What are NFTs? A Beginners’ Guide

Have you ever heard of non-fungible tokens? The term has been buzzing around the Internet lately and the echo has even reached the mainstream media: past the astonishment at the million-dollar sales, have you ever been curious to know what NFTs are and how they work? Moreover, what is the difference between non-fungible tokens and cryptocurrencies? If you still haven’t found a definition of NFTs that satisfies you, let’s try to formulate it together!

What are NFTs: definition and history

Let’s rewind: where did non-fungible tokens come from? The first NFT in history didn’t actually know it was a NFT: meet Quantum, the video of a pulsating, colour-changing octagon. Its creators, husband and wife Jennifer and Kevin McCoy, were looking for a way to prove the ‘provenance’ of digital works: in other words, they wanted to certify their uniqueness, trace their ownership and verify the identity of the artist. 

Aided by Anil Dash, then, they registered Quantum’s information on Namecoin‘s blockchain in 2014: they called the result ‘monetized graphics‘, because this technology, by proving the authenticity of tokens that are impossible to ‘copy’, actually gives value to online art. Indeed, Quantum’s verified data, since it is immutably stored in a shared ledger, made it possible to sell it without intermediaries: it was transferred from McCoy to Dash, for only $4, as a demonstration.

The acronym NFT was only coined, however, on 20 September 2017: Dieter ‘Dete’ Shirley proposed the name while working on the CryptoKitties project, a game based precisely on non-fungible tokens. This dApp (decentralised application) was an instant success, so much so that it congested the Ethereum blockchain, where it was hosted: this is where the real story of non-fungible tokens begins.

From the very first example, it has always been clear what NFTs are: in simple terms, ‘packets’ of data recorded on blockchain, which prove ownership and authenticity of content, making them unique and non-reproducible. Each non-fungible token functions as a kind of ‘contract’: it assigns any object, whether digital or physical, an identification number and clarifies its issuer and owner. 

In practice, the creation of an NFT by an individual artist or a company happens as follows:

Since anything can be ‘mined’, the characteristics and purposes of the resulting tokens vary greatly. What they all have in common, however, is their non-fungibility: let’s find out what it means.  

Fungibility: the difference between NFTs and cryptocurrencies

Defining the meaning of non-fungible is essential to understand what NFTs are. First of all, this quality makes each token unique and therefore not interchangeable with others. Furthermore, an NFT is not divisible into sub-units: if deprived of the iconic smile, the Mona Lisa would lose its identity and value – in the same way, fragmenting a non-fungible token would shatter or nullify its value. 

These are the main differences between NFTs and cryptocurrencies, because cryptos are, on the contrary, fungible: all Bitcoins are the same, so any BTC can be replaced by any other, and fractional; the minimum unit is one satoshi (0.000001 BTC), so they can be easily spent. Their fungibility makes cryptocurrencies a suitable medium of exchange for payments, like fiat currencies.

How do NFTs work?

At a technical level, non-fungibility is achieved by assigning distinctive characteristics to each token, recorded in special software on blockchain. These are the smart contracts that enable minting by assigning an identification code (ID) to each non-fungible token and attaching essential information and characteristics to it, called metadata. 

In particular, each NFT is associated with a wallet address that, together with its public and private keys, gives proof of ownership of the work; indeed, a user in the network of a blockchain is identified by their crypto wallet. Smart contracts also regulate the exchanges of NFTs, reassigning ownership as they are sent from one wallet to another: in this way, traceability of the tokens is realised and their authenticity can be proven, going all the way back to the creator’s account. 

In addition, metadata shows where the content the NFT represents is stored: the excessive size usually prevents files from being stored directly on the blockchain (on-chain), as the gas fees required by the operation would be too high. Therefore, images, videos and audio are often stored off-chain, exploiting cloud storage services. The debate on ‘where’ to store off-chain content focuses on the choice between centralised and decentralised solutions: a case study is the Moonbirds collection.

To sum up, it is the smart contract that defines how an NFT works from a technical point of view. This means that non-fungible tokens are programmable: their functioning can be established beforehand, with a view to the purpose they will serve. In this regard, several code models have been proposed over time, based on the most common applications of this technology. Most of these are standardised on Ethereum and therefore indicated by the abbreviation ERC (Ethereum Request for Comment) followed by an identification number. Let us look at the most important ones.

ERC-721 and blue chip

Searching online for what NFTs are, we would certainly find examples of one-copy images, single specimens designed for collecting. The scarcity of these NFTs is determined by particular smart contracts, which follow the ERC-721 standard: in a nutshell, a set of shared rules for the creation of non-fungible tokens on Ethereum, formulated by the aforementioned Shirley. The most famous collections, such as Cryptopunks and Bored Ape Yacht Club, are ERC-721 and because of their ability to retain their price over time, supported by a solid design, they are also called blue chips.

PFP: profile pictures

NFTs are often used as profile pictures: there are collections with limited elements designed precisely for this purpose, called PFPs. In particular, tokens from projects such as the aforementioned Moonbirds, Cryptopunks and Bored Apes are perfect for representing one’s online identity. These NFTs are the result of a combination of traits: the composition of the images is entrusted to an algorithm (also within the smart contract), which randomly matches a set of attributes. 

Depending on the frequency of the constituent elements, the NFTs will have a certain rarity, compared to the other items of the collection: rarity tools are used to calculate this coefficient for each non-fungible token. In general, when a random mechanism ‘assembles’ a set of elements creating a unique artwork, this is called generative art.

ERC-1155: semi-fungible tokens

Having understood what NFTs are and the meaning of non-fungibility, let’s take it one step further: when an object is tokenised in several identical copies, it is called ‘semi-fungible‘; the reference standard is ERC-1155, which assigns the same ID to all replicas. This is the case for some game items in the Metaverse, music tracks or just limited edition collectables. Actually, ERC-1155 accepts all ‘levels’ of fungibility, so even simple one-copy NFTs (in this case the number of replicas is 1). 

A particular example of a semi-fungible token (SFT) is tickets to a concert without assigned seats: they have a finite number but all serve the same purpose, so they are interchangeable (fungible). However, after fulfilling their function, they lose their face value, becoming a mere collectible, a non-fungible souvenir. In short, they turn from fungible tokens into NFTs.

POAP and soulbound

POAPs, an acronym for the proof of attendance protocol on which they are based, are essentially NFTs that certify your attendance at a certain event. These tokens, built on the ERC-721 standard, also record personal achievements on blockchain, including educational qualifications and work experience. They are similar to badges that can be ‘pinned’ to one’s crypto wallet to demonstrate one’s achievements. 

If the tokens are individual, however, it is necessary to bind them inextricably to one’s wallet address, so as to prevent the sale of fake certificates; soulbound NFTs are designed for this purpose. Basically, they are tokens that cannot change owners, in fact once minted they remain ‘locked’ in the destination wallet; there is a specific standard for soulbound, ERC-5114.

The gNFT: ERC-998 and 3664 for gaming

Non-fungible tokens find a natural application in the world of video games, because they can represent any game asset. Players, in this way, can monetise the fun, being direct owners of their progress and the items they have won: a prerogative of Web3, defined in the play-to-earn mechanism. 

Gaming NFT (gNFT) requires specific functionality and increased complexity, achieved through two new standards, 998 and 3664. First, consider your character in an online role-playing game, ‘composed’ of your weapons, shields, accessories and virtual coins, and imagine tokenising these items. The ERC-998 allows you to merge all these tokens, both fungible and non-fungible, into a single NFT: in a nutshell, you would have a single representation for the entire game experience, and be able to move and sell it as a ‘block’.

ERC-3664, on the other hand, allows NFTs to change over time: the characteristics of items in games can be changed, improved and transferred to other items, just as these items can break and deteriorate. In practice, this standard records how many times you can still use a weapon, definitive ‘upgrades‘ and momentary enhancements, opening up to greater game complexity. 

Dynamic and fractional NFTs

The case of gaming is representative of a certain dynamicity of non-fungible tokens: this mutability, however, could also depend on information from the offline world. Simply put, ‘dynamic‘ NFTs change their characteristics according to weather forecasts, the results of a sporting event, the outcome of a poll; all data suggested to the smart contract by so-called oracles.

Finally, among the types of NFTs there are ‘fractional‘ tokens. In a nutshell, a non-fungible token is transferred to a smart contract ‘vault’, which in return generates a number of fungible tokens. Each of these represents a ‘part‘ of the NFT property and a fraction of its value; the asset is thus shared among multiple users, who could not afford to buy the whole thing. Fractional tokens are a borderline case among non-fungible tokens, because they eliminate exclusivity and uniqueness; perhaps they even oppose the meaning of NFT.

What are NFTs used for?

By listing the existing forms and applications of NFTs, we have already given a general overview of their uses, but let us try to elaborate with a few examples. First of all, the art world is fertile ground for non-fungible tokens, so much so that Beeple managed to sell the work Everydays, the first 5000 days for $69.4 million! 

Music, likewise, is a protagonist: the Gala Games project has created a platform dedicated to musical NFTs (Gala Music), while some wonder whether blockchain-based streaming can replace services such as Spotify. Comics and books, meanwhile, have their first tokenised versions, as in the case of DC comics stories or the NFTBooks project. Finally, sport has literally seized the ball, creating collections of iconic moments such as NBA Top Shots, from the creators of CryptoKitties, and NFTs from the World Cup (a collaboration between Algorand and FIFA).

Non-fungible tokens can also be used for the creation of digital identity: in addition to the already mentioned PFPs, NFT domains can replace the long alphanumeric strings of wallet addresses with comprehensible words, such as your own name; Ethereum Name Service is among the platforms offering this type of solution. Similarly, Telegram is planning to turn every username or channel into an NFT by organising auctions through the Ton DNS platform. Finally, some crypto lending platforms give the possibility of locking non-fungible tokens as collateral for loans.

Now that you know what NFTs are and how they work, it will be much easier to choose which non-fungible token to buy, but first you will need to determine the true value of that specific NFT! In any case, always remember to do your own research and assess the legitimacy of a project before buying NFTs and cryptocurrencies.