How Do NFTs Work?

Cryptocurrencies have been skyrocketing in recent years, but these digital assets have more to them than just rampant speculation. Blockchain — the digital ledger technology that enables cryptos -has actual, real-world use. Non-fungible tokens (NFTs) are one example. NFTs are tokens based on a blockchain that represents ownership of a digital asset. The recent craze in NFTs involves digital art and creation (for example, Twitter (NYSE: TWTR) CEO Jack Dorsey sold the first-ever published tweet for $2.9 million via an NFT).

Sound silly? Perhaps. But there’s more to the discussion around NFTs than meets the eye.

What are NFTs?

Non-fungible tokens aren’t actual cryptocurrencies in the same sense as Bitcoin (CRYPTO: BTC). Cryptocurrencies utilize blockchain for their ability to track financial transactions between parties and were designed as a type of digital currency for use on the internet and in a digital-first world.

NFTs are also built on a blockchain but instead are used to guarantee ownership of an asset. Think of it as a certificate such as an auto or real estate title stating the legal owner of a car or home, except that an NFT is proof of ownership in digital form. Most NFTs are based on the Ethereum (CRYPTO: ETH) blockchain network.

An NFT is a unique digital asset that is not directly replaceable with another digital asset (thus the name “non-fungible”). Many physical assets are also non-fungible. Real estate, for example, is non-fungible since each piece of property is unique from the others.

A “fungible” token, by contrast, is one that is replaceable with another one identical to it. Ether is the fungible token that trades on the Ethereum network, meaning one Ether is identical to another. The same goes for Bitcoin. One Bitcoin can be exchanged for another Bitcoin because they have the same value. Physical currencies work this way, too. One physical dollar bill is the same as another dollar bill, and thus each is “fungible.” But each NFT is unique; there isn’t another one exactly like it out there, so they are non-fungible — or unable to exactly replace another.

Code is written into this digital token and recorded using the blockchain network it’s based on (again, usually on Ethereum) to prove a list of historical ownership and the current owner of a unique digital asset. An NFT can represent any digital creation — art, music, videos, writing, etc.

How many NFTs are there?

At the end of October 2021, there were nearly 7,000 different types of cryptocurrencies worldwide. Most NFTs are built on Ethereum, but many of these tokens utilize a different blockchain or were built on a proprietary NFT platform. As a result, there are innumerable individual NFTs representing works of art, videos, video game content, music, and more. As more artists and creators make use of NFTs to secure and monetize their work, this number will only increase over time.

How do NFTs work?

How exactly are NFTs used? Digital art collections, for one. In March 2021, an NFT representing an image, “Everyday: The First 5,000 Days,” by artist Beeple was auctioned by Christie’s for $69 million. The purchaser of the NFT now has ownership of the digital art attached to it. Digital creators Larva Labs auctioned off individual CryptoPunks characters in 2017; some of the NFTs are now worth millions of dollars.

These are some extreme examples of ballooning NFT values. For common functionality, though, artists can use NFTs to sell their creations to collectors and other digital creators. An owner or creator of an NFT can also collect royalties for the art’s copy or use online. NFTs hold promise as a way to enforce digital copyright and trademark law.