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Crypto basics: NFTs

BY LAWRENCE J. | Updated June 07, 2024

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Financial Analyst/Content Writer, RADEX MARKETS Lawrence J. came from a strong technical and engineering background before pivoting into a more financial role later on in his career. Always interested in international finance, Lawrence is experienced in both traditional markets as well as the emerging crypto markets. He now serves as the financial writer for RADEX MARKETS. read more
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The last cryptocurrency bull run coincided with a rapid appreciation of a different kind of digital asset: the NFT, or Non-Fungible Token. In 2021, as the price of Bitcoin was going parabolic, so too were valuations of digital pictures of cartoon apes. For a while NFTs were all the rage, attracting attention not only in crypto circles but also much further afield. The phenomenon was polarising to say the least, its defenders espousing the virtues of a new type of art, its opponents condemning the apparent greed and lack of artistic merit. Whichever side of the debate one stands, the undeniable truth is that the NFT market subsequently underwent a brutal correction. The collapse in valuations was in some cases astronomical, even by cryptocurrency standards.

Before looking more into the financial and polemical aspects of the NFT craze, it is perhaps worth establishing what an NFT actually is. The “token” part of the name identifies it as a digital asset stored on a decentralised ledger, or smart contract platform, such as Ethereum. An NFT is therefore something that can be sent and received on a blockchain and is cryptographically secured. The non-fungible part requires a longer explanation.

Fungibility is the property of an item that makes it interchangeable. Cash is fungible. Gold and silver are fungible. Cryptocurrencies and tokens are also fungible, at least functionally. One ten pound may be swapped for a different ten-pound note, or even two five-pound notes, with no possible loss in value. A lump of gold may be swapped for another, providing the weight and purity remain the same. One bitcoin is equal to another bitcoin. The definition is important from a legal perspective because it establishes that one item is equivalent and indistinguishable from another.

In contrast, a non-fungible item is one that possesses an inherent property that makes it unique. A painting is not fungible, there will only ever be one original painting no matter how many copies or reproductions or photographs of it exist. The copies cannot substitute the original.

In the case of cryptocurrencies, making a token non-fungible is trivial. It is as simple as generating a unique identifier to the token that cannot be replicated. That token then becomes a representation of the ownership of a certain item. In the case of the typical NFT, the pictures themselves are not usually stored on the blockchain; the NFT instead acts as a certificate of ownership, linking it to the artwork that is stored somewhere else, such as in an IPFS network or even AWS.

NFTs are older than most suspect, although the idea first appeared under different names. Namecoin, which released all the way back in 2011, was the first to implement the concept of a token associated with a unique identity, in this case a domain name. A year later, coloured coins attempted to expand the capabilities of Bitcoin by allowing the creation of tokens representing digital resources on top of the Bitcoin blockchain.

The first instance of NFTs as we understand them today would have to wait for Ethereum to roll out. One of the earliest and most famous examples would release in 2017 under the name of Cryptopunks, a collection of 10,000 pixelated avatars. These developments would prompt the development of the ERC-721 non-fungible token standard, which defines the rules and interfaces for creating and managing NFTs on the Ethereum blockchain.

A few years later, in April 2021, the NFT craze would take off in earnest with the release of the Bored Ape Yacht Club collection. At the time of minting, a bored ape could be purchased for the sum of 0.08 ETH, or $200. The collection sold out in 12 hours and would go on to experience a vertigo inducing bull run. NFTs were back on the menu and everyone wanted a piece of the action. Demand was high; crypto traders piled onto the collection; old crypto whales drove valuations through the roof; celebrities and even companies made public purchases of bored apes. The price floor, i.e. the price of the cheapest item in the collection currently on sale, peaked a year later at about 150 ETH per ape, or $400k at the time. As of the time of writing, the price floor stands at around 12 ETH, or $50k.

Various celebrities would go on to incur catastrophic losses, with Justin Bieber losing over a million Dollars on his investments; Logan Paul, Eminem, Neymar, Snoop Dog, Paris Hilton, Madonna and many others would also get absolutely destroyed by the collapse in NFT prices. Some pieces falling over 99% in value.

The price action in NFT markets would attract a lot of attention. Debates surrounding tokenised artwork would rage back and forth just as much as their valuations. Critics levelled considerable scorn and ire at the NFT scene, their main gripe relating to the artistic merit of poorly drawn cartoon characters. An understandable concern, but a brief glance at contemporary art doesn’t exactly bolster their argument on an aesthetic front. A secondary criticism, greed, may not hold much water either if the supposed money laundering practices of modern art galleries are to be believed.

All this leads back to the only question that really matters: what can we actually use this technology for? We mentioned earlier that the images themselves are not usually stored on the blockchain, only the certificate of ownership is. With that in mind, what is stopping us from applying NFTs to other assets? The original point, discussed over a decade ago now, is that of using decentralised, immutable technology to establish ownership. This is not limited to mere digital assets either, there is no reason such a framework cannot be applied to real-world assets (RWAs) as well.

The move towards tokenised RWAs is in fact already well underway and promises to have a much more profound impact than pictures of monkeys ever did. How about tokenised property ownership? Imagine transferring the deed to a house over a blockchain. The legal power of a real estate attorney replaced instead with cryptographic truth. The scope of tokenising real-world assets very quickly expands to potential use cases we can only begin to wrap our heads around. This is not meant to be disparaging towards the current instances of NFTs - far from it. The first step down a certain path is always an important one, but just like many other aspects of the cryptocurrency sphere, the path extends much further than most imagine.

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Risk Warning : Trading derivatives and leveraged products carries a high level of risk.

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