Non-fungible tokens (NFTs) have taken the world by storm in recent years. But what exactly are they and how NFT work? This comprehensive guide will explain everything you need to know.
What is an NFT?
A non-fungible token (NFT) is a unique digital asset that represents ownership of a specific item like art, music, videos, and more. NFTs are minted on a blockchain like Ethereum, which provides public proof of ownership that is transparent and permanent.
NFTs are different from fungible tokens like Bitcoin because each NFT has distinctive properties and is not interchangeable. For example, 1 Bitcoin is equivalent to any other Bitcoin, but an NFT representing a specific piece of art is unique and not replaceable.
How NFT work: Key Characteristics
Here are some key characteristics of NFTs that explain how they work:
- Non-fungible: Each NFT is unique and not interchangeable with another NFT
- Indivisible: An NFT cannot be divided into smaller parts
- Verifiable: Ownership is recorded on a blockchain, providing transparent proof of ownership
- Indestructible: Once created, an NFT exists forever on the blockchain
- Programmable: NFTs can be programmed with additional features like royalties
How NFT work: Minting Process
The process of creating an NFT is known as minting. Here are the main steps involved:
- Creating the Digital Asset
- The digital asset can be art, music, videos, 3D models, etc. This is the actual item being represented as an NFT.
- Choosing a Blockchain
- Ethereum is the most popular blockchain for NFTs, but others like Flow, Tezos and Solana also support them.
- Using an NFT Marketplace
- Platforms like OpenSea and Rarible facilitate creating and selling NFTs. They handle the minting process.
- Adding Metadata
- Metadata like name, description and image is added to provide details about the NFT.
- Minting the NFT
- This writes the NFT to the blockchain, creating a permanent record and tokenizing the asset.
- Listing the NFT
- The owner lists the NFT on a marketplace where it can be traded or sold.
How NFT work: Trading Process
NFTs can be traded or sold just like any other digital asset:
- The owner lists the NFT for sale on a marketplace at a set price or bids.
- Buyers browse through listed NFTs and purchase them using cryptocurrency wallets.
- The transaction transfers ownership of the NFT to the buyer’s cryptocurrency wallet address.
- A transaction record is created on the blockchain, publicly displaying the new owner.
Some platforms like NBA Top Shot allow peer-to-peer transfers of NFTs directly between buyers and sellers.
How NFT work: Use Cases
NFTs have a wide variety of use cases across multiple industries:
- Digital artmakes up the majority of current NFT use. Artists mint their work into NFTs to sell directly to collectors.
- NFT collectibles like CryptoPunks are highly sought after. Just like physical collectibles, their scarcity drives value.
- NFTs can represent in-game assets that players own and trade. Axie Infinity pioneered blockchain gaming with NFT characters.
- Artists can release exclusive songs, albums or music videos as NFTs. Their royalties are automatically paid via smart contracts.
- Virtual worlds like The Sandbox have parcels of virtual land represented as NFTs that players can buy and monetize.
- NFT domain names like .nft allow creating decentralized websites. The domains are minted as NFTs on the Ethereum Name Service.
How NFT work: Programming Royalties
A groundbreaking aspect of NFTs is that they can be programmed for royalties every time they are sold or traded.
For digital artists, this means they can receive a percentage of all future sales of their work. Normally art resales only benefit collectors, so this is a gamechanger for artists.
Here’s how NFT royalties work:
- When minting the NFT, the creator specifies a royalty percentage (e.g. 10%)
- This royalty amount is coded directly into the NFT’s metadata
- Whenever the NFT is sold or traded in the future, the royalty is automatically paid to the creator
- This provides an ongoing revenue stream as their work increases in value
Royalties are usually around 10-20%, but can be customized by the creator.
Pros and Cons of NFTs
|Authenticity and proof of ownership||High minting fees|
|Opportunity for artists to monetize work||Subject to high volatility|
|Transferable and resalable||Lack of regulation currently|
|Royalty payments||Potential for fraud or fakes|
|Interoperability across platforms||Environmental impact concerns|
|Full control and ownership rights|
The Future of NFTs
While still in their infancy, NFTs have exploded in popularity and show no signs of slowing down. They open up countless possibilities for both digital and physical items.
Here are some potential directions for the future of NFTs:
- Virtual fashion, accessories and skins for metaverse avatars
- Social tokens that allow fans to support creators
- Physical art and collectibles with real-world redeemable tokens
- Event ticketing, granting access when scanned digitally
- Gaming assets and currencies
- Music royalties and streaming
- Brand licensing and endorsements
- Investments and fractionalized ownership
- Identity and certification
- Supply chain tracking
- Legal documents like patents and deeds
- Much more we can’t yet imagine!
The possibilities for NFTs are endless. While still controversial, they continue to transform business models across industries. Love them or hate them, NFTs represent an exciting new paradigm and are here to stay.
This guide covers everything you need to know about how NFTs work – from the minting process to trading, royalties and use cases.
NFTs utilize blockchain technology to provide verifiable proof of ownership for unique digital items. They are programmable, allowing creators to build in royalties.
While the full potential of NFTs is still unknown, they are already disrupting multiple sectors from art to gaming. However, concerns around environmental impact, volatility and fraud remain.
Regardless of your stance on NFTs, their explosive rise demonstrates promising new possibilities for our increasingly digital world. They allow assets to be owned and traded in revolutionary new ways.
There is still much to explore with NFTs. But for now, understanding the basics of how they work will allow you to better navigate this brave new world of blockchain. The future promises to be very interesting!
- NonFungible.com. (n.d.). The Complete Guide to Non-Fungible Tokens (NFT). https://nonfungible.com/
- Entrepreneur. (2022, August 15). How Do NFTs Create Value? Entrepreneur https://www.entrepreneur.com/
- Decrypt. (2021, August 31). What’s an NFT? Beginner’s Guide to Non-fungible Tokens. Decrypt. https://decrypt.co/resources/non-fungible-tokens-nfts-explained-guide-learn-blockchain
- Berkowitz, S., & Chapman, M. (2021, November 11). What are NFTs and How Do They Work? Investopedia. https://www.investopedia.com/
- Foundation. (n.d.). What are NFTs? Foundation. https://foundation.app/