A non-fungible token (NFT) is a cryptographic asset on a blockchain with particular metadata or identification that makes it uniquely identifiable and distinguishable from other assets. Not only can NFTs be scarce and valuable, digital ownership of an asset is provable based on the public nature of the blockchain, where transaction history can be tracked and verified.
The value of rare or unique assets has existed long before cryptography and blockchain enabled NFTs. Prized paintings, artwork, baseball cards, antiques, comic books, and even clothes from famous celebrities have had significant monetary value due to their rarity and uniqueness. The monetization of these assets previously happened with in-person auctions or online auctions. However, access and knowledge of these auctions are often dispersed, local, or limited based on geographic location or socio-economic status.
Long before native token support for NFTs was added to Cardano in 2021 and the ERC-721 smart contract standard for NFTs was released on Ethereum in 2017, the concept of NFTs was envisioned by Meni Rosenfeld in the 2012 release of the “Colored Coins” paper. Rosenfeld surmised that by tracking the origin of a given bitcoin through the blockchain, it’s possible to color a set of bitcoins, or uniquely distinguish them from the rest of bitcoins. These colored bitcoins could then be used for alternative currencies, commodity certificates, smart property, stocks, or bonds. However, the limitations of Bitcoin restricted the realization of Rosenfeld’s colored bitcoins concept.
The first widely recognized NFT called “Quantum” was minted by digital artist Kevin McCoy on the Namecoin blockchain on May 3rd, 2014. Quantum is a digital image of a pixelated octagon that hypnotically changes color while pulsating with different circles, arcs, and other shapes. Afterwards, the research on NFTs on blockchain blossomed. NFTs didn’t go mainstream until Ethereum released its ERC-721 smart contract standard for NFTs in 2017. With the Ethereum blockchain, developers realized NFTs could be used for much more than buying or selling of ownership of unique assets. CryptoKitties, became the mainstream success for NFT gaming on Ethereum, which allowed players to adopt, breed, and trade virtual cats. Including gaming and monetization of rare assets, NFT has expanded to the metaverse, where users can now purchase ownership of land plots via NFTs, as seen with the Cardano-based project Smart Places Protocol. Today, NFTs have many use cases and have become a significant part of various blockchain ecosystems like Cardano, with thousands of NFT projects that can be bought or sold on multiple NFT marketplaces.
NFTs are cryptographic assets with unique identification data that makes them different from any other asset. NFTs, or the digital ownership, exist on a blockchain and cannot be replicated. Non-fungible tokens are markedly different from fungible tokens or coins, which are identical and therefore can be used for mediums of exchange or commercial transactions. For example, the $GENS token and ADA are fungible, meaning one $GENS or ADA owned by one user is identical and has the same value as one $GENS or ADA owned by a different user, respectively.
Why are NFTs safe? NFTs enjoy the same security of regular transactions on Cardano since they adhere to Cardano’s native token standard, giving them the same security properties of Cardano’s native coin ADA. However, on other blockchains like Ethereum, where NFTs are smart contracts, additional computing resources and overhead are required to transact. Immutability and an audit trail are all possible on public blockchains like Cardano.
However, each NFT has specific metadata, identifier codes, or transaction data that makes them unique compared to any other NFT. NFTs also enjoy the security of decentralized public blockchains like Cardano because this data is stored on-chain and is immutable. Blockchain technology also makes NFTs fraud proof, as any individual can check the on-chain data to ensure a NFT is original. For example, many NFTs listed on popular marketplaces such as cnft.io or JPG Store are just links to jpeg images of unique cartoon characters with different artistic traits. Anyone could go to these marketplaces, save the image from a lucrative NFT, and then mint a new NFT using the same picture on a marketplace for sale. However, the fraudster would not be able to make up the transaction history and certain identifier codes, eg. the Policy ID. A potential buyer would be able to review this data and see that a NFT is not from the original owner and is fraudulent.
NFTs are prolific today, and thousands can be found on blockchains like Cardano, Ethereum, Solana, and Avalanche. For illustrative purposes, let’s review NFTs on Cardano:
Cardano NFT Key Terms
- Policy ID - As asset names are not unique and can be easily replicated, Cardano NFTs are identified by their policy ID. This ID is unique and is permanently attached to the asset, which can be easily verified on a Cardano explorer such as Cardanoscan. Many NFTs make the policy ID publicly available so anyone can differentiate duplicate or fraudulent NFTs from the original tokens.
- Metadata - Includes additional information such as image URIs or other data that makes the transaction a NFT, allowing you easily trace back to the minting transaction, and query images and attributes.
- Fingerprint ID - These are unique identifiers for each asset inside a minting policy. For example, a project could mint 1,000 different NFTs under the same policy ID with different characteristics or features. However, each of these NFTs would have a different fingerprint ID, which is used to identify each of the assets separately.
- Mint transaction hash - A project can also mint multiple NFTs with the same fingerprint ID and same policy ID. However each of these projects would still have their own minting transaction hash, allowing you to trace each NFT back to its unique mint transaction.
- Research to find the real SpaceBudz github, website, or other official social media account of SpaceBudz like Twitter.
- From SpaceBudz’s github, you’ll see the policy ID is: d5e6bf0500378d4f0da4e8dde6becec7621cd8cbf5cbb9b87013d4cc.
- After verifying you are using a trustworthy application or site to buy NFTs, you can copy and paste the address linked to the wallet that is trying to sell the NFT into the Cardanoscan website. The site will list various details, including their stake key, their transaction history, and other data.
- Go to “Token Balance” and search for “SpaceBud1903”, which should be one of the tokens in the wallet.
- After clicking on the token, you’ll see the policy ID, fingerprint ID, and mint transaction hash. If the policy ID of the NFT listed for sale matches the official policy ID from SpaceBudz’s github, the token listing is legit. If not, this token listing is fraudulent. You can also review the other IDs and data too. While many trustworthy sites will verify popular NFTs before listing, it’s important to validate a NFT yourself before buying, as all executed transactions on Cardano are immutable and cannot be reversed.
ApplicationsThe use of NFTs go far beyond digital cartoon characters. Let’s go through some applications where NFTs can provide real-world utility.
- Music licensing and sales - The current most popular method for music distribution are subscription-based services. Artists typically get paid very little from listing their music on these services, with many making less than $0.01 USD each time a song is played. Popular artists and record companies can increase their profit margin significantly by directly selling the album or songs as NFTs to consumers. Independent artists can also bypass these distribution services and sell their material directly to customers via NFTs, keeping the majority of the profits. Artists or other performers can also use NFTs to sell tickets directly to customers for future live performances, bypassing companies that sell tickets and keeping a higher percentage of each ticket sale.
- Music royalties - Artists can earn royalties in perpetuity by coding in a royalty percentage for their albums or songs. After selling the NFT, a royalty could require that each subsequent sale sends 10-25% of each sale price to the original artist’s wallet address. Cardano NFTs typically have a 2-10% royalty rate.
- Photography licensing - Current photography is rife with fraud, as photographers can upload their photos to sites where users use them in ways that violate copyright laws and licensing of the photos. In addition, if a user purchases a photo and shares it with another person, it is difficult to prove that the second copy is unlicensed and therefore committing copyright infringement. NFTs solve this issue by allowing a photographer or photography site to mint a new NFT for sale to each user that licenses a photo. Through the blockchain, the user can verify the authenticity of their license through a transaction using their wallet. The user can also sell or transfer the license to someone else, with the blockchain allowing easy trackability of ownership.
- Proof of land ownership - NFTs can be used to represent proof of land ownership, with parcels of land representing each NFT. Metadata recorded in transactions on the blockchain can have data to identify current ownership and details of each transaction and the history of ownership. Various countries and entities are already exploring the use of NFTs to create a fraud-resistant land registry.
- Sale of unique assets - Sales of unique assets such as real estate or transfer of title property, paintings, boats, and other assets can be listed and sold as NFTs, where ownership, sale prices, date of transactions, and other details can be verified by any entity through the blockchain.
There are two types of NFTs. Off-chain NFTs can signify digital ownership of real assets such as real estate, artwork, or video games. On-chain NFTs are completely written and live on the blockchain via metadata attached to the NFT, allowing a person who buys that NFT to see specific details or data that gives that information about the NFT, such as a picture of a digital avatar.
There are many additional real-world use cases for NFTs, such as voting, decentralized identities, division of ownership of an asset, or revenue-sharing agreements. NFTs will likely be one of the biggest real-world applications of blockchain technology.
Legal aspectsThere are legal questions surrounding NFTs that’s similar to other blockchain based assets and applications. NFTs that operate on decentralized blockchains are not controlled by legal authorities, making their use for activities such as tokenizing assets that are normally regulated by the government potentially illegal. In addition, NFT markets can be used for crime and are subject to market manipulation.
One of the biggest controversies with NFTs is the enablement of money laundering and wash trading.
- Money Laundering - Money laundering is the process of a person or entity going through a series of transactions to move illegal funds into the banking system as legit money. Money laundering via NFTs could involve purchasing artwork or rare items at subjective prices with illegally gained funds and selling them later, seemingly bringing in “clean” money. Another example of money laundering would involve utilizing a decentralized NFT marketplace that does not require KYC (Know-Your-Customer). For example, an individual can do an illegal transaction and decide to receive payment in ETH in a private wallet. The illicit actor could then use a mixer such as Tornado Cash to hide the source of transactions. The person could then set up two separate accounts on the decentralized NFT marketplace that does not use KYC. One account would have the illicit funds and another account would be the real account of the entity that will be traced to their identity. Next, the illicit actor could list an arbitrary NFT such as a cartoon or handwritten picture through their real account on the decentralized NFT marketplace at the price of the illicit funds they have on the fake account. Then the entity could act as the buyer and seller, using the illicitly gained ETH in the “anonymous” account to “buy” the NFT from themselves on the decentralized NFT marketplace.
- Wash trading - Wash trading is executing trades as both the buyer and seller to create a misleading picture of an asset’s value and liquidity. For example, on a decentralized marketplace with no KYC a person could make multiple separate accounts linked to multiple private wallets. They could create a NFT, list it on the NFT marketplace, and then on a regular basis sell the NFT to their multiple wallets for 2,000 ADA, incurring small transaction fees. Other users looking at the asset’s history could be tricked about the asset value and its liquidity, which is all manipulated. Then the illicit actor could drop the price of the NFT to 1,500 ADA. A user, seeing the multiple previous sales of the NFT at around 2,000 ADA, could think the asset is selling at a discount and subsequently buy the asset at 1,500 ADA. The illicit actor makes a substantial profit and the honest user is left with a NFT whose real value may be much lower than its purchase price.
The European Union, the United States, and many other countries have raised the risk of NFTs and decentralized marketplaces that don’t implement KYC/AML (Anti-money laundering) regulations easing the ability for entities to launder money globally.
NFTs have many benefits. Land registry, transfer of real estate titles, royalties on creative assets such as photography or music, and other tasks could become more efficient and secure through the use of blockchain-based NFTs. In addition, NFTs has opened up new revenue streams and opportunities for artists in Africa and South America, allowing them to sell their artwork to a global customer base, unburdened by a bloated global payment system with high transaction fees, government capital controls, and international sanctions. On the other hand, NFT market manipulation, wash trading, and money laundering have been increasing as global adoption of cryptocurrencies.