Non-Fungible Tokens (NFTs): A Beginner's Guide​

Navigating the creators’ economy: Non-Fungible Tokens (NFTs)

Remember life before money?

What an absurd question to ask, one may wonder.

We are well familiar with the history of evolution of money- going from tangible objects like shells, metal, paper bills, and plastic cards to the intangible- net banking and digital wallets. But what we may not be so cognizant of is that art and other forms of expression in the new age economy have undergone the same leap with the introduction of intangible digital assets called non-fungible tokens (NFTs). The rapid speed of expansion of NFTs has led some to believe that the future belongs to this digital creators’ economy and a world without it may soon be unimaginable.

What are NFTs? The fundamentals.

Non-fungible tokens are digital assets that rely on blockchain technology for sale and purchase. What distinguishes them from cryptocurrency and other things based on blockchain is their quality of not being fungible, or interchangeable in an exchange for an equivalent item. It is unique and cannot be traded for something similar, like a bitcoin for another bitcoin for example. Even though in the digital world, plagiarism and piracy is quite the norm, NFTs are designed to give you something that could be copied by many but owned by only one. Besides, they cannot be as easily duplicated or endlessly copied like any other thing over the internet in the very first place. There is a distinct value attached to each of them because each non-fungible token exists on a decentralized and public digital ledger based on blockchain technology. Nevertheless, even though NFTs have been around since 2014, turning digital files into digital assets using blockchain technology has become increasingly popular only now as people have begun identifying the various advantages of the authentic ledger technology.

At a very high level, NFTs are part of the Ethereum (ETH) blockchain (a popular cryptocurrency) but with more information stored in their blockchain than say the blockchain of an ETH coin. (On a slightly technical note, the files of an NFT aren’t stored on the blockchain itself. Instead, the blockchain stores in itself a link to the file along with the token that acts as proof of ownership) If you go looking, NFTs have taken on the form of various forms of art- paintings, photography, music, digital collectibles, even autographed tweets for that matter! Basically, think creativity, think NFT. Albeit, the reason for their tremendous popularity could be attributed to this very characteristic of NFTs that has pushed the horizons of creativity by many, many miles.

Working with NFTs- minting, trading, exploring.

As news of NFT sales that go up to mind-boggling figures drops in by the minute, it is only fair if you are considering dabbling in the space yourself. This section of the blog focuses exclusively on the process of minting NFTs, gas fees, marketplaces, trading currency etc.

Prior to beginning the process of minting your artwork into an NFT there are two considerations you may want to pay heed to- the processing fee (or what is called the gas fees) and the energy costs involved in the process of minting, which is part of the larger debate on blockchain mining and its huge claims on energy. First things first- the gas fee. Since most transactions happen on Ethereum blockchains, the miners of which need to be paid, if you are looking to mint an NFT you will be required to pay a gas fee based on the amount of transactions you need to do on the blockchain- from minting to transferring it, etc. Think of it as the cash in your wallet before you set out to establish an entrepreneurial venture. Of course, a heavy wallet isn’t any guarantee for success at your business but having it handy is nonetheless advantageous. Thus, anyone considering creating NFTs must be mindful of the losses in gas fees if blockchain transactions don’t go through or their products are never sold even after minting.

Some of the largest marketplaces for NFT trading, however, such as OpenSea and Rarible allow creators to begin with zero gas fee, thanks to their “lazy minting” systems. These systems allow NFTs to be created and put up for sale without actually writing them on blockchains and thus avoiding gas fee. Most of these and other NFT marketplaces charge commissions on sales of NFTs, that go from as low as 1.0 percent to as high as 16-17 percent. In India, some of the most preferred marketplaces are OpenSea (largest in the world by volume), Rarible, WazirX, Foundation, etc.

Once this system is in place, your NFT will be up for sale in a matter of a few steps. Firstly, since NFT transactions go through mostly through crypto wallets (though there are a few marketplaces that have begun to accept credit cards and PayPal) you will need a crypto wallet, if you don’t already have one. I personally found Coinbase to be most suitable, although Binance, MetaMask, WalletConnect and FTX are some other great options. MetaMask and Coinbase come as both apps and Google Chrome extension, which in my opinion made the process a lot simpler. Having completed this step, it is then time for creators to create their ‘Smart Contract’ (protocol as per which transactions will happen on a blockchain) on the blockchain technology of their choice (mostly Ethereum) and then mint tokens using it. You are then required to connect your wallet with the marketplace and begin creating your NFTs.

Upsides and downsides of dealing in NFTs

There is certainly no doubt that NFTs have transformed the entire narrative of art in a digital economy, the scope of finance as it transforms the way we look at ownership and valuation of digital assets, and so much more. They have revolutionized the monetization of art and in a way also democratized expression. It is no secret that throughout history only a select few have enjoyed privileges of mass attention and inflated valuations of their works. With NFTs, however, small artists from across the globe have been able to channelize their imaginations into creating collectibles for enthusiasts who often look beyond the closely guarded circles to find their boast-worthy pieces of digital art, online avatars, etc. Anyone equipped with internet and perhaps a personal computer, the urge to do well, an uninhibited imagination (and well, some money to afford some cushion cryptocurrency) in any part of the world now has access to collectors in other parts of the world. And this genius of the internet that NFTs have embodies spill over to other aspects as well- there have been instances of millions raised in charity through online auctions of celebrity signed t-shirts, the rise of NFT-gaming and virtual ownership of even land in games like The Sandbox. Plus, with demand and supply expanding in volume each day, investing and trading in NFTs has come to be seen as a very viable possibility.

That said, the rise of NFTs has not been devoid of its fair share of skeptics. There has been concern over the unchecked popularity of this concept that has led many to wonder if NFT investment is an economic bubble in brew. Common concerns relate to the uncertainty regarding price movement of NFTs as valuations are based simply on people’s expectations of their performance, not pegged to any material backing, which leaves this concept exposed to volatility risk. Plus, for people in the area just for investment purposes, there is the overarching risk of over speculation leading to massive swings in the asset prices, thus making NFTs a less than optimum choice of financial product for people with limited appetite for risk.

The second major downside is the risk of illiquidity surrounding NFTs. Liquidity of any asset is defined as how readily can the asset be exchanged for cash. All assets, from stocks to bonds and precious metal, can be offloaded and converted into hard cash that can ultimately buy them goods and services in exchange. The debate surrounding legalization of cryptocurrencies by central banks of several countries, including India, puts NFTs is a tough spot. So even though cryptocurrency is well accepted as the form of payment for many transactions online, there is always the risk of complete crackdown on this form of currency and its usage that looms large over traders. However, it is not all bad since it is this very risk of illiquidity that also prevents panic selloffs among NFT traders, like in the case of equity.

The third and much more under-discussed risk associated with NFTs is that of adverse selection. Anything off the internet can be minted into an NFT- which implies not just the broadening of the scope of creativity but also the existence of a lot of “lemons” (reference- Economist George Akerlof’s award winning theory on moral hazard and adverse selection in the paper, The Market for “Lemons”). Without the presence of any further regulatory authority in place, which is the very characteristic of decentralized finance in which NFTs operate, this problem is exacerbated even more as it is only the collector’s eye for detail that is his safeguard against low quality/rip-off assets.

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