What Are Non-Fungible Tokens (NFT)

Olga Shirimova
May 14, 2020
What are non-fungible tokens

The term “non-fungible tokens” is at least vaguely familiar to every cryptocurrency user who follows the industry news. This token class is connected with the idea of asset tokenization that has been a hype for the last couple of years.

In this article, we will answer the question “What are non-fungible tokens?” and explore their use-cases and distinctive properties. 

What Is Fungibility

Before we start talking of non-fungible tokens, let’s clarify what fungibility is.
In an economic context, fungibility is the interchangeability of assets and goods. For instance, 1 kg of pure gold, or crude oil, or sugar has the same value as any other 1 kg of the same stuff. If you mix your sugar with somebody else’s you won’t be able to recognize it in the mixing bowl.

Example: Mark has borrowed a 5 euro coin from Peter. He can pay his debt with the same coin if he hasn’t used it. Also, he can give Peter another 5 euro coin, or five 1 euro coins, and so on. It does not matter as the guys deal with a fungible currency. All the coins and banknotes representing it are interchangeable.

Fungibility is an important feature of a coin that we use to exchange or store value. It applies both to traditional and digital currencies.

Fungible and non-fungible tokens: basic properties juxtaposed. Image source: 0xcert

What Are Fungible Tokens

Fungible tokens have dominated the crypto landscape for many years. The best example would be Bitcoin, which is:

  • Interchangeable: one BTC is as good as any other, as a means of payment;
  • Identical: all bitcoins feature the same specifications;
  • Divisible: you can split BTC or ETH into smaller units of value (satoshi, gwei), just like you can change a 1 euro coin for ten 10 ct coins.
Dragon Kitty: This is what 600 ETH (over $170,000) may look like.

What Are Non-Fungible Tokens (NFTs)

In recent years, non-fungible tokens have got into the spotlight. It’s a new type of token that has a lot of potential use-cases.

Explained simply, NFTs are tokenized scarce or unique assets. Such tokens got popular due to the famous blockchain game Crypto Kitties. The game allows you to create and breed unique digital cats. If you want to upgrade your pet, you pay for all the bells and whistles with ETH. Each pet’s digital DNI is stored in the Ethereum blockchain, so no one can take a kitty from its owner. Some types of kitties are very scarce, so you can see them as an investment or a store of value. For instance, the CryptoKitty #896775 (aka Dragon) was sold for as much as 600 ETH.

The creation, development, and exchange of these non-fungible creatures were possible due to the ERC-721 token standard. It was the backbone of the game.

ERC-20 and ERC-721: the Ethereum standards for fungible and non-fungible tokens, respectively. Image source: TomoChain Docs

ERC-20, ERC-721, and ERC-1155 Token Standards

You have probably heard about ERC-20 tokens in connection with smart contracts and the ICO boom of 2017-2018. Without going into detail, ERC-20 is the set of rules that allows creating Ethereum-based assets similar to Bitcoin (i.e. fungible). You can trade such tokens on an exchange, store them in your crypto wallet, etc.

ERC-721 is a more advanced standard that makes it possible to create non-fungible tokens.  In simple terms, you can see an ERC-20 token as a regular 1 euro coin, while an ERC-721 token is similar to a commemorative coin, or a rare stamp, or another collectible. Under this standard, each token is unique. In many cases, the owner wouldn’t accept a substitute. We can also compare it to having a pet. A dog owner is unlikely to exchange their dog for another one of the same breed and age. But they can tokenize this dog (real or digital) to secure their ownership rights.

In January 2018, a new token standard was introduced. It was ERC-1155 that offered some important advantages over ERC-721. For instance, this new standard allows us to create various types of tokens (fungible, non-fungible, and semi-fungible) and use multiple NFTs in one transaction. The ERC-1155 standard has been growing in popularity recently, though it’s not yet so widely spread as ERC-721.

Non-fungible token ecosystem: currently, most startups aim at transforming online games. Image source: The Block

What Are Non-Fungible Tokens Use Cases

Asset tokenization can transform many industries beyond recognition. Below, we will briefly explore some of the most promising use-cases.

Gaming

Due to CryptoKitties, gaming is the first NFT application that comes to mind. Right now, the implementation of non-fungible tokens is primarily limited to this industry. The innovation allows players to trade various game assets like customized armors and weapons, mascots, magical artifacts, cards, etc. The good examples are the games like Gods Unchained, Decentraland, MLB Champions, My Crypto Heroes.

Some people may argue they could own and manage game assets without any blockchains, but there is an important difference to keep in mind. Without a blockchain, players never really possess their stuff. In fact, all the in-game riches belong to the game owners, and not to the players. If tomorrow these owners decide to shut their Decentraland down for some reason, “your precious” will be gone. But if your game assets are blockchain-based, you will keep them even if something goes wrong.

A crypto stamp issued by the Austrian Post, with a unicorn referring to Ethereum. Image source: Cointelegraph

Managing collectibles

NFTs can make managing and trading your collectibles an easier task. We have already mentioned crypto-collectibles like cards or kitties, but in the future, people will probably be able to tokenize real-world items, including works of art. Their ownership rights will be verified and stored on a blockchain.

An interesting project to follow is Crypto Stamps by the Austrian Postal Service. Reportedly, they issued 150,000 copies of the blockchain-based stamps that can be used as normal ones, too. 

CryptoArte: a blockchain-powered art project that uses NFTs.

Fractional Ownership of Assets

Tokenization makes it possible for a regular person to buy a fraction of an asset that he would not be able to afford otherwise. Under this scenario, multiple individuals could collectively own a painting, a historical building, a plot of land, securities, and collectibles. If the price of the asset grows, you can sell your share at any time. It would be much easier than selling a million-dollar painting or a mansion as a whole. Thus, non-fungible tokens will add liquidity to respective markets and allow middle-class people to make unique investments.

Potentially, non-fungible tokens can replace traditional ownership records. Image source: 0xcert

Identity and Ownership Management

Another sector that could benefit from the NFT introduction is identity management. If you store your ID and ownership data on a blockchain, it will eliminate bureaucratic friction from many procedures. It will also help protect your information — once added to a blockchain, it will be impossible to delete or modify. Therefore, the assets become easier to transfer and manage from any place.

Also, you can tokenize different certificates and licenses. In this case, you won’t have to collect and move papers to prove your identity, access rights or qualifications. Potentially, it could streamline the procedures like identity checks, voting, visa issuance, you name it.

Tokenization brings many benefits, but there are some important challenges to face on the way to mainstream adoption. Image source: My Stellar

Non-Fungible Tokens: Adoption Challenges

To make it all come true, the developers have to overcome some barriers on the way to the NFT mass adoption.

The main challenge, as often is the case with blockchain innovations, is regulation. Today, we spend more and more time online, so the borders between the material and digital worlds are getting increasingly blurred. But for regulators, the centralized and decentralized worlds are very different, and this gap hasn’t been bridged yet. For instance, though many people see smart contracts as an improved version of traditional legal agreements, it’s far from the current reality.

Another legal concern is that regulators might see shared ownership of tokenized assets as a method to create securities. Therefore, they will apply the respective laws. Some blockchain startups have already faced similar problems, resulting in a long and tiresome legal battle.

The second big challenge is also generic: to start using blockchain solutions, mainstream users have to understand how the technology works and learn the basic security principles. For newbies, managing the tokenized property might be difficult. The developers should provide them with a really friendly interface that will make non-fungible tokens simple and easy to deal with.

Non-Fungible Tokens: Conclusion

NFT is a very promising technology, but it’s too early to talk about its mainstream adoption. According to some experts, getting there will take a few years. Others are more optimistic in their predictions. Only time will tell who was right.

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