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Thursday 30 September 2021

The Fundamentals of NFTs

What do you get when you cross digital art with blockchain technology? A match made in heaven. The investment world has found a new asset in non-fungible tokens (NFTs). In the first half of 2021, NFTs had $2.5 billion worth of sales. When “EVERYDAYS: The First 5000 Days” became the first purely digital work of art offered by a major auction house, it sold for $69 million. When Twitter founder Jack Dorsey turned his first-ever tweet into an NFT, it sold for $3 million. NFTs are the hot new thing in asset trading.

But how do NFTs work? What is the point of owning a digital asset that can be perfectly copied? The distinction lies in the blockchain side of an NFT. Using the same technology as cryptocurrencies, digital keys secure the ownership of an NFT. A public key serves as the ownership agreement while the private key acts as a password that can authorize change in ownership. All the while, the blockchain maintains a tamper proof ledger of transactions. So when it comes to how much indisputable ownership of an easily-copied asset is worth, only the market can set a price. As seen in the examples above, the market is more than willing to make that determination.

Blockchain has given digital artists a lifeline. Before their team-up, digital artists struggled to prove they were the original creator of a work, monetize artwork that can be copied, and prevent unauthorized use of their work. These factors put them at a massive disadvantage in the already difficult art field. Now, when an artist creates an NFT, they can ensure future sales pay them a certain percentage, sell art that would otherwise lack a market, and prove they are the original creator of a digital file. Through blockchain, digital artists have found a way to sell art in a way functionally similar to their physical art peers.

For collectors, ownership of an NFT conveys certain rights. Anyone can download a digital file, but only the owner can sell it. NFT collectors can also brag online by setting the file as their profile pic on (say) social media. Since most people buy NFTs as an investment, they are hoping the value will increase over time. This prediction came true for Pablo Rodrigues-Fraile, who purchased “crossroads” for $66,666 on October 31, 2020. When he sold his 10-second video clip on February 24, 2021, it went for $6.6 million.

In all the excitement surrounding NFTs, it is important to remember that no investment is risk-free. NFTs have the same risk of theft and loss as cryptocurrency, plus the unique problem of link rot. NFTs are a deed of ownership that link to a digital collectible, usually via URL. No single party is responsible for maintaining the file. If the file’s web host goes out of business, the file is lost. The URL’s creator could redirect the URL anytime, potentially reducing the NFT’s value. With new types of assets come new risk considerations.