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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