be remedied soon.
It’s likely that there will come a time when NFT simply stops being a buzzword, when it’s used as a mechanism behind things that are taken for granted, like licences, or event tickets.
In the meantime, NFTs will continue to be a substantial part of the blockchain and crypto ecosystem, and both the hype and the counter-hype are here to stay.