NFTs explained

Mar 31, 2021

NFTs explained

Co-authored by Chris Ebell and Luc Jodet 

 

Non-fungible Tokens, or NFTs, have received wide coverage in recent weeks. They are currently booming on marketplaces like OpenseaRaribleSuperareMintable …., and others. But how do they work and how are they used? And why the current boom?

 

An NFT is a form of digital asset similar to cryptocurrencies such as bitcoin or ether. Its specificity is that where one bitcoin is just as good as another bitcoin, an NFT represents a unique asset. In other words, one NFT is not the same as another NFT, which can be described as being “Non-Fungible”. 

 

Now for what are NFTs used? 

 

NFT is a medium or a tool, meaning there are plenty of ways they can be used. A simple analogy is to compare it with a sheet of paper.  A sheet of paper can be used to draft a contract worth billions of dollars, paint a masterpiece which might be bought for millions, or it can be used to write a personal letter with no inherent financial value. NFTs are similar and their applications infinite. 

 

Where fungible tokens already have some commonly accepted classification (in Switzerland, FINMA recognizes three types: payment, utility and security tokens), no such classifications exist today for NFTs. While such classifications are never perfect, it does help to visualize some of the use cases. Here we will attempt a simple and functional (not legal) classification.

 

Important issues to take into consideration when dealing with NFTs, especially when high values are involved, include tax, anti-money laundering (AML) regulations, secure custody, market knowledge, and interoperability. 

 

Collectibles

Historically, this is the category that really launched NFTs. While CryptoPunks (launched in June 2017) is considered the first NFT project, CryptoKitties was the project that put NFTs on the map for a large public at the end of 2017. Users can collect these NFTs the same way baseball or Panini cards are collected. It is here that the relative scarcity of certain cards makes them more valuable than others. 

 

Digital fine art

This category is the leader of this current boom. This is a new medium for artists such as Beeple or Refik Anadol to produce digital artwork. The current explosion culminated with an auction organized by Christie’s where an NFT by Beeple named The First 5000 Days sold for $69.9M, making it the second most expensive artwork sale by a living artist. Creating NFTs of digital art opens up new ways of presenting and selling artwork, including also fractional ownership of more expensive pieces. On the demand side, new collector communities are buying NFTs to build a collection or as an investment to trade on secondary markets. But the coming months may see a consolidation. As the market matures, more traditional concepts for the valuation of art will start to play a much bigger role. Other physical assets and non-digital Fine Art can also be tokenized. Arcades Digital is an example of a company providing NFT tokenization for Fine Art, both of physical and digital origin.

 

In-game assets

One of the most interesting and widely used application for NFTs is in-game assets. There is already a market for in-game assets such as sword and armor in World of Warcraft or skins in Fortnite. However, these in-game assets are constrained to the limits of the game. NFTs enable players to take their in-game assets to other platforms to either trade them on an independent market or to be used in a new game.

Axie InfinityGod’s Unchained or Cometh are some of the games that have attracted large numbers of players counting tens of thousands of daily active users. 

 

Property rights

The music industry is the first industry to make a foray in this sector. With on-demand digital streaming, the notion of property has almost disappeared from the music industry. This is something that many avid music enthusiasts find unfortunate, and while CDs and mp3 purchases have almost disappeared, vinyl sales experienced an unexpected resurgence. The experience of owning music with a physical art cover that can be displayed is something that many fans find attractive. Artists such as 3LAU and Kings of Leon have already released NFT based albums or songs. 
This is a nascent category, but one with a lot of room to grow as digital property rights can be applied to many other industries beyond music. 

 

Digital twins

Digital twins aim to bridge the physical and the virtual world by giving a digital identity to physical products or assets. Connecting physical assets to the digital world enables new services. RealT partnered with the Decentralized Finance (DeFi) protocol Aave to enable collateral loans backed by tokenized real-estate. In the luxury industry, Breitling partnered  with Arianee to provide an NFT digital passport for every one of their watches. This digital passport becomes the center for their customer engagement strategy. More prospective applications could enable fashion to be worn both in the real and virtual world such as Decentraland or Victoria VR. For the tokenization of physical Fine Art, creating a digital twin enables added security features to be integrated through the token, but also services such as counting “views” in a gallery or environmental conditions and location data. 

 

These different classifications should be seen as fluid as some NFT projects could fit into multiple categories. For instance, in-game assets can also be considered collectibles.

 

After a first explosion in 2017 followed by several years of disinterest, NFTs are making a major come-back this year. Currently, the market is most likely over-heating as the $69M Christie’s sale would suggest. Now while the market might see a correction at some point, NFTs have proven that they are more than hype. Numerous applications will continue to provide real value to users and projects will continue to build year after year. NFTs are here to stay and investing in projects and startups now could be a classic ground-floor opportunity.

 

About the Authors: 

Chris Ebell is the co-founder and CEO of Arcades Digital, a startup company specializing in end-to-end services for tokenization of Fine Art, both digital and physical. For more information go to www.arcades.digital and follow them on Twitter @ArcadesDigital

Luc Jodet is the co-founder of Arianee, the first luxury protocol on the blockchain that will record all genuine products of value. Arianee provides owners with the ultimate security layer for all their valuable assets.  For more information go to www.arianee.org and follow them on Twitter @ArianeeProject


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