Updated: Mar 29, 2021
First, let me share a story.
The peculiar record shop
Last week I bought my first non-fungible token (NFT). The experience went a bit like this. Imagine you want to try this new record shop that’s just opened. You go there, there's a record you like, it’s $20. You go to pay, but they only take a new type of debit card. So you go to the child sat in the corner who is processing card applications. He doesn’t speak, and you’re not sure he’s legit. He throws your first two applications on the floor in disgust. You come back the next day with your passport, and he tells you to come back tomorrow, and each day after that, to check with him if he’s ready for you yet. After a few days he gives you the thumbs up and passes you your new card and a note, you’re not sure why but you’re pumped by this sense of progress. The note instructs you to go outside and meet a monkey who can put cash on your card. Wary of the pickpockets hanging out in front of the store, you go outside and give the monkey $20, just enough for the record because you don’t know if you’ll use the card again. He says he'll do it but wants $40 for it. You reluctantly say yes and hand him $60, he runs away with your money. You return to the store, your card is declined. You wonder if the monkey was a dream. Maybe the record cost $20.001 and the final decimal got truncated on the shop sign? You can't ask the shop staff because they are invisible. So you head back outside and give the monkey another 50c just in case that's the reason, costing you another $40 fee. By now you've figured out the monkey is using the cash to buy coal to power his magic money transfer machine. Back inside the shop, this appears to have worked. But after a while, the till starts flashing, oh no your card’s been declined, you have enough for a record but not enough to cover the payment fee to the shop, we can’t tell you how much because it depends on how many other people are buying records at the same time as you, but will probably be around $50. Clearly subject to the sunk cost fallacy, you head back outside and hand the monkey another $50, he starts to remind you about his fee and fuck it you say here's $100 keep the change, you’re starting to get the hang of this. Finally your purchase goes through and you get a voucher which you can redeem for your $20 record that cost you $200 all up, at a later date, TBC. A couple of weeks later you sell the voucher for $2,000. Welcome to the future.
Now that I’ve shared my cautionary tale, what actually are NFTs and why was I so desperate to buy one?
What's in a name?
Non fungible tokens are slowly but surely going mainstream. Chances are most of you have heard of NFTs somewhere, most likely in recent press coverage of some high profile examples, like the Burnt Banksy piece, or Jack Dorsey's historic first tweet or Elon Musk's song about NFTs (very meta). But you’re probably still not sure what they are. Here’s my 5 minute tutorial - which assumes you already have some basic familiarity with blockchain 😃.
First the word ‘fungible’, and where it comes from - because no crypto lesson can begin without some etymology. Fungible comes from the latin fungi (unrelated to the mushroom variety), meaning to perform, and subsequently through phrases like fungi vice, meaning 'to take the place'. So it means to take the place of something, or something you can take the place of - so interchangeable.
I started using the term long before this whole crypto malarkey, a while back as a nerdy accountant. It was in the context of the money we earn, while mansplaining to my wife how to spend money. My key point was, any dollar equals any other dollar, they are all interchangeable, therefore the idea that a dollar earned from a certain source might be ear-marked for a certain expenditure (eg I will keep this cash I got for my birthday in my purse to buy myself something nice) was not rational. Of course this goes against most people's approach to saving and spending, and being irrational is fine if it makes you more effective at managing your money.
Every token not alike
In the same way as cash, crypto currencies would typically be viewed as fungible – if I pay you one bitcoin, you don’t care about its provenance, and once it is in your wallet it is assimilated within and indistinguishable from your other bitcoin. This is where non-fungible tokens come in – they are each unique due to some additional code written into them on the blockchain, with their value being largely derived from that differentiation.
So far so good – but how is that useful? Unlike bitcoin, ethereum allows stuff to be written into the blockchain as part of each unique token, using its own programming language, and as such allows a richer range of use cases. While ethereum is the name of the network, ether abbreviated to ETH is the name of the main currency which runs on the network. To process any transaction on ethereum, a certain amount of ether (called 'gas fees') is required to power the magic.
You may have heard of smart contracts for example, which is a pretty cool application of blockchain to the world of commercial contracts, where an enforceable contract is formed and executed by the code itself. By initiating the transaction, you and I are entering into a contract the terms of which are contained within the code, but also the execution of which can be automatically triggered subject to the agreed parameters written into it. For example, if my sports team wins the final, a payment is triggered to me. The more complex the code, the more gas fees are required.
Another use of this technology is crypto art and the world of collectibles more generally.
NFTs are a unique digital asset attached to another asset. They act like a digital certificate of ownership backing a specific asset being traded. This operates a bit like the deed to a house: there is the house, and then there is the deed. The asset being traded is likely digital, but not necessarily. The asset might be a work of art, a fantasy figurine, a digital audio recording - basically something desirable and collectable. Your ownership of the asset and the authenticity of the asset are independently verifiable (goodbye counterfeits), by virtue of being written into the blockchain. While we're used to relying on centralised third parties to record ownership of our assets - eg land registry services like Landgate, business registries like ASIC or local government agencies recording car registrations - with NFTs, this trusted record keeping function is handled by the blockchain and so is decentralised rather than centralised.
Note that this ownership is not copyright - the two are distinct. While it is possible for an artist to transfer copyright to a buyer through an EFT, this is not the way it would typically work. Think of it more as a licensing agreement. The issue of intellectual property rights with NFTs is in itself a complex minefield that is not yet fully understood, and actually quite interesting to contemplate. For more read this.
Digital or physical assets
Somewhat confusingly, the asset backed by the token can be physical, digital, or both.
A use case of a NFT-backed physical asset would be an expensive piece of artwork being stored in a vault somewhere. When the artwork is sold, the seller provides the buyer with the token. Whether the physical asset being purchased physically moves or not is irrelevant, but its ownership has legally been exchanged, as established by what would most likely (I imagine) be a combination of a traditional sale contract and the smart contract contained within the token.
Digital assets will typically be digital collectibles or art. The big news in NFT land this month was 250 year old auction-house Christie’s selling its first ever NFT – a digital piece by an artist called Beeple selling for £50m. This was noteworthy, as the first NFT-backed sale by a major auction house, but also the first use of crypto to pay for an auctioned piece of art. After receiving his ether Beeple converted them to USD and declared that NFTs were "aboslutely a bubble." Digital artwork gets most people confused and this is where they lose the plot and start losing interest in NFTs. The common hang up is: so what is the value in ‘artwork’ that can be endlessly copied, like a digital file can be? Why would I pay money for that? There are multiple reasons, and I think a driver may be ego. People want the bragging rights: to be the publicly verifiable owner of the original piece, of which millions of copies are being displayed and enjoyed by people around the world. Try replacing ‘digital art’ by ‘the Mona Lisa’, and the reasoning becomes more familiar. It can be a tricky one to wrap your head around – but I would argue it is worth trying, becomes it then opens the door of imagination into what the future may hold, which is fun and intriguing. I use the analogy of people before the days of audio recording trying to conceptualise music as a recording, or theatre-goers trying to imagine a video file. I like to imagine the art galleries and museums of the future, and what those experiences may be like. Another advantage of a digital artwork is that it cannot be destroyed or stolen (technically it can be both destroyed and stolen, but not in the multiple ways a physical asset can be).
But you can also have a combination of digital and non-digital assets. Last week Kings of Leon closed an auction of its latest album, where the NFT on offer was redeemable for the digital audio file and a promised limited edition physical vinyl record.
OpenSea is one of the biggest NFT marketplaces - the ebay equivalent of the NFT world. Just last week it closed a US$23 million round led by Andreessen Horowitz and involving other notable investors including Naval Ravikant of AngelList fame and Mark Cuban. OpenSea is of course the 'record shop' of my cautionary tale.
New opportunities for artists
These NFTs provide a really cool way for artists to interact with their fans and monetise their fans’ support. For example the Kings of Leon also offered a limited run of six tokens redeemable for lifetime entry to their gigs. This is all the more relevant in the days of reducing royalties and the loss of touring revenue following Covid lockdowns.
Artists also have more control of the economic model, as they can set the terms and rules of how their work is monetised, and this can vary between artists. More sustainable economic models will emerge, and creativity can be infused into the commercial aspects of the transaction rather than just the art itself. Imagine for example the artist receiving a clip of the transaction each time a piece changes hands, rather than just on the initial sale. Artists are only just starting to test the limits of what's possible.
Experimentation around how the technology is leveraged is on-going. With digital artwork, imagine for example buying a piece that changes over time, according to instructions pre-coded by the artist, or even according to random rules. Generative art, which is artwork generated using non-human means like algorithmic computer programs, is a field that has found a happy marriage full of new opportunities with NFTs, as demonstrated by leading platform Art Blocks.
Another advantage is the better liquidity offered by NFTs over traditional art markets. A collector can sell their piece instantly, with no middle man required and with much lower fees. Price discovery is exponentially improved.
Bubbles and emissions
Our first instinct is to dismiss NFTs as a fad. The effort and investment of mindspace required to fully understand what is going on is this space feels too onerous for most. The ecosystem seems characterised by frustration, high fluctuation in asset prices, a user experience seemingly designed by a two year old, lack of customer support and the absence of familiar signals of consumer protection that we are used to. Clearly I’m not promoting it as an entirely satisfying or pleasant transacting experience. As with all new frontiers, there are those who will exploit it, as evidenced by tales of copyright theft where artists are discovering their work being sold as NFTs without their permission. Many fortunes will be made and lost – and no doubt many bubbles will burst - along the way. Then there's the elephant in the room of carbon emissions caused by the unsustainably high amounts of electricity used to 'mine' each transaction of the blockchain ledger.
But more crucially, there will be new business models that stick, micro-economies that develop, and whether you work in financial services, government, health, the arts, entertainment, professional services or many other sectors, it’s just a matter of when – not if – the models you know and work with will change.
If the above has whet your appetite and you want to learn more of the detail behind these trends, I highly recommend this podcast by Kevin Rose in which he interviews NFT guru Aftab Hossain.
Another awesome source of information is Collective Shift where you can pay to subscribe to news and analysis service covering crypto and loads more (also they're a scale.partners client and therefore pretty awesome).
I eventually managed to make my first NFT purchase. It was an exercise in frustration and perseverance. It took me in excess of two hours of mindspace over the space of a week. I didn't want to transfer my ether to the wallet I’d set up for the purchase, because the gas fees would have been more than the item I was buying. I resorted to simply funding my wallet using my credit card, but it took repeated attempts day after day until my card and my identity were finally accepted. I foolishly overlooked the need to pay for gas fees each time I funded my wallet, on top of the gas fees for the eventual purchase itself. I transferred the exact purchase price to my wallet – only to discover that the purchase price displayed wasn’t showing all decimals, so I needed to fund an additional transfer. And then a third transaction to cover the platform's fees, which weren't clearly disclosed up front but a more experienced punter would have known about. Throughout the process it felt like I was being taken for a ride. I don't even know for sure today that I haven't.
But it's an investment in my education, and that is priceless.