Non Fungible Tokens

NFTs are digital tokens that represent ownership in an underlying asset. At present they are a means by which to monetise digital art but eventually they will become the digital bridge that various commercial applications need for monetisation.

This article was first published in The Mint. You can read the original at this link.

NFTs - or non-fungible tokens - are are all the rage today. Not only are ordinary folks spending inordinate sums buying them at dedicated marketplaces, even auction houses like Christie’s and Sotheby’s have begun to get in on the action. But despite this frothy excitement and widespread publicity, ask someone what an NFT is and chances are you will get a blank stare in response.

At its most basic an NFT is a digital token that represents ownership in an underlying asset. Think of it as a way for Leonardo da Vinci to certify the original Mona Lisa in a sea of identical copies. Except, unlike the Mona Lisa that carries evidence of its authenticity in every ridge of paint on its canvas - each a brushstroke applied by da Vinci himself - NFTs are tokens of ownership, the acquisition of which confers no special rights to the underlying digital artefact.

So why are people falling over themselves to buy NFTs? Why, for instance, did Sina Estavi pay $2.9 million for an NFT of Jack Dorsey’s first tweet even though he didn’t, just by buying that NFT, secure for himself any sort of exclusive rights to it.

It’s not as if, now that he owns the NFT, we will all need his permission before we can view it in the same way that we need to buy tickets to see the Mona Lisa in the Louvre. So what exactly is the point of investing in NFTs? Before answering that question lets take a quick detour around the blockchain and some of its diverse applications.

Blockchain Applications

Whenever we mention blockchain our minds immediately go to bitcoins. However, distributed ledger technology has applications that extend far beyond the decentralised cryptocurrency through which it first became manifest. A decentralised, distributed ledger makes it possible for unknown, unseen people to transact with each other in purely digital environments without the need for a trusted third party intermediation. This core feature of the blockchain, when applied in other commercial contexts, allows us to re-design many of the legal and commercial constructs we’ve relied on for centuries.

Take bills of lading, for example. Since the 1300s, the process of transporting goods from a consignor to a consignee has revolved around the exchange of this specific document that serves, at the same time, as title to goods as well as evidence of their shipment and receipt. Even today, goods cannot be received at their port of destination unless the consignee presents a physical copy of the corresponding bill of lading. And since they have to be produced in original, there is $5 billion industry that just revolves around couriering these documents to different parts of the world.

But things have already begun to change. Companies like Maersk and COSCO are experimenting with electronic bills of lading on a distributed ledger that will serve as certificates of title and evidence of shipping. In time, the blockchains they establish will incorporate IoT devices into their workflows so that the precise location of the consignment will automatically trigger payments or other obligations without need for human intervention.

There are many other such uses of blockchain. In an earlier article I suggested it might have several useful applications in governance:

There are many government functions that can be replaced by blockchain equivalents. A blockchain registry of public records will ensure that birth certificates, land records, tax receipts, passports, certificates of incorporation, minutes of official meetings and a whole host of other records are automatically recorded in a format that is tamper-resistant and publicly verifiable. If applied creatively, it will reduce our investment in governance and offer greater accountability in the provision of public services.

I concluded that article by suggesting that we should think of using blockchains for state-guaranteed title records - such as was being implemented in Rajasthan. But despite the hype the real-world application of blockchain technology has been surprisingly slow.

The Fatal Flaw

Think of the Non Fungible Token as just another blockchain application, one that has been designed to solve a very specific problem. In 2014, when it was first conceived, digital artists were creating and distributing millions of purely digital artworks, uploading them onto microblogging sites like Tumblr from where they were widely re-blogged without attribution or context. None of these artists, true to the spirit of the time, really expected compensation for their efforts - but Anil Dash and Kevin McCoy wanted to make it possible for them to assert ownership over their creations if they wished - so that, if nothing else, the works they created could be attributed to them.

In a recent article in The Atlantic, Anil Dash talks about their motivations behind building the original NFT:

Technology should be enabling artists to exercise control over their work, to more easily sell it, to more strongly protect against others appropriating it without permission. By devising the technology specifically for artistic use, McCoy and I hoped we might prevent it from becoming yet another method of exploiting creative professionals.

The solution they devised involved generating a token to represent ownership of the digital asset and then subsequently attaching that token to the blockchain where it could be bought and sold freely, creating a strong digital paper-trail of ownership.

But they would have been the first to admit that their prototype was, as solutions go, far from perfect. Due to technical limitations, it was not possible to attach the actual digital artefact to the blockchain. As a result the token they created was only loosely linked to the underlying asset serving as a mere representation of the actual artefact. Even today, most NFTs just provide a link to the underlying asset or, at best, a compressed representation of it. Which means that even after you’ve spent millions on an NFT, your access the underlying digital asset could still depend on whether the website that hosts it is still active.

This single fact underscores one of the most fundamental differences between NFTs and cryptocurrencies. Unlike bitcoins - that are valuable assets in themselves - NFTs are not digital assets. They are just tokens that symbolise ownership. Even though your purchase of an NFT might imply that you can claim ownership over the underlying asset, your token cannot be used to exercise any of the rights commonly associated with ownership - such as preventing someone from accessing it or seeking rent for its use.

Tokenise the World

This is not to suggest that NFTs are worthless. Just as cryptocurrencies introduced blockchains into the commercial world, non-fungible tokens could well be the digital bridge that creative applications need. Some have gone so far as to suggest that NFTs might be the next stage in the evolution of the internet itself.

In a free market, people are free to find value wherever they see it - even if that happens to be in a digital token of implicit title. The increasingly frenetic market in NFTs should be all the evidence anyone needs of the community’s interest in NFTs.

As long as this enthusiasm persists who are we to question why.