What is a Non-Fungible Token?

Tokens 101

What is a Non-Fungible Token?

Most digital tokens trade at equivalency. For example, one Bitcoin is always equal in value to another Bitcoin. Similarly, one Ether always trades at par with another Ether. In this respect, tokens resemble fiat currency, where a $1 note always equals another $1 note. Such tokens are known as fungible tokens and have become the norm in cryptocurrency.

While fungible tokens are excellent representations for cryptocurrency as a medium of regular transaction and store of value, they are not adequate for tokenizing unique, scarce objects or certain abstract concepts for two reasons.

The first reason is related to value. Consider the example of a work of art, such as a painting. No two paintings can be considered identical in value because each artist is unique and brings her own perspective, context and technique to the work. Value is heavily impacted by the name attached to the work of art. Thus, the cost of any work of fine art varies greatly.

The second reason is related to provenance. When tokenizing unique objects, ownership becomes an important attribute. Most fungible tokens are anonymous and identified only as addresses on a blockchain. While these transactions are traceable on the open ledger, it would not be possible to conduct transactions for unique objects, such as paintings, using these tokens. It would be possible to track the quantity of token, but not its unique attributes, as all individual tokens are interchangeable.  

This is where non-fungible tokens (NFT) come in. Each NFT is unlike the others and not equivalent in value. Non-fungible tokens are similar to collectibles, such as baseball cards. Each card is distinct and traded for a different value based on unique characteristics. One baseball card cannot be traded for any another. Contrast that with ubiquitous cash, where each denominated note is equal in value to its counterpart; you can substitute one $5 bill for another without any loss in value. The uniqueness of each non-fungible token serves as a marker of identification and authenticity for the asset.

Everything You Need to Know About ERC-721 Tokens

ERC-721 tokens are an evolution of ERC-20 tokens. The latter led to an explosion of ICOs on Ethereum’s blockchain and enabled easy transfer and distribution of tokens. ERC-721 tokens add slightly more information to distinguish them from one another.

ERC-721 tokens are compatible with ERC-20 tokens and further include ownership parameters for the token. This means that it is easy to transfer and distribute these tokens. They also pass on ownership details for a platform. Unique metadata or attributes pertaining to the asset can also be included in these tokens. For example, ERC-721 tokens representing coffee beans can be classified as fair trade and distinguished from other, generic versions, based on their data.

Developed by the team responsible for the ERC-20 smart contract, ERC-721 is the most popular non-fungible token standard developed in the last couple of years.The standard defines a minimum interface required for exchange and distribution of these tokens. There is currently no centralized registry for smart contract interfaces pertaining to non-fungible tokens. But, the contract’s developers have held out for the prospect of developing a global registry of interfaces for contracts through an Ethereum Improvement Proposal (EIP) in the future.

What Are NFTs Used For?

According to the development team behind ERC-721, non-fungible tokens can be applied to a wide variety of assets including physical property and unique artwork, or virtual collectibles, such as pictures of kittens, and even more abstract concepts like a person’s identity. They can also be used for “negative value” assets such as loans, burdens and other responsibilities. In the latter case, the assets would include metadata such as the amount of a loan and its owner.

With regard to physical property, consider a piece of real estate that has been parceled out into divisions, each of which holds different characteristics and property types. One division might be next to a beach while another might contain an entertainment complex and yet another might be in a residential district. Depending on its characteristics, each piece of land is unique and priced differently and can thus be represented by an NFT.

Such a concept already exists in the form of Decentraland, a virtual reality platform on Ethereum’s blockchain. Decentraland users can purchase and develop their land and resell it within the platform using NFT tokens. It is not difficult to imagine a similar situation within the physical world, where each piece of land, commercial or residential, is tokenized according to its attributes and resold using NFTs.

Another popular application of NFTs is gaming applications. Cryptokitties is the most famous example of this application. Each Cryptokitty is distinct from another and is priced differently according to rarity and demand. The game was popularized in December, 2017, and is still considered one of the most popular applications of Ethereum’s blockchain.  

NFTs can also be used to generate royalties from intellectual property for premium content. In such cases, each token pertaining to a unique piece of work, such as a book or musical composition, will be programmed with the necessary attributes for transfer and ownership. Blockchain agreements can remove intermediaries, such as agents, responsible for negotiating and shepherding the process, and tokens can be used to facilitate the transfer and payment of royalties.

While these are examples of immediate use cases, the use of non-fungible tokens in the future could expand the use of cryptoassets across industries. For example, they could be used to issue important documents, like licenses for driving, and enable seamless transfers of land title deeds.

Are Non-Fungible Tokens Crypto?

The current operational framework for cryptocurrencies began as an experiment in peer-to-peer transactions.

Satoshi Nakamoto, Bitcoin’s inventor, intended for the cryptocurrency to be a medium of exchange for daily transactions. “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution,” he wrote in the whitepaper that introduced Bitcoin to the world. Disintermediation of central authority also meant anonymity in transactions. There was no personal identifying information on Bitcoin’s blockchain; only addresses tracked the flow of money. Coins and tokens succeeding Bitcoin have, for the most part, adopted a similar credo and positioned themselves as a decentralized medium for daily transactions.

Non-fungible tokens, however, shift the cryptocurrency paradigm slightly. They are digital representations of assets and are not meant for daily or frequent transactions, Ownership information, including their personal details and financial details, is essential or required to maintain the unique characteristics of these tokens. Several stakeholders can initiate NFT transfers. For example, NFT owners can make changes or transfer the tokens as can authorized operators and approved owners on Ethereum’s blockchain. This is a contrast to other cryptocurrencies, where the provisioning of public and private keys ensures that only a single individual is able to make changes to a transaction.

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