What are non-fungible tokens? How do NFTs work? Learn all about them and see if they are worth investing in.
The growth of the NFT market has been nothing short of remarkable. Investors have been flocking to the markets to acquire these unique digital assets, growing this niche into a multi-billion dollar industry.
Although NFTs have been around for quite some time, their popularity has exploded during the last couple of years.
Single NFTs are selling for millions of dollars, and renowned artists are jumping on the hype bandwagon, releasing their own. Quentin Tarantino recently announced a collection of NFTs based on the Pulp Fiction motion picture, while sports clubs like Barcelona FC are planning to release iconic NFTs based on their history.
To the uninitiated investor, NFTs might seem like another hyped crypto asset, and that soon the fad might die. In this article, we try to enlighten you about the NFT phenomenon by explaining the basics behind them. You get answers to questions like ‘What does NFT stand for?’ and ‘How do NFTs work?’
We explore the reasons why NFTs have value and why you might want to invest in them.
Finally, we explore some of the underlying risks that they carry, giving you a complete picture of these unique digital assets.
What Does NFT Stand For?
NFT is short for “non-fungible token”, which is a unique asset recorded on the blockchain.
Similar to cryptocurrencies, they are recorded as transactions on the digital ledger. They don’t have a physical representation in the world.
However, NFTs come with a twist. They contain various characteristics embedded in their code that make them distinguishable from one another. NFTs are unique, each one with its unique properties, and cannot be interchanged for one another.
This is in contrast with cryptocurrencies, which are fungible and can be seamlessly swapped.
What Is the Origin of NFTs?
The first NFTs go back to 2012. They were created on the Bitcoin network through a concept called “colored coins”. Small denominations of BTC could hold various characteristics and allow users to tokenize assets.
However, it was the implementation of smart contracts on the Ethereum network that made them possible. One of the first NFTs to explore these capabilities were the famous Cryptopunks in 2017.
This collection of 10,000 avatars are considered to be some of the most valuable NFTs today, because of their longevity and scarcity.
How Do NFTs Work?
Each NFT contains a number of characteristics that make it unique – number of tokens issued, date of issuance, linked artwork, etc. And because they are recorded on the blockchain, they can be accessed only by the user that controls the private key of the address where they are recorded. Hence, the blockchain provides NFT holders with immutable proof of ownership.
Because they are unique, they can be used to tokenize digital assets such as artwork, music and gaming items. Consequently, users can place them on various NFT marketplaces for sale and make profits from them.
Since most of the NFT market runs on the Ethereum blockchain, you can use Ethereum cryptocurrency to buy an NFT. NFTs created on different blockchains will require different cryptos for purchase.
What Is So Special About Them?
Investors buy NFTs because they provide exclusive ownership of the underlying digital asset. This is an important feature for collectors, as it proves their uniqueness and scarcity. The original creator of the NFT can program it to receive royalties from each sale. This empowers artists, giving them a source of passive income.
Moreover, NFTs can be used to tokenize almost anything of value and applied in the upcoming metaverse. For example, a collector can purchase a unique artwork in the form of an NFT and decorate their virtual house with it.
Additionally, NFTs can be programmed to provide utility to their owner. An NFT holder might gain access to special features of a certain blockchain, or be part of a VIP club. The Bored Apes Yacht Club is an example of such a community filled with high-profile celebrities and influential individuals.
Finally, NFTs can be used in games to provide digital asset ownership to the players, enabling them to monetize the time spent in-game. Players can sell their unique items on open marketplaces and make profits.
What Do You Need to Create or Buy NFTs?
Now that you know how do NFTs work and what they are all about, let’s talk about creating your own non-fungible token.
The process of creating an NFT is quite simple. To become an investor, you will need to hold a certain amount of the tokens from the blockchain and a blockchain wallet in which to store them.
For creators, it’s the same principle. They need a wallet and some funds to pay for the gas fees needed for the creation of the tokens.
How to Create an NFT?
Creating an NFT as an artist is a streamlined procedure, made easy with marketplaces such as OpenSea. In a nutshell, you have to:
- Pick a preferred blockchain and fund your wallet with its native tokens.
- Connect your compatible wallet to the NFT marketplace.
- Mint your NFT by providing artwork.
- Provide royalty details.
- Create an auction, set a starting, reserve, target price, and timeframe.
Once that is done, your NFT will be listed on the marketplace, and you will be able to sell it to the highest bidder.
What Do You Need to Purchase NFT?
Buying an NFTs is even simpler than creating one. Link your wallet to the NFT marketplace of your choice and find an NFT or a collection of NFTs that you would like to invest in. Then, simply place a bid, and follow the auction to ensure you remain the highest bidder by the end of it.
Is It a Good Decision to Buy NFT?
Investing in volatile digital assets like NFTs is a risky venture and remains your personal choice. That said, we can list some of the benefits and drawbacks of such an investment to help you with your decision.
What Are Potential Risks?
There are some important drawbacks of investing in NFTs that you should be aware of.
- Speculative Assets. The main drawback with NFTs is that their value is directly linked to speculation. This means that their price is incredibly susceptible to hype and could crash within a few hours.
- Illiquid. NFTs don’t allow you to fractionalize their value, and it can be difficult to find a buyer for them. This can make it quite challenging to unlock your capital if you need access to cash.
- Scams. There’s always the risk of buying a fake or an NFT that has been copied from another artist. Make sure you check the NFT history on the blockchain thoroughly.
You can minimise the risks if you stay diligent and up-to-date on news about the NFT world.
Why Do People Want to Buy NFTs?
There are quite a few compelling reasons to buy NFTs. These include:
- High-profit opportunity. You can make huge profits if you get in early on some collections.
- Proof of ownership. NFTs provide you with indisputable proof that you own artwork, which is highly praised in the collector’s community.
- Empowering artists. Artists can easily reach highly profitable markets, avoiding red tape barriers and curations and reaching out directly to the buyers.
- Monetizing metaverse items. NFTs can be used to give digital items real-world value and allow for an intricate economy in the virtual world.
If you think purchasing NFTs is something you would like to engage in, you had better get in on the action sooner than later.
Why Are Non-Fungible Tokens so Popular?
NFTs have taken the world by storm. There’s no doubt about it. They provide users with proof of ownership of their digital assets, a feature that will become essential in the upcoming metaverse ecosystem. They provide collectors with a streamlined platform for exchange and motivate artists to release unique and valuable work.
While investing in them is not without risk, new technology is racing towards NFT adoption. With Facebook and Microsoft launching their own metaverses, we are bound to see NFTs become a part of our daily lives in the near future.
Now that you know the answer to the question ‘How do NFTs work?’, you can make an informed decision and see if they are the right investment avenue for you.
