Why NFTs (might) matter?

Where we are today at a high level?

There is obvious hype building around nonfungible tokens (NFTs) at the moment, particularly profile picture NFTs (PFPs). Paris Hilton was on Late Night with Jimmy Fallon showing off her Bored Ape Yacht Club (BAYC) PFP recently, the host of which is also in the BAYC club. The lowest price a BAYC is being offered for sale at the moment is 100 ETH, or currently about $300k. There’s even a list of all the celebrity owners. These PFPs are status symbols, clearly, but can also act as keys that unlock access into online communities.

This is the tip of the iceberg that most people would see. There’s thousands of PFP collections that trade on Opensea and other platforms, but mostly on Opensea. At times last year Opensea was probably 95% of all NFT transaction volume across all blockchains, and they have done almost $20B in transaction volume since inception, most of that in the last year. They are a US-based company from San Francisco that is rumored to be going public. Critics often call NFTs in general a money-laundering scheme, but it seems doubtful a US company that wants to go public could tolerate that on a large scale and actually manage to go public.

Where we came from to get here?

This is a good overview of the 2012-2019 history of NFTs:
https://medium.com/@Andrew.Steinwold/the-history-of-non-fungible-tokens-nfts-f362ca57ae10

The article mentions an “NFT Cambrian Explosion” of 2018-2019 towards the end, but that is nothing compared to the 2020-2021 growth. This does not seem to be a flash in the pan.

What does an NFT represent?

An NFT is a digital proof-of-ownership token that is (generally) in the sole control of the cryptocurrency “wallet” that holds it. What is owned? It could be:

  • A digital piece of art and/or collectible
  • A token that represents ownership of physical art or other tangible asset
  • In-game items
  • Tickets for events

These are all common examples used to tout the possible benefits of NFTs. Let’s take a look at each one in more depth:

Digital art and collectibles

This is where the trading volume has been concentrated so far in the on-going Cambrian Explosion of NFTs, and also where some people have a really difficult time just grasping the concept. To date the interest and trading volume has been primarily in PFPs, which straddle the line between pure art and collectible. However, there are some notable exceptions in one-of-one pieces, such as Beeple, generative artwork such as Fidenzas by Artblocks, and in the realm of sports collectibles like NBA Top Shot.

What prevents someone from just “right-click saving” someone else’s NFT?

Nothing. And it’s beside the point. The “ownership” an NFT represents when it comes to digital art and collectibles is about establishing ownership at a specific time with respect to a specific file. Typically the part of an NFT that is actually recorded on the blockchain is metadata that consists of:

  1. A token ID (if it is part of a series or collection)
  2. A reference to the hash of one or more files
  3. A link to where you can find the file(s) on the internet
  4. Attributes of the file (what features your PFP has or what athlete is on your digital baseball card)

A hash of a file can be thought of as a signtarure of that file that is unique across all files and all files that could possibly be. Often the hash of the image is the URL of the image, because typically a network known as the interplanetary file system (IPFS) is used to host NFTs images/files, and in this network files are stored at a URL that corresponds to the hash of the file itself. For example, this is the URL of a Nonfungible Soup NFT and the hash (the bit that starts with ‘Qm’) is also stored on the Ethereum blockchain:
https://ipfs.io/ipfs/QmZ8atnWsGrRYzEG5ApDwvqdf2HHztH5QbXTLMs6jnLZv4

Someone could copy that file and create another NFT, to be sure, but when they create that NFT and record it on the blockchain, the hash of the file(s) would be exactly the same. So if it was actually a valuable piece of art or collectible, then the evidence is there recorded on the blockchain, hopefully immutable for all eternity, for anyone who cares to look and see which NFT came first. And yes, someone could alter the file a tiny bit, change a pixel or something, which would alter the hash, but if the work is actually valuable and well-known, then this type of fraud would be easy to identify by anyone who is paying attention. I think a good analogy is the original printing of a classic comic book - there are official reprints by the creator/IP owner for $10-100, and there are scammers that try to counterfeit the original and rip people off, but anyone that really wants to can figure out if a copy is an original and actually valuable (perhaps with the help of a historian or archivist or something). With purely didgital NFTs the investigation into authenticity should be much more straightforward and the item absolutely un-counterfeitable.

So what?

The world is rapidly moving towards a mostly digital state. Until 40 years ago or so there was not even a concept of “digital” in the minds of the general public. Now the average person probably spends more time interacting socially with people outside their immediate family online than they do in real life. Maybe more time online than they do with their immediate family. How do we represent ownership in the digital world? Especially in a way that the individual owner is truly in control of the digital asset (it is not just a row in a company or government database that can be revoked or frozen without the consent of the “owner” individual)? Maybe NFTs.

A token that represents a piece of physical art

The example chosen here is an NFT that represents ownership of physical art, but it could just as well be any object in the physical world: a plot of land, an extremely high-end watch timepiece, etc. Why would you want an NFT to be associated with something in meat space?

Provenance

Tracking the ownership and authenticity of a piece of art is a field of study and industry unto itself. There have been instances of paintings going missing only for a fake to resurface and be sold for a large amount, and there are estimates that ~20% of paintings owned by major museums may not be authentic. It is true that even if there was an NFT attached to every piece of art throughout history that the NFT and artwork could be separated and end up in the control of different people, and scammers could still try to sell counterfeit works, but it would add to the tools available for buyers and their advisors to come to a conclusion about the authenticity of a piece.

In the case of physical real estate an NFT representing ownership seems more directly applicable, because as far as I know there is no one out there counterfeiting parcels of land. Blockchain records of land have been proposed as a way to mitigate fraud, reduce paperwork, and speed up processing.

In-game items

This use case is constantly brought up when it comes to NFTs - give players real ownership of their CS:GO skin or rare magical sword or goat mane or whatever. This could have several benefits for the player of the game:

  • Cut out the middle man on sales of game items
  • Items are actually controlled by the player (company can’t just delete or freeze)
  • Potential interoperability of items across different games or publishers

But what’s in it for the game publisher? Potentially hype as well as a large (quite literally) invested fan base. Ubisoft is the first triple A game publisher to announce they will move to support NFTs, although it has been met with quite a bit of skepticism and cynicism from many gamers. Presumably Ubisoft sees what has happened with Axie Infinity though, which is an NFT-based play-to-earn game that that has almost 10M active daily users.

Tickets for events

This is another frequently cited use case of NFTs mentioned by proponents. Again, NFT tickets could allow trustless p2p resales, potentially killing the entire middleman business model of Ticketmaster and Stubhub. Event attendees would just open their wallet on their phone to scan a QR code proving ownership of an NFT ticket, and they would get to keep the digital ticket stub in their cryptocurrency wallet forever after as a memento. They could even throw a bunch of them in a digital shadowbox.

So…………..

Why haven’t NFTs already taken over the world then?

I think there are two reasons limiting NFT adoption at the moment, and one reason was tucked away in the last paragraph about ticketing:
In order for NFTs to be used and stored people need non-custodial cryptocurrency wallets.

What’s in your wallet?

In order for these things to be used people need to be able to receive, hold, and send them. If they become popular then there will certainly be custodial services that will hold NFTs on behalf of people, but if the vast majority of people are using a custodial service that defeats the purpose of having on-chain ownership, since those platforms would control the ecosystem and any decentralization provided by the cryptocurrency networks the NFTs exist on would be moot. I think at the moment the number of unique people with a non-custodial cryptocurrency wallet on their computer or phone is probably 100M or less (which is honestly huge). It’s hard to put a number on, but blockchain.com claims to have 80M downloads, but probably some chunk of those are users with multiple wallets. Coinbase’s non-custodial wallet has over 5M downloads on Play Store, and other wallets such as Metamask and Electrum seem to have 1M or less installs on the Play Store, so presumably would have same order of magnitude on the Apple App Store. In totality I would guesstimate about 100M and not more than 200M, which is nothing to shake a stick it, but still only 1-2% of the global population.

Personally, I expect the number of non-custodial wallet users to continue to grow as more folks get acclimated to the idea of cryptocurrency and being responsible for the money in their accounts, but this continued adoption of non-custodial wallets is something that I consider absolutely critical to the continued growth of NFTs, and it is also something a lot of people kind of implicitly assume will happen when discussing NFT potential, but they never say this part out loud.

The issue of permanence

The other (maybe) slightly less important issue is data permanence. If you envision NFTs being the final arbiter of ownership with respect to a piece of valueable artwork or a plot of land, then you have to expect the data will be available in 5 or 10 or 50 or 100 or maybe even 1000 years from now. I’m not sure anyone actually expects the Bitcoin or Ethereum networks will still be operational in 1000 years, but at this point if you had to guess then Bitcoin would probably be your best bet. It is probably a safe bet that both Bitcoin and Ethereum will still be running in 5 or maybe 10 years, but 50 or 100?

The longer these networks continue to run without major incident, the more trust will build in them to around further into the future. Currently the most used and longest running cryptocurrency network is Bitcoin, which has been operational since 2010 January 3, so a bit over 12 years now.

tl;dr

NFTs are neat and have a lot of potential use cases, but in order to continue to grow they need: (1) more people with cryptocurrency wallets, and (2) more faith that the blockchains they live on will exist in 50 years.