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Non Fungible Tokens : What are they and Why should you care?

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Just when we think we have seen it all, something new comes along and leaves us scratching our heads for an explanation. Something similar can be seen in the crypto world these days. Non Fungible Tokens (NFTs) are all over the internet, and it has made us all confused. What NFT means ? And why should you care ? 

What are NFTs?

NFTs are blockchain based tokens that represent ownership of an asset. The asset can be anything : photos, digital files, artwork, patent, or even a tweet or meme! To understand what NFTs are, we need to first understand two things:

  • #1. Fungibility
  • #2. Blockchain

#1. What is Fungibility?

Fungibility is basically the characteristic of any goods or commodity whose individual units are interchangeable and indistinguishable from each other. In most simple terms, fungibility is a synonym for replaceability and non-uniqueness. Let us understand it with an example.

Pure Gold is Fungible

We can say that pure gold is fungible because one unit of pure gold will have the same value no matter what form it is in. You can cast it into a coin, ingots or any other form, it will have the same value irrespective of shape or state it is in.

Money is Fungible  

Money is also a fungible token. One dollar will have the same value no matter what form it is in. You can represent it as a hundred ‘one cent’ coins, or a single paper bill, or a combination of multiple denominations.

What about Diamonds or Jewelry?

Well, they are not so fungible. Their varying cuts, colors, grades, and sizes makes them Non Fungible items. Two diamond rings can have very different prices depending upon how they are designed, even though the weight of diamond in both rings are the same.

Currency should be fungible but ‘Art’ should not

Let’s say you get your salary in cash every month and you deposit it in a bank in Mumbai where you live. You send pocket money to your kids in Delhi through online transfer. If your kids withdrew that money from an ATM in Delhi, would they get the same cash with your fingerprints over it that you deposited in Mumbai? Definitely not. Your kids will get a different set of paper currency, but it does not matter because the value of that currency will be the same irrespective of whether it has your fingerprints on it or not.

Can you say the same thing about a diamond ring that you wish to give to your partner on their anniversary? The ring you bought is very special and unique. It is not replaceable unlike cash. The only option you have is to transfer it over a courier service or hand it over personally. Therefore cash is Fungible and a diamond ring is non Fungible.

#2. What is Blockchain?

Now that you understand what non-fungibility is, let us try to understand Blockchain

Blockchain is a network of computers that maintain some data publicly. Since the data (let’s call it ledger) is distributed over all computers in the network, everyone has visibility on it. It is difficult to manipulate such a data set, and any genuine change needs to pass through a  complex algorithmic and democratic validation process.

Application of blockchain

Once application of blockchain can be seen in Banking. Rather than having central banks to store and process our payment information, we can have the blockchain do it. This reduces the chances of “corruption”. 

In other words, blockchain eliminates the ‘central point of failure’ by transferring the authority from a single entity (bank) to a group of computers connected through a network. All your payment info can be stored in that distributed ledger and it will be impossible to manipulate it.

The bitcoin network is an example of blockchain-based banking where you don’t need a central bank to keep record of transactions. This makes bitcoin free from any government influence. Blockchain in banking (also called Decentralized Finance or DeFi) can help us deal with challenges like uncontrolled inflation which happens when the central banks and governments print money uncontrollably and give it to unworthy corporations and individuals through vehicles like loans, grants and subsidies

Coming Back to NFT

Non Fungible Tokens share some characteristics with Bitcoin. The only difference is that bitcoins are fungible but NFTs are not. Let us come back to our example of sending pocket money to your kids. Let’s say you get paid in bitcoin and you transfer it to your kids through a crypto wallet. Because bitcoins are digital representations of money, there is no such thing as a unique bitcoin, just like a paper currency or gold. 

NTFs are different because they are unique. Think of them like diamond rings. The NFT you won as a record in the blockchain has some characteristics that make it unique and irreplaceable. You cannot split it into fractions because the asset it represents is not fungible like money. 

If an NFT represents a painting, you cannot transfer half of it to someone and keep the half. This might be possible with bitcoins. If you have 1 Bitcoin, you can transfer 0.5 bitcoins to a friend. But you cannot do the same with an NFT. It is illogical to think about splitting an NFT, but it’s like splitting the painting in two halves.

NTFs are a record of digital ownership. Bitcoins are also a record of digital ownership. The difference is that bitcoin represents ownership of a fungible item (money), while NFT represents ownership of a non-fungible item (artwork, movies, digital IPs, copyrights, patents, tweets, memes, cars, houses, and just anything that is unique). 

Why do we even need NFTs ?

Well, right. Why do we need them?

For the same reason that many people think they need bitcoins. A blockchain-based system to track  ownership of an asset eliminates the need of a central authority. With bitcoins, you don’t need banks to validate your transactions. With NFTs, you don’t need a central authority to validate that you are a true owner of some unique asset.

Supporters of blockchain say that it is better than the conventional way of keeping ownership records. For example, if you buy a house, the only proof that you have for its ownership is the purchase agreement. This ownership record gains its legitimacy from the seal of government. What if someone forged the seal and sold you a house that he does not even own? NFT can solve this issue by removing the need for depending on a government seal to identify the true owner of an asset. NFT does it through the blockchain.

How to get involved with NFT?

You can turn your digital files (or apparently anything unique that you own) into NFTs. When you create an NFT, you basically create a record in a blockchain network that you are its owner. This ownership is verified through an algorithmic process run by the computers in the network. Once your digital asset has an ownership record on the blockchain, no one can deny that you are it’s owner because the blockchain is almost impossible to manipulate.

You can transfer NFTs to other users in the network, but it is much like sending your anniversary ring to your partner than transferring cash to your kids online.

Problems with NFTs

NFT can seem like a brilliant idea, but just like any blockchain applications, there are some problems involved. One such problem is climate change. The amount of electricity that the blockchain network consume is huge, and it is not good for the planet. One solution can be to run this technology on renewable energy, but it is not so easy.

Other problems involve “asset mania” that can spring from irrational valuation of an asset based on “assumed importance”. Recently, a tweet’s ownership was sold through NFT for millions. Do you really think a tweet is worth in millions? It’s is up to us how we want to value something, but this aspect of human psychology creates volatility making NFTs a very risky investment.

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External Resources

Non-Fungible Tokens Wikipedia

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Shopify NFT

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What are cryptocurrencies? Should you invest in them ?

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We Indians love cricket. What could be a better way to understand cryptocurrencies than to use the example of cricket!

What is Cricket?

Cricket is a bat-and-ball game similar to baseball. It is played between two teams of eleven players on a field at the center of which is a 22-yard pitch. There is a set of wickets at each end of the pitch, each comprising two bails balanced on three stumps.

game of cricket can help us understand cryptocurrencies
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As is it with any sports, there are a set of rules that defines the game of cricket. This rule has to be followed by all the participating players. Any attempts to disobey the rule can lead to disqualification

What is a protocol?

Protocol is a fancy name for rules. The cricket protocol is nothing but a set of rules that determines how cricket should be played. There is a protocol by which schools and colleges operate. There is a protocol for running a business. A protocol for governing a country. And so on. 

Enforcing the Protocol

Who is supposed to ensure that the players abide by the protocol of cricket? The obvious answer in your mind would be the umpires

Umpires are the protocol-enforcers of the game. Just like we have referees in a game of wrestling, the umpires in the game of cricket ensure that the players are playing by the rulebook. In case of any conflict or rule-breaking, the decision of the umpire is said to have the final say. Without an enforcer of protocol, players can breach the rule, and that can lead to problems. 

Protocol enforcers are the centralized authority to whom we have given our trust to enforce the rules. We depend on them to make sure that the rules are followed without any bias. 

The Central Banks

The central banks are also a kind of protocol-enforcers. They are the central authority to whom we have given the role of enforcing the protocol of our financial system.

Are the central banks doing their job well? 

Experts say that the recent trend of uncontrollable money printing by central banks has put the world on the brink of a financial crisis. In simple terms, they say that the protocol-enforcers of the financial system are failing in their job terribly!

The problem with central authorities

There is a problem with giving so much control to a central authority to enforce a protocol. How can we ensure that the central authority will enforce it fairly? 

What if the umpire on the ground of cricket gives a biased judgement ? And what if the supreme leader of a nation fails to enforce the protocol of the constitution? What if the central banks start printing money uncontrollably and create a hyperinflation ?

Clearly, the monopolistic control of decision-making by a central authority has its dangers.

Monopoly Everywhere

Today we see monopolies forming in almost every aspect of trade. We have social media giants that control how information is disseminated over the internet between individuals and groups. We have monopolistic e-commerce platforms that control a large market share of the online retail trade. These pseudo central-authorities have become the de facto rule enforcers in the area of certain business sectors.

When we text someone on messenger, we expect the messenger to enforce the protocol of anonymity. We expect them to enforce the protocol of data privacy. When we order something from an eCommerce platform, we expect the platform to enforce the protocols of online trade and competitive pricing.

But what could go wrong with such an arrangement ? 

Would you be surprised if your social media feed shows you ads of a Nike shoe the very same evening after you texted to your friend that you love to have a Nike shoe? Are these apps really forcing the protocol of encryption and anonymity? Are they keeping a watch on you? And are they selling your personal information to advertisers and governments? 

I am not accusing social media of breaching privacy laws. They are wonderful tech companies that have been doing their best in ensuring that the protocols are followed. They have contributed a lot to society. In fact, I own stocks of these companies, and I want them to do well.

I am simply saying that it is possible that these apps could abuse the power that we have given to them. Any central authority can abuse their powers. The central-authority based protocol-enforcement is always subject to corruption

Proponents of blockchain claim that we don’t need central authorities to enforce a rule. Instead, we can rely on complex computer programs based on distributed networking and cryptography to automatically enforce protocols, leaving no room for bias or corruption.

The misconception about blockchain and cryptocurrencies

One of the biggest misconceptions people have with new technologies like the blockchain is that they are a rule changer. People think that such technologies are going to change the protocols of the game. But the goal of blockchain technology is not to change the protocol itself. Their goal is to change the way that the protocol is enforced. 

Blockchain technology aims to remove the need for a central authority to enforce the rules of society. It is hated by central authorities because it carries the potential to completely disarm them. It poses an  existential  threat to organizations like Central Banks that enjoy the monopolistic control of the financial system. 

People believing in blockchain technology are not anarchists. They are not rule breakers. They do not intend to rewrite the rules of society. Instead, they just want to create a robust way to ensure that any rule that society agrees upon is enforced infallibly without giving too much control to a central authority

A world without central banks

In the absence of a central bank, anybody can counterfeit and manipulate money. How can a technology like blockchain claim that the financial system can be managed without the central banks

According to the proponents of blockchain, it can be done through blockchain-based cryptocurrencies like Bitcoin !

What is a bitcoin?

When we think of bitcoin, the first thing that comes into our mind is a coin. But a bitcoin is nothing like a coin. Bitcoin is more like a software program.

They ecosystem of a cryptocurrency is designed using complex algorithms. It makes use of cryptography, distributed networking, and mathematics. In cricket lingo, these concepts can go like a bouncer above our heads.

Luckily, we do not need to understand the intricate working of a cryptocurrency to invest in it. If you want to drive a car, you go to a driving school, not an engineering college.

What are the skills required to become an investor of cryptocurrencies?

Unfortunately, I am not qualified to give you professional investment advice on cryptocurrencies.

My opinion is that if you are financially educated, the decision to invest in crypto will come to you naturally. I do not invest in bitcoin because the current price levels are not sustainable. It does not sync with the intrinsic value of cryptocurrencies.

Anyone can create a cryptocurrency using programming platforms like Ethereum. But the real legitimacy of a currency comes from the ‘legal tender‘ status that the government guarantees . The rule of money creation is that the total money supply should justify the total productive capacity of a nation.

Intrinsic Value of Cryptocurrencies

The value of US dollar is the closest intrinsic value that the bitcoin should have according to me (assuming that the FED is enforcing the rules of dollar printing efficiently). At the current price levels, investing in bitcoin is like buying a land on the mars hoping that one day humans will live there. It might be possible, but you cannot say with certainty if it will ever happen.

The future of cryptos

Cryptocurrencies carry great potential, but there are flaws that need to be dealt with. For example, relying on hard-coded programs to make decisions for ourselves can strip away the ‘humane’ aspects from society. Sometimes we break rules for the greater good. That’s how human society functions.

A better solution is to have a balance between centralized regulation and blockchain technology. Today new types of currencies like the Central Bank Digital Currencies (CBDCs) are cropping up that tries to balance these two aspects.

Blockchain is a revolutionary technology that is finding use in other areas like supply chain management and data science, and the government should encourage development in this field (with proper regulations in place) to solve the challenges of modern society.

Best App for cryptocurrencies in India

The future of cryptocurrency trading in India seems to be uncertain. But currently there is no law that prohibits the buying and selling of cryptos. Below are some popular apps used for cryptocurrency trading in India:

Financial Education is the key to becoming a successful investor

Before you invest in cryptocurrencies, I suggest that you spend some time in understanding how the financial system works. The decisions will then come naturally to you.

I have written a book on financial education, and it can be a starting point for anyone who wants to become financially educated. You can check it out here !

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