What Exactly is an NFT?
Let’s talk NFTs. What are they? How do they work? And why did Justin Beiber spend $1.3 million on a Bored Ape NFT? We may not be able to answer that last question, so let’s tackle the first two.
Before we get into it, there are three basic definitions you’ll need to know:
- Blockchain: a network database that stores encrypted pieces of data that are linked together in chronological order.
- Smart Contract: a digital contract where the terms of the agreement are set in code. The program attached to the code runs when the terms of the agreement are met.
- NFT: a unique token linked to a digital asset, serving as proof of ownership
NFT stands for “non-fungible token.” What does that mean? A very simple explanation would be that an NFT is any unique asset: a piece of art, a song, a home, etc. Which means that the concept of a non-fungible item is not new, but the rise of “NFTs” as we know them are differentiated by one, critical difference: it’s a reference to digital assets that live on a blockchain.
On blockchain, NFTs have a digitally recorded chain of ownership, creating a digital authentication ledger. Similar to NFTs, the concept of recording a chain of ownership is not new. It has existed in real estate, where the deeds to homes are publicly recorded and signed over from owner to owner. A website like Zillow will make the property records easily accessible for potential buyers to access information about any given home. Details like the year the house was built, previous dates of sale and price for each transfer of ownership of the home are collected and shared in one location.
Blockchain works much like this in creating an easily accessible digital record. A unique feature of the blockchain is that once information is recorded, it cannot be deleted or altered. This allows for the traceability of the asset’s authenticity, as well as the history of ownership and purchase prices.
When going to sell or purchase an NFT, a smart contract lays out the terms of the change in ownership for the given asset. Once the payment is made, the smart contract will serve as the proof of ownership to the new owner, adding the information of the sale to the already existing record of the asset on the blockchain, and will provide the new owner with the asset itself, typically in the form of a link.
Although NFTs were only thought to exist in the digital realm, they have already been used to serve as proof of ownership for real world assets. In February, one of the first home sales using NFTs occurred in Florida. While a physical asset can never live on the blockchain, proof of ownership can be stored there. NFTs are still predominantly digital art, but as their popularity increases, the use cases will continue to expand.