What is an NFT and how does it work? A guide for beginners
The value of NFT’s has seen rapid growth in recent months. We saw JPEG, PNG and GIF images sell for millions of dollars. What exactly is NFT? Is it another crypto trend that will burst like a bubble or an innovation that will completely transform investing?
What is the connection between Jack Dorsey’s tweet, the JPEG of a red pixel and the GIF of the flying cat? Probably there is none, except the fact that each of these things is now worth a few million dollars.
The NFT craze is currently taking over the world. Since everyone is talking about NFT’s lately, it may seem that we are witnessing a new trend. The thing with a trend is that it’s popular only for some time and then it disappears. But there is something that indicates that NFT’s will not go away any time soon. In fact, NFT’s been present for quite some time.
NFT projects appeared in 2014. Even then, you could buy a unique form of digital asset for a certain amount of cryptocurrency.
Despite a significant presence in mainstream media, many people still wonder what NFT is, how it works and why some of them cost a fortune?
In this text, we will try to explain in a simple way everything you need to know about NFTs.
What is NFT and what does it mean?
NFT consists of three words: "non-fungible token". The term “fungible” is used in economics for assets that can be exchanged for another asset of the same value.
The simplest example of fungible assets is cash. For example, you can exchange a €100 bill for another €100 bill, or two €50 bills, or five €20 bills. There were no profit or losses in these transactions.
If something is labeled as non-fungible, it means it can’t be replaced, even if two types of assets can have the same value.
Take real estate for example. Each property has unique specifications. Finding another property that has the same characteristics and the same value would be impossible, so they cannot be replaced.
The term token refers to a type of certificate stored on a blockchain network. The principle is the same as cryptocurrency. Basically, a token contains information that is stored on the blockchain (transfer time, amount, etc.)
So NFT is a form of digital asset that cannot be exchanged for another NFT, and information about its purchase or ownership is transparent as it is stored on the blockchain network.
Because this record is stored on the blockchain network, each NFT is unique and its data cannot be changed.
How does NFT work?
NFT is a unique form of digital asset that has similar functions as cryptocurrencies, but they are not the same.
It is a unique digital record stored on a blockchain network. Today, the most popular NFTs are created on the Ethereum blockchain network (although the Tezos and Flow networks also support NFT).
Also, many NFT projects are created using smart contracts. For example, if you buy NFT, the smart contract will make the transfer for you.
With a smart contract, each NFT can contain more detailed information such as information of the person listed as the owner of the NFT, the current value of NFT, etc.
Why is all this NFT information important?
NFT digital assets can be anything digital, such as artwork, videos, music, physical stuff turned into digital form and even tweets.
NFT’s are something like collectibles. However, instead of physical possession, the NFT collection owner has a unique digital certificate of ownership stored on the blockchain network.
Because cryptographic technology prevents any kind of data manipulation, it is very easy to get information about who owns and how he bought NFT.
What are the benefits of NFT?
As already mentioned, every NFT is unique and can’t be easily forged. Each NFT has unique data (metadata) that proves the authenticity of the work.
Many NFT projects usually have a limited number of items in a collection. The reason why artists create collections with a limited number of NFTs is that some of the items can be very rare. When something is rare it attracts the interest of a large number of people. If the popularity of the rare NFT item grows, the value gets higher.
Since all NFT data is stored on a blockchain it is easy to access the entire NFT history. You can find out information about the creator, buyers (if the digital art has been sold more than once) etc. Such a degree of transparency confirms authenticity and eliminates the need for third party verification.
NFTs are based on blockchain technology, which guarantees that they can’t be deleted, modified, or replaced with another NFT. This also applies to the ownership of NFT. Once you purchase NFT, you become the owner of all copyrights. Compare that to music services like Spotify or iTunes. On these platforms you buy a license to listen to music, while with NFT you are the owner of the digital asset.
What is the purpose of NFTs?
A common question asked by first-time NFTs is "Why would I buy NFT when I can easily download it to my own computer"?
People buy NFT for 3 reasons:
- simple proof of ownership
- a new way to create a collection
- social status
Today, digital art collections have a large number of followers and a whole community built around them. Just look at the number of people who follow everything related to the Cryptopunks or Axie Infinity game.
NFT communities are not limited to the arts. They are also present in the gaming, sports and fashion industries.
When something becomes mainstream, everyone wants to become part of the trend. That is why many want to buy or sell NFT. People think they are missing out on a good opportunity (FOMO) to earn some profits. Things went so far that many celebrities and even companies like Visa got involved in NFT madness.
It’s important to say that NFTs are not just a trend and are not just another cash grab stunt.
If you scratch the surface, you’ll be able to see that NFT is an innovation that adds another value to the entire blockchain industry.
The Internet has opened up new markets for many people. Today, you can easily create content or a product and easily find a market for them. However, one of the problems that many (especially content creators) face is copyright. Digital authors can hardly keep track of who is using their content. Unfortunately, there is also the possibility of someone else taking credit for someone else’s work.
NFT appears here as a potential solution to the problem. The purpose of NFT is to use blockchain technology to point out the authenticity of digital assets. Both the NFT buyer and the NFT creator can benefit from each other.
They can easily agree on how the copyright will be used after the purchase. Ultimately, NFT digital assets can be a financial incentive for creators to continue creative work, while it can serve customers as a form of investment.
Is it worth investing in NFT (non-fungible tokens)?
Every investment is similar to purchasing a new product. First, you must do your own research to make sure you are not wasting your money.
NFT is a completely new market that is growing rapidly, and every new emerging market brings opportunities and risks. Billions of dollars have already passed through the NFT industry and we are just in its infancy.
Due to the great interest and the jump in the value of non-fungible tokens, the fear of missing out the opportunity is also growing. The market attracts a large number of buyers who are trying to find "good and safe" investment, and new creators who are trying to sell their content for a great price.
This makes the market oversaturated, which is why it’s hard to recognize the good NFT project with long-term value. That is why NFT would be a risky investment for a first-time user.
Investing in non-fungible tokens just because you feel you are missing out on a great opportunity to make some profits is not a good idea. Just like with cryptocurrencies you need to educate yourself before investing in NFT’s.
On the other hand, it makes sense to invest in NFT if you understand the basic concepts of art trade, the collection of sports cards, etc., and if you see the long-term value of NFT projects.
How to buy NFT (non-fungible token)?
To buy NFT you need to have your own wallet. The most popular choice for all NFT traders is Metamask. Furthermore, before the purchase it is necessary to make a cryptocurrency deposit on the wallet.
All you have to do is select your favourite NFT and buy it on one of the most popular and secure NFT platforms. Once purchased NFT will be stored in your wallet.
These are the most populat platforms for buying NFT:
Every NFT buyer and creator needs to be aware of fees. Each NFT author pays a gas fee for publishing their own NFT. The buyer also pays a gas fee for his transaction.
Fees are one of the challenges with NFTs. Many of these projects rely on the Ethereum network. Due to its popularity, Ethereum faces the scaling problem. The more transactions take place within the Ethereum network, the slower it becomes, resulting in higher transaction fees. This problem should be solved by upgrading to ETH 2.0.
Does NFT have a future?
In the following years, the entire market will have to go through a maturing process. It is certain that the NFT market will go through several cycles. The price will rise and fall. Once the market stabilizes and only top- quality projects remain, NFT will be an important economic factor.
Also the NFT market will have to find a solution to problems like high fees and copyright along the way. There are often authors who claim that unknown people have taken their content and advertised them on the NFT marketplace as their own.
Despite the problems, NFT will continue to grow in the coming years. The fact that big players like Visa, Paypal and others are entering the NFT space, clearly shows that this is not just another trend that will be forgotten.