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What are NFTs and how do they work?

A new way of earning money.

What are NFTs and how do they work?
Venus De Milo inside blocks of digital information blackdovfx/iStock

If you use the internet regularly, you’ve probably heard about NFTs. But what are they and why is there so much buzz around them? 

Let’s start at the basics. “NFT” is an acronym that stands for Non-Fungible Token. In a digital world where every file is reproducible, Non-Fungible Tokens are a special kind of digital file that represents a single unit of value

NFTs work as verifiable assets with unique identifiers and attributes that give them worth. They are an individualized digital commodity that can’t be exchanged for another asset, but only for themselves. This is what being “non-fungible” means —and why non-fungibility matters in crypto.

What are NFTs and how do they work?
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Bitcoin, for example, is a fungible asset because one bitcoin is interchangeable with another bitcoin. If you own one bitcoin, no one will see any reason to give your coin more or less worth than any other bitcoin. But if there was only one bitcoin in the world, then its individual existence would be more valuable. Similarly, an original artwork, such as a painting, is non-fungible. If you traded one painting for another painting, even one by the same artist, you would have a completely different painting. 

This is what happens with NFTs. Blockchain is essentially a decentralized ledger of all transactions that occur in a network. Using blockchain technology, digital transactions can be confirmed without the need for a central clearing authority, such as a bank. Instead, it uses encryption to verify transactions. Most people are familiar with the use of blockchain to verify transactions involving cryptocurrency. 

However, cryptocurrency is not the only asset whose ownership can be verified using blockchain. This is where NFTs come in. An NFT is a digital asset. It can be anything, a drawing, a doodle, a piece of music, text – as long as it is digital. In fact, most of the excitement around NFTs is about collecting NFT artworks. 

And creating and investing in NFTs, in spite of the environmental concerns regarding the amount of energy that cryptocurrency and NFT use, and concerns over the huge amount of scams, fraud, and thefts of intellectual property rights involved, is becoming a very big business.

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How to make an NFT

NFTs can be any digital file that you own intellectual property rights to. For example, a meme, a picture, a drawing, a piece of music, etc., created by you is a unique digital asset that you, as the owner of that asset, can convert into an NFT. However, one issue with NFTs is that anyone can create a digital file as an NFT, whether or not they have rights to it in the first place. Because the process is anonymous, it can be very difficult to track down 'thefts'.

To create an NFT, you must first select a blockchain platform to “encode” your digital asset. In cryptocurrency, blockchain technology is used to store and record information related to transactions in encrypted blocks that form an unalterable chain secured in peer-to-peer networks. This way, trusted third parties are not required to confirm trades. 

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What are NFTs and how do they work?
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NFTs are also saved in the blockchain as unique units of data that identify them. NFTs owners can choose on which blockchain to store their digital assets. Currently, Ethereum is one of the most popular options among NFT creators.

But making an NFT is not free. Just like you’d have to pay for a copyright license if you wanted to register your work traditionally, you have to cover certain fees to register your NFT’s information in the blockchain (a process called minting) or to put it up for sale on an NFT marketplace. The exact costs really depend on the NFT platform that you’ll be using. When paying to mint an NFT, cryptocurrency is used, so getting a crypto wallet is an additional, necessary step for NFT creators.

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Once the NFT is up for sale, NFT buyers and investors can purchase it as an original digital asset. However, this doesn’t mean that they will be the ones to own it — just the ones that own the original file instead of a copy. Therefore, there will not have copyright privileges over the NFT. Owning an NFT gives the buyer ownership of the NFT, not the original work it was based on. In addition, anyone can view an NFT for free.

In a sense, you are buying the right to say you own an NFT. For example, an NFT of Jack Dorsey’s, the founder of Twitter, first tweet (“just setting up my twttr”) was sold for €2.5 million. The buyer purchased a digital certificate of the tweet, digitally signed and verified by the creator. However, The tweet itself can be viewed by anyone for free on Twitter.

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NFT art

For artists, NFTs have opened up a new way to earn money. NFT art has been called the art of the future. It works pretty much like traditional art except for the fact that NFT artworks are always digital and the NFT system replaces conventional certificates of authenticity. 

Artists, gallery owners, and art collectors require one of these certificates to buy and sell artwork in “real” life. But in the crypto world, all you need to do to prove your artwork’s ownership and authenticity is an NFT registry in the blockchain. For smaller artists, in particular, NFTs may represent a new opportunity to monetize their work without relying on galleries or auction houses (which also charge fees). Artists can also program royalties to be paid automatically whenever an NFT is sold to a new owner.

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One of the most famous NFT artworks is “Everydays: the First 5000 Days”, a collage of 5000 digital illustrations by American digital artist Mike Winkelmann (also known as Beeple). This artwork was sold for $69.3 million at British auction house Christie’s in 2021. 

However, it is also much easier to make forgeries in the blockchain space than in the traditional art world. No materials or technical knowledge is required. NFT forgers use automated bots to "scrape" whole galleries of artists’ works. The pieces are then offered for sale on NFT marketplaces. The anonymous nature of blockchain makes it very difficult for artists to track down this stolen work and gain compensation.  

NFT games

In gaming, collectibles are items that are not essential to play the game. They are used to let you unlock certain rewards (like special artwork, 3D models, trophies, etc.) and/or help you reach a 100% completion percentage (if you are a completionist).

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Collectibles in video games have been around for a long time. Think of the Gold Skulltulas from The Legend of Zelda (1998) or the oysters and snapshots of GTA San Andreas (2004). Collectibles are even present in modern AAA games like Red Dead Redemption 2 (2018), in which you can find collectible dinosaur bones, cigarette cards, dreamcatchers, etc., across the map. 

Every player who owns a copy of Red Dead Redemption 2 can collect these items, but what if each one of them were unique? This is what happens in NFT-enabled games. Players can collect and trade NFT items that are valuable because their ownership can be traced as well. 

What are NFTs and how do they work?
Phira Phonruewiangphing/iStock

One of the most popular NFT games is the Ethereum-based game CryptoKitties, which consists of collecting, breeding, and selling virtual cats. Each cat is an NFT item with a unique sequence of numbers, referred to as its 'DNA'. This makes them one-of-a-kind crypto-collectibles.

There are also play-to-earn NFT games, in which the player can be rewarded with tokens and NFTs if they overcome certain challenges or complete certain tasks. 

But not everything is rosy. Because they are based in cryptocurrencies, NFTs are highly volatile and speculative, and there is no guarantee that you won’t lose money if you get into the world of NFT investing.

Moreover, as stated above, there is an active climate debate with regards to the amount of electricity consumed by crypto mining, the process that is necessary for the blockchain that backs up cryptocurrencies and NFTs to work. 

Some prominent artists have received a lot of backlash for the emissions generated in minting NFTs. Beeple, mentioned above, has announced that all of his future NFTs will be offset to make them carbon “neutral” or “negative."  

Although there are no formal measurements of the emissions generated specifically by NFTs (as opposed to all the crypto mining), some statistics calculate that a single Ethereum transaction can use as much electricity as an American household in nearly 9 days, which annually may have an environmental impact that is comparable to Singapore’s carbon footprint.

Ethereum is planning to replace its current algorithm with a more energy-efficient alternative, called proof-of-stake, but there is no official date for the beginning of the transition.

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