A Brief NFT Explainer

…and why they are just as pointless as you think they are, environmental issues aside!

NFTs confuse many people. What, exactly, is a non-fungible token? Why are some ostensibly worth $100,000s to millions? What do you receive if you “purchase” one? What’s the notion behind them?

An NFT relies on a blockchain, an ostensibly immutable record of ownership that uses cryptography to prove ownership. If you own a particular secret (a private key corresponding to a transaction), you are the owner. Period.

Bitcoin ascribes arbitrary value to its units, which are fungible: any Bitcoin or portion of it is exactly exchangeable with any other. This is true of cash money, too, as a dollar is worth a dollar, no matter the form in which it exists.

Where do original creations fit in a digital world? In the non-cryptocurrency universe, artists, writers, singers, and other creators typically sell a mix of unique and fungible analog works but can onlysell fungible digital works. It’s an easy example with a cartoonist as there’s a straightforward concept of unique items: original sketches and drawings and the original art for comics or comic books before they were digitized for production. The artist’s hand.

A cartoonist can produce 500 identical prints using modern printing method (a fungible item: all prints are intended to be the same), but they can also a limited-edition signed and numbered lithograph in which each print involved their oversight, lower-numbered prints are considered more valuable, and so on. Easily identifiable as fungible.

How does a creator work in a digital world? Selling digital-only work directly or via sites designed for them: artwork (such as DeviantArt), music (Bandcamp), essays (Substack), etc. But because they are digital, each work sold is always fungible and thus by many standards of art and commerce has less potential value than a unique or limited-edition work. Patreon and other revenue streams can help underwrite the creation of fungible digital work that people distribute, but it’s stil fungible.

(The closest non-fungible thing are rewards in a Patreon or Kickstarter campaign or sold directly that are not intended for public distribution: an artwork that you can’t post online; a song you can play only for yourself or in person with others. The only true way to enforce such exclusive digital distribution is through litigation, so it’s not great for a relationship with a buyer.)

NFTs offer a solution, badly implemented, that tries to offer the concept of uniqueness — of non-fungibility — to creators, dealers, other intermediaries, marketplaces, speculators, and collectors, like the auction-based art market, really.

If you cast around to find a way to make something unique, a blockchain is the obvious place to go right now. If I want to sell you a unique digital good, a blockchain (most NFT transactions are on Ethereum) provides a way for me to ensure three things:

1. I can transfer the item to you with absolute assurance, as the transfer relies on secrets you possess.
2. I will absolutely collect all the value (in Ether, etc.) for what I sell with no way for the sale to be reversed or me to be defrauded*.
3. You as the buyer have absolute certainty you are the only owner of the NFT. (For an edition of multiples, the only owner of a given multiple.)
4. (Bonus point) I can built in a downstream royalty, so that if the NFT is ever sold, I receive part of that sale price.

(*I could be conned about a transaction, but if I use a regular NFT marketplace and handle the details right, the transfer is public, simultaneous for both the NFT and value transfer, and eternal.)

That all sounds pretty great, right? But what does a seller mint as an NFT; what does a buyer buy? More or less a pointer. The pointer lives on the blockchain, not the asset in digital form. The pointer mostly points either to a website page or a distributed system that may allow for more permanence than a single page at a domain. The seller might deliver a high-resolution digital image or other stuff, including rights of reproduction, etc., but that’s not part of the NFT transfer.

The NFT is a uniquely numbered transaction with a pointer to somewhere else that the owner can prove possession of through their possession of an associated secret. Not very exciting.

If I create a beautiful new painting and sell you an ordinary NFT, you don’t own the painting. You don’t own the right to all pictures of the painting. You don’t own the right to issue or license digital or print reproductions of the painting.

The only thing an NFT gives you is the ability to prove that you own a unique digital certificate associated with the painting. If you buy a Beanie Baby, you get it and a certificate of authenticity. (Let’s pretend that’s always the case and the certificate is genuine.) With an NFT, you would not be buying the Beanie Baby nor a picture of the Beanie Baby. You’d be buying a receipt that proved you and only you owned the certificate of authenticity.

Why is the NFT market exploding for this weird-ass meaningless pointer on a blockchain? Lots of reasons:

• Missed the train. People are miffed they missed out on the cryptocurrency juggernaut when Bitcoin was 1/10,000th or less of its current price. They think they might be able to jump in here and see 100x or 10,000x returns.
• Excess cryptocurrency. A lot of people are crypto millionaires. They don’t know what to do with the money, which may be held in ways that result in taxable events if they cash out or, in some countries, criminal acts (China, etc.). This keeps their crypto in the system.
• Hype machine. Nobody knows what the hell is happening in this world of chaos, and people in the crypto world and increasingly worlds of art, music, sport, and celebrity are hammering away at the idea that this incomprehensible thing has inherent worth. (It does not.)
• Scams. NFTs are rife with scams of all sorts because of the irreversible transfer aspect. Just for starters, an unknown number of NFTs aren’t being issued by the people who own the underlying creative work, video clip, etc. It’s just outright fraud.

Why are terrible algorithmically generated “drawn” variations of apes, skulls, and lions bringing in so much “money”? Because of pumping. People with enough crypto to invest in this stuff get in, inflate prices, get people hyped, encourage speculation.

In the end, NFTs are just a bunch of hot potatoes. Some number of people own them out of genuine interest. Most people are just trying to realize the maximize possible tulip value before the entire market collapses either to a far-lower natural valuation or to dust.

NFTs try to solve a problem: how creators and collectors could work together to produce digital “originals” that convey a form of ownership. But they’re the worst solution we’ll likely see. With no inherent value and no rights associated, they’re a pandemic blip.

Note I didn’t get into the environmental issues here. That’s in part because, while huge and real, it’s possible that Ethereum will transition to a vastly more power efficient blockchain mechanism in 2022 — but it doesn’t make NFTs any better otherwise.

The ultimate form of unique digital art sales and ownership has yet to be seen. It may involve a blockchain; it will certainly involve provable ownership and uniqueness! I don’t think we have scratched the surface yet of what it will be.

I wrote a sensible book on cryptocurrency, all about understanding it and where it fits in the online and financial worlds — not about investing in it. Get a copy of Take Control of Cryptocurrency.