Topic 1

What the heck is an NFT?

Introduction

If you’ve been paying attention to the crypto industry, you’ve probably heard everyone talking about ‘NFTs’. And it’s not just hardcore crypto-enthusiasts that can’t stop blabbering on about them – mainstream culture has been investing in and trading these digital assets.

 

In this guide, we’re going to provide you with some foundational knowledge around NFTs, blockchain, and why so many people are hyped up about three letters.

 

Before we jump in, let’s start by defining what the letters N-F-T stand for.

 

Non-Fungible-Token

 

Could they not have made this an easier term to understand? We are going to break this term down because as soon as I hear the words ‘fungible’ and ‘token’ you’ve lost me.

Defining Fungibility

To understand the concept of fungibility, bear with us and change the words to Non-Replaceable Token.

 

Non-Replaceable 

 

*You can’t replace it, there is only one of them, it is unique.

 

Examples of non-replaceable items:

  • wedding dress.
  • engagement ring.
  • Tiffany and Co one of kind jewelry piece.
  • your ex bf’s hoodie, your ex gf’s hoodie.
  • a special wine that you bought in Italy from a winemaker that has no online presence or overseas sales.
  • your childhood teddy bear.
  • the Mona Lisa.
  • a card or letter written by your current love or your favorite pearl necklace. 

 

Examples of replaceable items:

  • eggs.
  • bottles of cheap champagne.
  • new shoes put out by Jimmy Choo that everyone is buying.
  • lulu lemon leggings.
  • iPhone.
  • ray bans.
  • coffee. 

 

Non-fungible/ non-replaceable items are WAY MORE valuable than fungible items.

 

Makes sense right? Because there is only one of them – which is what we call scarce.

 

Scarcity = something valuable.

 

Now that we’re across the basic concept of fungibility, let’s dive a little deeper and look into ‘tokens’, blockchain, and finally, NFTs.

Tokens

What is a token?

 

This is advancing a little beyond where we are with our existing modules though bear with me as I explain what a token is.

 

Tokens are typically the term used to describe every asset in the cryptocurrency space. Sometimes, you’ll hear people say ‘coins’ too, although this isn’t technically correct, nor is it truly appropriate to say that every asset is a token.

 

Tokens are digital units of value that sit on top of and work within blockchains. They can serve many different purposes, for example; accessing platform-specific purposes, and holding them to receive rewards.

 

This is a pretty huge topic so if you want to learn more, you can read our blog; Tokens v’s Coins (Coming soon).

Next, we will tease out what a blockchain transaction looks like.

Blockchain and Banking

I feel that one of the easiest ways to explain blockchain is to look at how transactions between two people differ when they are conducted via the traditional banking system versus on the blockchain.

 

Let’s outline both scenarios below.

 

Note: If you want to get a deeper understanding of how crypto works, you can read Topic 1: A crypto story.

 

Banking Transaction

  • Sarah is your bestie, and she’s low on money for the holiday she is taking with her boyfriend after spending it all on swimsuits.
  • She calls you from the store asking for some cash which she will return when she gets paid. 
  • The transaction: you transfer $1000 from your bank account to Sarah’s account. Both your banks acknowledge money leaving your account and entering Sarah’s. This happens on the bank’s “books,” also known as a “ledger.” 
  • You and Sarah trusted both banks to acknowledge the transfer of money leaving and entering the respective accounts.

 

History has shown us that banks and financial institutions don’t always do what they should with our money. A great example of this can be seen with the Global Financial Crisis of 2008… With this in mind, enter “the Blockchain”.

 

Blockchain technology has allowed these kinds of transactions we mentioned above to occur without a bank/middleman – they occur publicly (anyone can view them) with complete reliance on technology (blockchain technology).

Now, let’s tease out what a cryptocurrency transaction on the blockchain looks like. 

Crypto/Blockchain Transaction

  • Sarah is low on cash for a holiday, so she calls you and asks, ‘can you transfer me crypto? Bitcoin please :)’ (there are lots of different crypto tokens like Bitcoin, Ethereum, and Dogecoin), which people value and might want. As we can see, Sarah wants Bitcoin (BTC).  
  • You send your BTC tokens to Sarah. They leave your crypto wallet, and go to hers, and what happens when you do this? The transaction goes onto a public ledger (an online space that records all of the transactions—think green matrix screen) where a bunch of computers (called miners) keep track of every single transaction. If you don’t have the right amount of crypto in your wallet, the computers verifying this will not allow the transaction to go ahead. 
  • Now, in this particular example, you have enough bitcoin in your wallet to transfer to Sarah, and the miners have agreed that you do, so now your transaction is successfully sent to Sarah’s Wallet. 
  • The group has verified the legitimacy of the transaction.
  • Let’s hope the bikini store accepts bitcoin 🤪

Now that we’ve covered all of that, we are finally ready to move onto how NFTs work in more detail. 

NFT's - How Do They Work?

In our banking example, we demonstrated transactions between people using the traditional banking system, where they transferred fiat (another term for your local currency—USD, AUD, GPB, YEN).

 

From there, we showed the same example, but we looked at how the value is transferred using cryptocurrency on a blockchain.

 

We’re now going to show you a third transaction example that focuses on NFTs. An important distinction to note is that with NFTs, users are transferring asset ownership, not currency.

 

  • What are assets? Assets are anything that retains or accrues money or value.  For example; a home, jewelry, a company, car, piece of clothing that appreciates in value – it is basically anything that creates positive money value for a person or a business.

 

NFT transactions using the blockchain are transferring ownership of an asset rather than actual currency/money.

 

A Typical NFT Transaction

 

Let’s use the ‘Sarah’ example again, and this time, she’ll be selling you her digital art.

  • Sarah has created a piece of digital art and she now wants to sell it to you.
  • She has made the art an NFT, meaning, the ownership of the art is represented via a non-fungible token (which is simply a digital certificate of title).
  • You both agree on a price of $1,000 worth of Bitcoin and upon agreeing, you send Sarah $1,000 worth of Bitcoin and Sarah transfers the NFT to you and makes her digital art piece available for download. 
  • Transaction complete. You are now the proud owner of one of Sarah’s cool digital art pieces. You can download it and use it as a Twitter profile picture, add it to your website, send it to people…do whatever you want with it. It’s yours. 

 

There are some cool things to take away from the above example.

Asset Ownership

For the first time, a distributed technology (blockchain) is the reference for asset ownership.

Seamless

There is a seamless transfer of asset ownership through the NFT (the digital certificate of title).

Transparent

The blockchain has recorded the transaction details, and the transparent nature of the blockchain means that anyone can see the details. Ownership of the NFT is irrefutable.

Digital art isn’t the only thing being linked with NFTs. Lots of different assets are being tokenized: music, art, NBA top shots, tweets, and more.

 

We love useful stories at Clutch, so here is another one for you. This time, we’ll look at a recent musician’s use case for NFTs.

Doja Cat – Using NFT’s To Sell Digital Experiences

 

Doja Cat: the female musician who on Saturday 11th September, launched her first NFT collection, selling ‘digital experiences’.

What does that mean?

 

Doja Cat has a large audience who values her and what she creates: music, art, clothes… She was able to create a collection of 26,000 items that are available for purchase from a specialized site she has made. Each item is represented by an NFT token, and interestingly, the NFT’s have different rights, and perks attached to them. Unlike our previous example, they aren’t just simply ownership rights to an asset… Doja Cat is using NFTs to also provide experiences to her audience.

 

Marketed as a “digital token experience” – Her audience can purchase these unique NFTs, which range in price from $5-$2,500. Depending on what you buy, the NFTs give you the right to certain ‘perks’. For example:

 

  • $2,500 NFT gives you VIP access to her upcoming tour.
  • $5 NFT gives you access to the discord (online social media space) where you get exclusive access to the Doja group and Doja jumping into the channel herself. 

 

Have a browse through her website and see all the different things you get access to, depending on what NFT you buy.

 

We wanted to share this story because it’s an excellent example of how tokens and the blockchain are being used on a range of assets, and experiences. Doja Cat’s discord group, music festival, and competition giveaway are all valuable to Doja Cat fans who are willing to pay to have exclusive access with a token (NFT) that represents that.

 

You might ask: can’t you just do this with tickets or normal membership?

 

To that we say, yes, but:

  • How often is the resale of a ticket a problem?
  • How much does it cost businesses to create features that are not replicable?
  • How easy is it to provide unique features and offer them to fans?
  • You’re relying on a centralized and often singular entity (the ticketing business) to take care of this. What if they are unethical? How can you verify they are telling the truth?

 

Blockchains are transparent, immutable, and decentralized, and by using them, we don’t have the above issues.

The Bottom Line

In summary, NFTs can be thought of as a metaphor for how humans value things, and to date, we have not had a technology that helps us attribute an ‘identifier’ to all objects’ value that we can transact on.

 

So now when someone says, WTF is an NFT? You can reply with: 

  1. It’s a non-replaceable token.
  2. It represents what we value. 
  3. It gives people the ability to transact on valuable items. 
  4. It represents a certificate of ownership for a particular asset or experience.

Key Terms

Blockchain

“Blockchain is a shared, immutable ledger that facilitates the process of recording transactions and tracking assets in a business network. An asset can be tangible (a house, car, cash, land) or intangible (intellectual property, patents, copyrights, branding). Virtually anything of value can be tracked and traded on a blockchain network, reducing risk and cutting costs for all involved.”

 

– IBM

NFT

“Non-fungible tokens or NFTs are cryptographic assets on blockchain with unique identification codes and metadata that distinguish them from each other. Unlike cryptocurrencies, they cannot be traded or exchanged at equivalency. This differs from fungible tokens like cryptocurrencies, which are identical to each other and, therefore, can be used as a medium for commercial transactions.”

 

– Investopedia