NFTs Explained

Updated: Oct 1, 2021

I've spent an increasing amount of time collecting and trading NFTs lately. Actually, way more time and money than I ever imagined. I first started experimenting with NFTs in early 2019 when making crypto gaming YouTube videos, but my interest in the space has really ramped up over the past year. A lot of my friends have reached out asking where to start with NFTs so I wanted to make a post that helps provide an understanding of what NFTs are and how to find valuable ones.


What are NFTs?

NFT stands for "Non-fungible token" but don't get hung up on the name if you don't fully understand what it means yet. NFTs are digital tokens used to establish ownership of unique, collectible items. These can come in a variety of forms including art, music, virtual land, in-game items, tickets, trading cards, domain names, and much more.


Pictured below are CryptoPunks, the first ever Ethereum-based NFTs created in June 2017.


Why are NFTs important?

To understand why NFTs are important, we must first understand how they work. To understand this, let's break down the NFT acronym by defining F & T.


F = Fungible


Fungibility is a characteristic that makes one unit of an item indistinguishable from another unit of the same item. Let's use cash as an example:


Pretend Alice and Tom both hand you a penny. You randomly mix the pennies around in your hand and then try to guess which one is Alice's and which one is Tom's. Is there a way to know for sure which penny came from who? No. This is because pennies don't possess any information that allows you to distinguish one coin from another; AKA pennies are fungible.


T = Token


It's important to define what a token is in the context of crypto. Tokens represent digital assets that reside on their own blockchain. Tokens can come in the form of cryptocurrencies or NFTs.


Since every token resides on its own blockchain, a record of that token's transaction history exists publicly and permanently. This record shows information including previous sales prices, past owners, and date/time(s) the token has been transferred.


Note: Privacy coins are an exception to the above statement because their transaction history isn't publicly visible.


Below is an example of a limited edition NFT on Makersplace. Notice that each individual edition is shown with additional details from their market history.


F + T = NFT

When combining fungibility with tokens, you may realize that they inherently cancel each other out. It is impossible for a token to be fungible if it exists on a public blockchain. This is because transaction history can be used to distinguish specific tokens from one another. Furthermore, public transaction history gives individuals the ability to verify ownership of specific tokens and prove their authenticity. The term non-fungible token (NFT) is just a fancy way of saying this.


This concept is the most important part of understanding NFTs because it explains how the legitimacy and uniqueness of each digital asset can be proven. This provides a HUGE advantage for verifying items like tickets, memberships, or collectibles because it eliminates the risk of counterfeits. If somebody thinks an NFT is counterfeit, they are able to track the item back to its source to determine its authenticity.


What makes an NFT valuable?

Similar to art, it's hard to put an exact number value on what an NFT is worth. There are a few general characteristics that apply to most NFT projects but typically each project comes with its own unique elements that should be considered.


General important characteristics:

  • Scarcity

  • Utility

  • Community


Scarcity

Scarcity typically comes in one of two different forms for NFTs. The first form would be an NFT that is a one of one edition. These NFTs only have 1 single edition that will ever exist. One of ones are regarded as the highest rarity since only one person can own them at a time.


The alternative form to a one of one NFT is a one of many. In this scenario, an artist can create as many editions as they want and then sell them to different buyers. Generally speaking, one of many's are less rare than one of one's because there are multiple owners of different editions of the same NFT. Each edition in a one of many can be tracked individually. Trading cards are the most common example of one of many NFTs.


Utility

Utility is another word for use-case. This is the most open-ended choice that NFT creators have when creating an NFT. Some NFTs are used as memberships, some pay dividends, some can be used in games, and some are collectibles with no utility at all.


It's important to distinguish the utility of an NFT before buying it; otherwise you may be making an investment that will generate negative returns. Just because an NFT doesn't have utility does not mean it is not valuable. For instance, purchasing art from an established artist like Beeple won't provide any utility to the owner but still has a great chance to increase in value over time because of Beeple's reputation in the NFT space.


Community

Community is arguably the most important aspect of any crypto project. Joining a Discord and familiarizing yourself with the community is one of the easiest ways to determine if you mesh well with the other members. If you join a Discord and it's dead or the community is toxic, its probably best to hold onto your money until another project catches your attention. Looking at the total number of members in a project's Discord is an easy way to determine a community's size.


Final thoughts

We are still very early in the NFT game. We've seen Paris Hilton, Steve Aoki, Tom Brady, and many other celebrities/athletes begin their own NFT startups in 2021 and this is likely just the beginning. Companies do not become successful overnight so I fully expect to see these grow and thrive over the next few years.


I highly recommend checking out an NFT marketplace or gallery to get an idea of some of the digital assets people collect and trade. Feel free to hit me up on Twitter @paper_ape if you have any questions or want to hear my thoughts on a specific project.

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