Non-Fungible Tokens: What are they & why are some so expensive?

Astronomical price tags are nothing new in the world of cryptocurrencies, but recently an uncommon type of crypto asset has made headlines for generating sales in the tens of millions of dollars. NFTs, or non-fungible tokens, are poised to become the latest craze in the crypto and blockchain world. But what are NFTs, how do they work differently from cryptocurrencies, and are the enormous pricetags which have grabbed investor attention at all justified? Below, we take a closer look at NFTs and explore what makes them unique in the crypto space.

Overview For Fast Readers

  • NFT stands for “non-fungible token.”
  • An NFT is a cryptographic token which utilizes blockchain technology for verification and security purposes.
  • Unlike a typical cryptocurrency, NFTs are not fungible; this means that each individual NFT is unique and cannot be interchanged with any other NFT.
  • Some of the benefits of NFTs include the conferral of unique ownership of a digital file, an indestructible record on the blockchain, and a lack of divisibility.
  • The most popular application of NFTs as of this writing is the digital art space. Artists such as Beeple and Grimes have sold digital media using NFTs for up to tens of millions of dollars.

What Are NFTs?

NFT Image

NFTs are cryptographic tokens that are verified using blockchain technology. In this respect, they share similarities with many popular cryptocurrencies. A key distinction between a cryptocurrency like Bitcoin and an NFT, however, is fungibility. A good, commodity, or—in this case—crypto token is considered fungible if it consists of individual units which can be interchanged without any meaningful distinction between different units.

A helpful example is a dollar bill. Each dollar bill in circulation carries a unique serial number, making every bill slightly different from every other bill. However, one dollar bill is functionally interchangeable with any other dollar bill, as both have the same purchasing power. In this way, the bills are fungible.

While most cryptocurrencies are fungible, NFTs are not fungible. Each NFT is one-of-a-kind and not interchangeable with any other token. This makes them uniquely powerful as a means of creating artificial scarcity or as a way of verifying individual ownership of a digital asset such as art.

Why Are NFTs So Expensive?

The fact that NFTs are not fungible is a significant part of the reason they have achieved such enormous pricetags. An NFT can represent anything digital, including music, visual art, movies, and more. The issue with most digital items is that they are easily replicated and copied (think of an image file that you see online but can easily download onto your own computer, for instance). The key distinction with NFTs is that the owner of the NFT is the owner of the digital item. This could mean ownership of copyright and reproduction rights, although in many cases the original creator of the digital item retains those rights. So it is, in a sense, more of a collector’s item. As such, NFTs have drawn attention from many wealthy investors looking to explore what they see as the cutting edge of high-end collecting.

How Do NFTs Work?

NFTs rely on cryptography and blockchain technology for verification and security purposes. As of this writing, most NFTs are created using the ethereum ecosystem, although other crypto ecosystems have also provided protocols for creating NFTs as well. With ethereum, the two token standards known as ERC-721 and ERC-1155 provide a means of building NFTs. Essentially, these two token standards are sets of rules created by ethereum which enable software developers to create NFTs that are compatible with the broader ethereum network.

In this way, NFTs are independently verified by a distributed network, which means that they are effectively indestructible, as a record of NFT creation and subsequent ownership is maintained on the blockchain in perpetuity. Ownership of an NFT is immutable, which means that an individual who buys an NFT owns the NFT, as opposed to a license from a company which retains ownership. (An example of the latter would be music purchased through the iTunes store: the purchaser does not own the music itself, just the license to listen to the music as provided by Apple.) Additionally, unlike popular cryptos like Bitcoin which can be split up into smaller denominations, NFTs are indivisible.

An Overview of NFT Art

There are many different potential applications for an NFT, but the most popular and noteworthy to this point has been the digital art world. As we explained above, NFTs offer the chance to own an original piece of digital art (with or without the actual copyright for that art). That, however, is where it begins to get complicated. A theoretical NFT which represents a GIF image file, for example, confers on the owner of the NFT the ownership of the verifiable, original GIF. That does not mean that any other person is prevented from downloading a copy of the GIF image file for him or herself, though. Those downloaded copies may contain exactly the same file. So what is the point of creating or owning an NFT to represent that GIF, if ownership confers neither copyright nor reproduction privileges?

One response to this question is that the NFT represents the original, while copies downloaded from the internet are just that: copies. It is akin to the original Mona Lisa as opposed to countless prints made of the Mona Lisa which may look the same but are decidedly less valuable.

NFTs and the Ownership of Digital Art

Popular Examples of NFT Art

The list of popular NFT artworks is growing rapidly. As of March, 2021, one of the most famous examples is the artwork Everydays — The First 5000 Days by Beeple, which sold this month for $69 million. Internet personality Logan Paul famously sold video clips from videos he had posted on YouTube for tens of thousands of dollars. Music artists including Grimes and Kings of Leon have sold digital media as NFTs, generating significant publicity as well as revenue in the process.

Any discussion of NFTs should also include mention of CryptoKitties, a blockchain-based collectible game which reached a high point of popularity on the ethereum network in 2017. The game was among the earliest applications of NFTs, and some of the most valuable collectibles in the CryptoKitties world maintain lofty pricetags. A CryptoKitty called “Dragon” is among the most expensive and is priced at 600 ETH, or over a million dollars at current prices.

Are Sky-High Prices for NFT Art Justified?

With all of the hype surrounding NFTs, and all of the money flying around in high-profile transactions, you may still wonder just what it is about these tokens which makes them so valuable. A short answer is simple supply and demand. NFTs by design create market scarcity because they are not fungible. When there is sufficient demand (among art collectors, for instance), prices have risen to sky-high levels accordingly.

But there are also other considerations to keep in mind when asking whether NFT prices are justified. Among artists and their supporters, NFTs present a number of new and valuable opportunities. NFTs can allow artists to sell new kinds of work which were previously virtually impossible to sell. They also allow artists the possibility of bypassing traditional channels in the art world such as auction houses, which exert control and take a portion of proceeds. Some NFTs even stipulate that the original artist be paid a percentage of all future NFT sales, ensuring that the artist continues to benefit from the work’s popularity over time. Of course, collectors looking for bragging rights related to ownership of the original work of digital art also benefit from NFTs, as do collectors who buy for speculative reasons (potentially, if the price of the NFT increases).

While NFTs may be a boon to the artist and collector, there are other factors to keep in mind, too. Specifically, while each NFT is unique from a cryptographic perspective, that is not necessarily a guarantee that the artist will not release subsequent NFTs of the same piece of art. In our GIF example above, imagine that the creator of the GIF sells an NFT of that image file one day and then, realizing the profit potential, turns around and creates 10 new NFTs of the same file. This is certainly possible to do, though it would likely have a significant negative impact on the value of the original NFT, not to mention the artist’s reputation in the digital art world. Nonetheless, it represents one of many potential problems in the NFT space.

How Do You Buy NFTs?

The most popular way to buy NFTs is through dedicated marketplaces. Some of the famous NFT markets include OpenSea, Rarible, and Nifty Gateway. Famous examples of NFTs have also been sold through traditional auction houses such as Christie’s or by artists directly. While many NFT purchases are made using cryptocurrencies, they can technically be purchased in any way that the seller stipulates.

What to Expect From NFTs in the Future

While NFTs as a concept have been in existence for several years, they have only recently gained prominent mainstream attention. For that reason, it is difficult to say whether they will continue to proliferate into the future and whether there will be new instances of NFTs fetching astronomical prices. It is possible that, if NFTs no longer capture such high prices, there will be a trend away from utilizing NFTs in the future. At the same time, new technological developments can expand the possibilities of NFTs and how they are created, stored, and traded. This may also continue to fuel investor and artist interest in this technology going forward.