The tech world has been abuzz lately about NFTs, fueled in part by celebrity endorsements. But few people outside the digital sphere understand what an NFT is, what it’s used for, and what its implications are.
While non-fungible tokens are similar to crypto, there are significant differences between the two types of digital assets. Also, as a new type of asset (or, more specifically, a technology to prove ownership over authentic assets), NFTs aren’t very well regulated yet. This makes them prone to fraud and other hazards.
We’ll discuss all of these things in this article.
What Does NFT Stand For?
NFT is short for non-fungible token.
What Is an NFT?
A non-fungible token (NFT) is a digital object, similar to cryptocurrency, with unique identifiers that distinguish it from any other piece of digital data. Existing on a blockchain, NFTs cannot be replicated or divided. And because of their uniqueness, NFTs cannot be replaced with any other asset.
Some of the information contained within an NFT denotes what asset it corresponds to, and who currently owns it. So the general idea is that the owner of an NFT owns (at least part of) the original and authentic asset associated with it, even if something very similar is created. The asset can be physical or digital, and ownership rights to it can be bought, sold, or transferred like with any other type of property.
Fungible vs. Non-Fungible Tokens
The difference between fungible and non-fungible tokens is that fungible tokens can be divided, and/or exchanged with similar assets, while retaining more or less the same value. In contrast, non-fungible tokens cannot be divided, or exchanged one-to-one with other NFTs, because they each represent an original asset with its own unique value.
To summarize the main differences:
Let’s use some real-world examples to illustrate.
A unit of currency – like a coin, banknote, or even a crypto amount – is a fungible token because:
- It’s not unique – If you have a $1 US bill, its value is typically not any different than any other $1 US bill because of the sheer number of copies in circulation.
- It’s divisible – If you give someone a $1 US bill and they give you four 25-cent US coins in return, you’re just exchanging different denominations of the same amount of value.
- It’s interchangeable – If you exchange a $1 US bill for another fiat currency (such as Mexican pesos) or a virtual currency (such as Ethereum), it only changes the context in which it can be used and not its value.
In contrast, an original painting by a famous artist is a non-fungible token because:
- It’s unique – Though a painting may be copied or used as inspiration for other artworks, the original piece has certain details and characteristics that prove it’s authentic when compared to imitations.
- It’s indivisible – A painting derives its value from its context as a whole piece, so it loses its value (and meaning) if it’s divided up into smaller parts.
- It’s irreplaceable – A painting cannot be conveniently exchanged with any other painting because each one has a unique value proposition through its characteristics (author, style, medium, subject matter, and so on).
How Do NFTs Work?
NFTs and crypto work somewhat similarly. They’re both created when information is recorded and validated on a blockchain computer network, in a unit called a block.
In the case of NFTs, that information is rather specific. It regards which asset the NFT(s) will correspond to, and who has the initial ownership rights (including the copyright, in the case of artworks or other intellectual property) over that asset. As this information is validated, some of the excess data is repackaged as unique digital value objects that correspond to (at least partial) ownership of the asset described in the block. These are NFTs.
Initially, NFTs are usually owned by the creator or owner of the asset they’re tied to. But they can be sold to other people in order to transfer (some of) the ownership rights to them. Such transactions are recorded on the blockchain as well for the sake of permanency.
What Are NFTs Worth (and How Is Their Value Determined?)
An NFT’s value varies from one to the next because each one has a different value proposition. Like paintings and other collectible items in real life, NFTs are worth what people are willing to pay for them.
This can be based on a number of factors, including rarity (i.e. how many NFTs are minted for a particular asset), what the asset is used for, who created and/or originally owned the asset, the asset’s aesthetic qualities (for media and other works of art), and so on.
So an NFT of an artwork may be worth thousands or even millions of dollars to an enthusiastic collector or investor. Meanwhile, someone with no interest in art may not think it’s worth much at all.
What Are the Pros and Cons of NFTs?
In some circles, NFTs are being heralded as a new digital class of accessible, efficient, and secure property ownership and investment. Others are concerned about NFTs being prone to price fluctuations, fraud, and even damaging the environment because they aren’t sufficiently regulated by governments or understood by the public yet.
Here’s a quick summary of non-fungible tokens’ pros and cons.
Advantages of NFTs
- They’re accessible to anyone with an internet connection to buy, sell, or trade.
- Their ownership information is recorded on the blockchain, where it’s difficult to alter or delete without majority approval from the network community, so they’re secure against theft.
- Like stocks, they allow for partial ownership of assets, which enables people who can’t afford to buy the whole asset to still invest in it.
- They can represent any type of asset that requires documented ownership.
- They allow the asset’s creator / intellectual property owner to collect royalties as the asset is bought, sold, and traded.
- Because NFTs are digital, transactions involving them are much faster and more efficient.
Disadvantages of NFTs
- As a relatively new and unregulated class of assets, their prices are speculative and totally dependent on market supply and demand.
- Unlike other types of investments, they only generate income if they are sold for a higher price than they were bought for.
- As illiquid assets, they cannot be converted into cash without outright selling them.
- They must be stored in a cryptocurrency wallet or other place locked by access keys, which are vulnerable to theft or platform failures.
- Despite being secured by blockchain technology, they are still vulnerable to fraud; someone could copy an NFT asset and create a new NFT to sell the asset as if it were theirs or even sell NFTs without any actual asset behind them.
- The computing processes required to create NFTs usually cost a lot of cryptocurrency; they also consume a lot of energy, which is bad for the environment.
Types of NFTs
There are many different types of non-fungible tokens, as NFTs can be created for virtually anything someone wants to claim and document ownership of. Some of the more common uses for NFTs include:
- Visual art: Many NFTs correspond to digital (and sometimes real-world) artworks, including photographs. NFT art is popular because it allows creators to earn money when the artwork is first sold, and then earn royalties as the work is resold and exchanged.
- Games: NFTs for games are also popular. Many blockchain-based games allow players to purchase NFT-based items or character customizations with either the blockchain’s native cryptocurrency or some other form of money. These assets can then be sold or traded to other players.
- Collectibles: Like trading cards in real life, collectibles such as NFT trading cards allow for collecting and investing in rare digital artifacts. Some are released in fewer quantities than others, making these very valuable and sought-after.
- Profile pictures: Also known as PFP NFTs, these can be purchased to let a person have a one-of-a-kind profile picture on a social network, or avatar in a virtual world.
- Music: Musicians are now using NFTs to grant fans fractional ownership over songs, albums, or even music videos (as opposed to just licenses to play them). This lets fans more directly support the artists they like, and artists reward loyal NFT-bearing fans with extra perks.
- Event/membership passes: Certain companies are beginning to use NFTs as access credentials to events or programs. This helps keep tickets from being stolen or faked, helps venues more accurately track event attendance, and allows brands to reward their most loyal customers.
- Domain names: Some web hosting companies use NFTs to sell unique website domain names. This allows for determining the authenticity of domain names in case copycat websites use similar names. It also allows for ownership of domain names to be transferred from one party to another easily.
So what does an NFT look like in a practical sense? The next section will introduce some real-world NFT examples to help you understand what they are (or can be).
Real-Life Examples of NFTs
So what are some non-fungible tokens that you may have heard of, or that are particularly popular? Here are some of the more famous ones.
The “Bored Apes” NFT is one of the most well-known collections of NFTs. The original set consists of 10,000 unique drawings of cartoon monkeys, all generated by a computer algorithm. Many celebrities have purchased these NFTs as investments or marketing tools, giving them some of the highest NFT prices on the market. Owning one of these NFTs also provides access to the Bored Ape Yacht Club, a collection of art projects, in-person events, merchandise, and other lines of NFTs.
Axie Infinity is an NFT game that revolves around virtual creatures called Axies. These creatures can be used across different sub-games in the series to earn resources, power-ups, new Axie breeds, and other items. These gameplay assets can then be sold or traded to others for Ethereum cryptocurrency on an open marketplace.
Decentraland is a decentralized virtual world owned by the people who play in it. Using Decentraland’s cryptocurrency, MANA, players can buy, sell, or rent NFTs of land parcels within the world. Then they can build on these parcels to create items, games, events, community spaces, and more. Land and created items can then be sold or rented to other players for MANA, which can be converted into Ethereum cryptocurrency.
NBA Top Shot is a trading cards NFT marketplace that goes beyond showing a picture of an athlete on a sports trading card. Instead, NBA Top Shot allows fans to buy, sell, trade, and own officially licensed video clips that depict NBA stars making iconic plays.
The first message posted by the X (formerly Twitter) co-founder on the platform now has its ownership rights in NFT form. The NFT initially sold at an auction for $2.5 million, which Dorsey donated to charity.
NFT Scams to Watch Out For
While ownership of NFTs is by and large secure thanks to how blockchain technology works, it hasn’t stopped unscrupulous opportunists from trying to cash in on the NFT craze fraudulently. Here are some common NFT scams to avoid.
- Rug pulls: Fraudsters promote a fake NFT project with no actual product behind it. Once they receive significant enough investment, they shut down the project and disappear.
- Phishing: Scammers use all sorts of impersonation tricks to get people to give away sensitive information, like crypto wallet keys or security seed phrases. They can impersonate NFT creators or marketplaces with websites, emails, phone calls, or social media messages, sometimes claiming to be holding a fake NFT giveaway. They can even impersonate NFT marketplace customer support agents using these same methods, claiming to want to help people resolve “issues” with their crypto wallets.
- Bidding scams: A fraudster places a high bid for an NFT on a secondary marketplace, then switches the type of cryptocurrency they’re bidding to one with much lesser value before the seller accepts the bid.
- Pirating: A scammer creates a copy or altered version of an NFT asset, then creates a new NFT for it, and illegally sells it as if it were their intellectual property.
- Pump-and-dump: Similar to rug pulls, a fraudster buys an inexpensive NFT and then relentlessly promotes it to inflate demand for it and raise its price. Then they sell it for a profit, while the buyer is left with an NFT that quickly loses value as activity around it fades.
The bottom line is to do your research, double-check things, use common sense, and beware of offers that seem too good to be true.
Unit21’s Solutions Help FIs Be Ready to Deal with NFT Fraud
Like cryptocurrency and other new technologies, NFTs have a “Wild West” period of limited understanding by the general public and—more importantly—government regulation. This makes them a ripe vehicle for fraudsters to swindle or outright steal from unassuming people who are just looking to test the waters.
So it’s important for financial institutions to be prepared to deal with these new assets, including watching out for potential fraud. Unit21’s Transaction Monitoring and Case Management tools work together to give FIs a wider view of the digital transaction landscape, making it easier to spot suspicious activity more accurately. They also allow for acting faster on alerts to meet compliance guidelines and keep scammers from getting away with their misdeeds.
To get a hands-on introduction to these and other Unit21 products, contact us for a demo.