Unless you've been living under a rock for the last few years, or live in some remote location on Earth, chances are you've heard the terms cryptocurrency and NFT. But, in your heart of hearts, do actually know what they are?
If not, then we highly recommend spending a few minutes of your day disentangling these commonly quoted terms. Your very future may, or may not, depend on it!
What are cryptocurrencies?
Cryptocurrencies are a form of virtual or digital currency that is secured using cryptography. This means that they are incredibly secure and are near impossible to counterfeit or double-spend.
Various encryption algorithms and other cryptographic techniques are usually involved in any cryptocurrency you care to look at that serve the purpose of safeguarding the networks from outside manipulation. Which cryptographic methods are used does vary, but can include things like curve encryption, public-private key pairs, and hashing functions.
Most cryptocurrencies are, by design, decentralized networks that are based on blockchain technology that acts like a distributed ledger maintained and enforced by a large network of computers. The decentralized nature is one of a cryptocurrency's defining features and, in theory, makes them immune from government interference or manipulation.
It is for this reason, primarily but not exclusively, that makes cryptocurrencies so attractive to the general public. Another reason for their rising popularity is the ability to send and receive "money" across borders faster and cheaper than traditional forms of money transfer.
In a sense, decentralization is the key to what is often termed "Web 3.0". Many experts in the field see this as something revolutionary for the future, akin, almost, to other groundbreaking decentralization events in history like the creation of the printing press.
But, let's not get too ahead of ourselves.
As previously mentioned, central to the appeal and functionality of many cryptocurrencies, like Bitcoin, is blockchain technology. This, as the name suggests, is a set of connected "blocks" of data in a "chain" across an enormous interconnected ledger. When a new block (or entry on the ledger) is created, this triggers a sequence of verification by each node on the network before the transaction is confirmed and authorized.
This system means that it is near impossible to forge changes to historical transactions on the network, as the contents of the ledger must be "agreed upon" by the entire network.
Cryptocurrencies can either be bought and sold on specialist exchanges or brokers or "mined" by using computers or specialized computing hardware (aka mining rigs). It is possible to make real-world purchases using cryptocurrencies, just like with traditional fiat currency, but the high volatility and skyrocketing value of some, like Bitcoin, have meant that cryptocurrencies have become a popular investment and trading instrument for large and small investors.
Cryptocurrencies, or rather the blockchain that underpins them, have far wider implications than just as a means of value exchange. The blockchain that underpins it will, most experts agree, revolutionize many industries and could have very significant implications for many aspects of our lives.
For example, blockchain is already being used for keeping track of supply chains, processing online voting, logging real estate transactions, crowdfunding, managing legal contracts, securing medical information, etc. Blockchain is very much still in its infancy and we are yet to really see just how powerful and important this technology is destined to become.
What are the pros and cons of cryptocurrencies?
Like any disruptive technology ever developed, there are various benefits and disadvantages to them. Let's start with the benefits of cryptocurrencies.
By far the most important benefit of cryptocurrencies is their decentralized nature. This sets to remove intermediary institutions like banks from the equation when it comes to payment processing between the customer and supplier. Because of the secure nature of the blockchain, it is not necessary to have a "middle man" enforcing, tracking, and policing transactions like with traditional currencies. It also means there is not a single point of failure, such as a large central bank, which could mitigate against things like the 2008 banking crisis.
The next major benefit of cryptocurrencies is their ability to make fast and relatively cheap transfers between two parties. Since there is no intermediary processing data, transfers can be made very quickly and efficiently (although the time needed varies greatly). One example of this is something called "flash loans". These loans, in which capital is borrowed and repaid in one transaction, are processed without backing collateral, can be executed within seconds, and are used in trading.
For this same reason, cryptocurrencies offer amazing opportunities for the remittance economy. As Investopedia explains, "currently, cryptocurrencies such as Bitcoin serve as intermediate currencies to streamline money transfers across borders. Thus, a fiat currency is converted to Bitcoin (or another cryptocurrency), transferred across borders, and, subsequently, converted to the destination fiat currency. This method streamlines the money transfer process and makes it cheaper."
From an investor's point of view, cryptocurrencies offer an unprecedented opportunity to grow your investment in a relatively short period of time - albeit with a lot of risks. The valuation of many of the older and tested cryptocurrencies like Bitcoin, Ethereum, etc, have skyrocketed over the last decade or so. Only ten years ago, for example, Bitcoin was valued at a yearly average of $5.27. At the time of writing, a single Bitcoin is now worth in excess of $37,000, which is a 7000% increase in ten years! Very few other investments have that kind of growth potential.
But, it is important to note, that cryptocurrencies are one of the most volatile trading instruments around. This means that their value can change rapidly from minute to minute, hour to hour, day-to-day. An unprepared or inexperienced investor could make huge losses if they are not careful. For some sophisticated or experienced investors, however, cryptocurrencies volatility is another part of its appeal. Daily swings of several percent, often several times a day, offer a great opportunity to make regular buy-low-and-sell-high opportunities for day trading. This is incredibly risky, however.
All well and good, but these benefits all come with some potentially very serious trade-offs.
The first, and probably the most serious, at least for criminals and those hoping to use crypto to avoid paying taxes, is the fact that cryptocurrencies are not necessarily a truly anonymous form of transaction. They are, in fact, what is more correctly termed pseudo-anonymous. Since transactions leave a digital trail on the blockchain (which is an essential part of its function), this can be deciphered by agencies like the Federal Bureau of Investigation (FBI). This opens up the very real possibility that governments or public authorities could track the financial transactions of citizens on the blockchain. This would, however, require the authority to know your account's address.
Another of the main disadvantages, though one that is a consequence of their inherent profitability, is the fact that some of the most popular cryptocurrencies are primarily owned by relatively few people. This is in stark contrast to their image of being decentralized. In theory, cryptocurrencies should allow the distribution of coins between all parties on the blockchain, but, in reality, the lion's share is actually highly concentrated. A recent MIT study, for example, appears to suggest that 45% of all Bitcoins in existence are owned by as few as 11,000 investors.
Another apparent benefit of cryptocurrencies is that they can, in theory again, be mined by anyone with a computer. While this was certainly true in the very early days of cryptocurrencies like Bitcoin, today it takes a considerable amount of computing power and energy to do so profitably. Nowadays, only more professional operations are able to reliably mine cryptocurrencies, which attracts enormous capital and energy expenses. Again according to MIT, somewhere in the region of 10% of miners produce 90% of all new cryptocurrency units.
Mining is also very energy-intensive. As of 2021, Bitcoin mining alone used almost half a percent of all the electricity consumed in the world, a rate which has increased about tenfold in just the past five years. Most mining also occurs in places that rely on fossil fuels for electricity.
Another major problem is that while the actual blockchain itself is very secure, the wallets and exchanges typically used to hold and exchange them are not immune from hacking. Many of the most popular ones have been hacked in the past, resulting in millions of dollars worth of stolen crypto coins.
As we previously mentioned, for anyone looking to make a quick buck on cryptocurrencies, they are highly volatile. While this can be exploited to make some impressive gains, it can also result in massive losses for those investors who are not prepared. Bitcoin, for example, has experienced rapid surges and crashes in its value over the years. It climbed to a high of $17,738 in December 2017 before dropping to $7,575 in the following months.
What are NFTs?
NFTs, or Non-Fungible Tokens to give them their full name, are cryptographic assets held on a blockchain. Fungible, if you are not aware, is a word that originally derives from the Latin verb fungi meaning "to perform". In modern parlance, though admittedly mainly in legal jargon, it tends to mean "interchangeable".
This is massively significant. To put it into perspective, physical fiat currency is the complete opposite. A pound is always a pound, a dollar is a dollar, so on so forth.
Each NFT comes with its own identification code and metadata that allows it to be uniquely identified from all other NFTs and, therefore, enables its ownership to be readily tracked and traced.
Each NFT cannot be replicated, only traded, and can be pretty much anything - so long as it can be digitized. Digital drawings, doodles, pieces of music, memes, or Tweets, for example, can all become NFTs. They can also be, of course, unique digital artworks. The main criteria are that they are entirely unique.
"Tokenizing" these intangible assets allows them to be bought, sold, and traded more efficiently while in theory reducing the probability of fraud. The reality is somewhat different, as we will see.
NFTs can be created using blockchain and a specialist NFT marketplace to encode and tokenize the digital asset. The marketplace mints the NFT, charging a fee for the service. There are also other associated fees involved. When NFTs are sold, for example, this process also attracts a fee, or fees, depending on the system used.
These fees are usually paid for using a cryptocurrency. For this reason, wannabe NFT creators and owners will also need their own crypto wallets. When an NFT is purchased, the original artist/creator maintains ownership of the intellectual rights to the work, while the new owner will buy ownership of the NFT, not the original work that it is based on.
However, when someone buys an NFT, they are not buying a physical object. If the original digital work was freely available to view on the Internet, for example, a Tweet, it will usually remain freely available - the NFT owner has simply purchased the right to say that they own the work.
All of this is tracked on the NFT blockchain.
You can compare the process to prints of works of art in the real world. The artist would keep the original painting, and each "print" has its own unique number and perhaps a certificate of authenticity that accompanies the print every time it exchanges hands.
One of the major benefits of NFTs is for artists and creators. Unlike the physical world, where artists sell their works through intermediaries like galleries and art brokers, who take a cut of the profits, NFTs are based on a blockchain the transaction process can be made without the need for any intermediaries. Not involving art galleries, solicitors, and brokers makes the process far more time and cost-efficient for the artists.
Also unlike real works of art or assets, NFTs can actually be combined together to "breed" a new third unique NFT. This is called extensible, and would obviously be impossible with real physical works of art. Imagine, if you can, combining Da Vinci's Mona Lisa with Edvard Munch's The Scream to make a new, admittedly probably quite odd painting.
For artists, NFTs are proving to be something of a revolution and open up many new opportunities for them to monetize their talent - especially for new artists trying to make a name for themselves.
For budding musicians, this could also be revolutionary. Not too dissimilar to the impact of social media, NFTs could open up the possibility for musicians to fund their activities, new records, etc, through selling NFTs rather than relying on agents or donations. Merchandise and yet unknown collectibles could be put on offer for musicians fans to reward their favorite artists and fund their activities. It could possibly even be used to mint music festival tickets that were free from the risk of scalping.
By far the most popular form of NFTs at present are so-called collectibles. Things like digital sports cards, rarities, even short clips of sports games, are all changing hands for millions of dollars. Even simple text, like Jack Dorsey's first-ever tweet, has been tokenized and recently sold for an astonishing $2.9 million.
NFTs, or rather the blockchain system that underpins it, could even potentially be used to verify life experiences like being at a particularly important sports game, music gig, landmark, etc. Rather than simply claiming it to be true, you could actually prove it. Although what this will do to the concept of trust is anyone's guess.
What are the pros and cons of NFTs?
The most obvious benefit of NFTs is their inherent market efficiency as investments. Exchanging digital assets greatly streamlines the process of exchange, and enables the removal of some intermediaries, as we explained above, although NFT marketplaces now act as the intermediary. However, this decentralization is likely to become ever more important in the future.
The consulting firm Ernst and Young, for example, has already developed NFT-based solutions for one of its larger clients. The firm announced that start-up CinTech has created NFTs for the 22 main scenes of an award-winning Italian film, La Leggenda Di Kaspar Hauser. In the future, NFTs could be used this way to raise funding for films. The company says, "We plan to use a portion of the revenue from the anticipated sale of the NFTs to develop a documentary on the phenomenon of NFTs, production of new films, works of art, and more." So, using NFTs of film stills to raise money for a film about using NFTs of film stills - it doesn't get much more "meta" than that.
Another important benefit of NFTs is their ability to be used for identity management. NFTs are often likened to a form of a digital passport, but, as it turns out, they could actually be used as an actual passport too. By converting individual passports into NFTs, each with its own unique characteristics, it could be possible to greatly streamline the entry and exit process for various jurisdictions.
Another potentially huge benefit of NFTs is their ability to democratize investing. Larger assets, for example, can readily be broken down into smaller digital "chunks" making it easier for multiple owners to have a stake rather than a few high net-worth individuals. For high-value investments like artwork, this could give small, individual investors the opportunity to own a piece of a masterwork. Of course, they could not hang it on their wall, but they could share in the profits when the work is sold on. This opens the door to a wider range of investment opportunities for small investors.
This type of fractional ownership tokenization is perhaps the most exciting future for NFTs, allowing the creation of new markets and forms of investment. After all, NFTs are simply unique digital titles to property that are stored on a blockchain ledger. And that property can be either digital or physical.
Fractional ownership of real estate, like the fractional ownership of artwork described above, is relatively simple using NFTs. Each fractional owner holds tokens that represent shares in the project. Entire asset (EA) ownership is more difficult to tokenize. It requires the property deed to be turned into an NFT. Because of the regulatory laws around property ownership, this is very difficult and will likely require the creation of a new asset class of EA token.
For some industries, like gaming, NFTs will likely change the entire landscape too. It has already opened up opportunities to buy and trade a wide range of in-game assets. NFTs could be used to represent unique in-game skins or in-game items that players could own, and which could then be sold on to other players or even carried between games. This could even create a world where gamers are essentially investors.
"Decentraland", a virtual reality platform on Ethereum’s blockchain, has already implemented such a concept. The platform offers users the chance to build scenes, artworks, and experiences in a digital space, but also to create, buy, and sell digital property, Avatar wearables, and names in the Decentraland Marketplace.
One of the main cons of NFTs is that anyone can create and "mint" one. This means that, in theory, someone could create an NFT for something they don't actually have the intellectual property rights to. What's more, much like cryptocurrency, the process can be done anonymously, meaning it is hard to actually identify which ones are fraudulent or not.
In fact, NFT "factories" are already causing havoc by scraping the internet for anything that could be turned into an NFT - including intellectual property (IP) owned by creators - and creating thousands of NFTs. It is very difficult for the IP owners to track down and remove these stolen works and in some areas, they are already the most commonplace type of NFT.
Another issue is that you could lose access to your NFT. Non-fungible tokens, which use blockchain technology just like cryptocurrency, are thought of as secure. The distributed nature of blockchains makes NFTs difficult, although not impossible, to hack. In February 2022, an estimated $1.7 million in NFTs was stolen from users of the popular marketplace OpenSea. Around 254 tokens were stolen over the course of the attack, including tokens from Decentraland and Bored Ape Yacht Club. This occurred just weeks after another collector lost $2.2 million in Bored Ape tokens in another hack. And the secure nature of the blockchain means that once gone, it is very difficult to get stolen items back.
Another security risk for NFTs is that you could lose access to your non-fungible token if the platform hosting the NFT goes out of business.
Another problem, at least at present, with NFTs is the cost of minting. For anyone hoping to jump on the bandwagon, the fees can be a little nebulous and, frankly, extortionate for anyone new to the game. Fee structures do vary, but the total cost to mint your first, and subsequent NFTs can be quite a lot. For sites like "OpenSeas", it can cost as much as $300 to set up an account, and then you need to pay about 15% of the value of an NFT every time it is sold.
However, as the NFT ecosystem becomes more mainstream, it is probably an inevitability that such costs will dramatically reduce as markets vie for business.
There are other indirect costs too. Most NFT markets (where you'll be selling and buying your NFTs) use cryptocurrency as the means of exchange. This means you need some and an associated wallet to hold that cryptocurrency. And since the value of cryptocurrencies can be very volatile, this could introduce another area of risk to NFT investing. Food for thought!
What is the main difference between them?
NFTs and cryptocurrencies are as much alike as human beings and chimpanzees. While they share many similar characteristics, they are completely different species with common ancestry. In the case of NFTs and cryptocurrencies, that common ancestor is blockchain.
We already touched on this above, but NFTs and cryptocurrencies share some significant similarities and a few important differences. The main is the fact that cryptocurrencies are, by their very nature, fungible.
NFTs, as their name suggests, are not. One Bitcoin equals another Bitcoin, but one NFT does not equal another NFT. Each is distinct, unique, and valued differently depending on their perceived value and demand.
And that is basically it. But, be warned, the very brief explanation above belies the significance of this concept. For anyone interested in this area, this is a very important concept to understand and appreciate.
Cryptocurrencies are destined to change the world of finance, but the question is whether NFTs will eventually change pretty much every other aspect of your life. Will NFTs offer something that could, quite literally, give back power and, more importantly, money to the people, or are they just another bubble that will eventually burst? Time will tell.
And that is your lot for today. We hope, most sincerely, that you now have a better grasp of what cryptocurrencies and NFTs are, and, we hope, appreciate the chasm of difference between them!