NFTs Primer: Overview, Features, Uses, Legal Status, Creating, Tracking, and Transferring Ownership of NFTs
The NFTs market has grown on a mind-boggling scale due to increased public awareness around them, which led to their mainstream adoption. Reportedly, the booming NFTs market generated over $23 billion in trading volume in 2021, compared to just $ 94.9 million in 2020.
NFTs rose to popularity in March 2021 when a collage of 5000 daily drawings, titled “EVERYDAYS: The First 5000 days” by the artist Mike Winklemann (Beeple) was sold for a record-breaking $69.3 million at the renowned Christie’s auction house. In fact, Christie’s made $150 million solely from NFT sales this year.
Though first hyped in the art and gaming industry, corporate players from the sports and entertainment world have also embraced NFTs. In 2021, the U.S. National Basketball Association (NBA) created its own NFT marketplace for buying, selling, and trading video highlights of its players called NBA Top Shot International sportswear brand Adidas partnered with a well known NFT project called Bored Ape Yacht Club to launch a line of NFTs called Into the Metaverse, which will offer buyers access to a very exclusive fan club.
Though the NFTs experienced a meteoric rise this year, they have also invited skepticism. While some experts believe that the NFTs are here to stay, the others believe that they are a bubble poised to pop, like the dot-com craze or Beanie Babies. They believe that if the number of transactions continues to go up, the average price of NFTs will go down.
What are NFTs
Non-Fungible tokens or NFTs are cryptographic assets on a blockchain that cannot be replicated. These digital assets represent ownership of a wide range of unique tangible and intangible items, ranging from collectible sports cards to virtual real estate and even digital sneakers.
What does being non-fungible mean:
Non-fungible essentially means something which is unique and cannot be replicated or replaced with something else. Fungible items on the other hand can be traded or exchanged at equivalency.
Fiat currencies and cryptocurrencies are fungible assets. For example, a user can trade one Litecoins for another Litecoin and end up with exactly the same thing, having exactly the same value; however, this is not possible with NFTs. Basically, one Litecoin will always be equal in value to another Litecoin or a single unit of Ether will always be equal to another unit.
No two NFTs are the same, even the ones that exist on the same platform or collection. One NFT can never be equal to another, this is because each NFT has a unique digital signature, which not only distinguishes it from other NFTs but also makes it verifiable. For instance, one NBA Top Shot clip, for example, is not equal to another NBA top shop clip.
How can NFTs be created and tracked?
NFTs are built on blockchain. Blockchain is a distributed public ledger that records and validates every transaction done on it. Most of the NFTs tokens are built using one of two Ethereum token standards — ERC-721 and ERC-1155. Even though other blockchains such as Cosmos, Polkadot, and Binance Smart Chain have also launched NFT marketplaces, Ethereum continues to remain dominant.
Most NFT tokens are built on ERC-721 and ERC-1155 protocols. ERC-721 is a token standard on the Ethereum blockchain. ERC-721 token standard deploys one smart contract for each NFT. Presently, ERC-721 tokens are mostly being used as gaming tokens or in-game assets. For instance, in the game CryptoKitties, wherein, players own, breed, and trade cats, an ERC-721 token is used to represent each cat.
ERC-1155 allows batch transfers of multiple tokens at once, and at a much faster speed than an ERC-721. This means that under the ERC-1155 standard, a single deployed smart contract includes varied combinations of non-fungible, fungible, and semi fungible tokens. Since ERC-115 can batch multiple NFTs into one single smart contract, thereby, significantly reducing the transaction and the storage cost.
As soon as an NFT token is minted or created on a blockchain a token certifying authenticity is generated automatically, which contains the creator’s name and other metadata, along with a link to the underlying asset.
Each NFT can be stored on the blockchain and transactions related to it can be traced on the blockchain. Each NFT is stored on the blockchain with a unique identification code and metadata. Metadata describes whatever piece of data it is connected to, so an NFT metadata stores details about the underlying digital asset. For example, metadata for a video NFT would be the length of the video and the images that make up its individual frames.
Transferring ownership of an NFT
When a user purchases an NFT, he is essentially buying the digital artwork and the metadata stored in the NFT. However, the original creator of the NFT not only retains the copyright to the NFT but also the right to duplicate the NFT. The creator can make multiple copies of the original NFT and each copy will be considered a unique NFT.
The buyer can also make copies of the original NFT after taking permission from the creator. The buyer also has the right to resell the NFT. In most cases, creators can program the smart contract deploying the NFT, in such a way, that whenever an NFT is resold they get a royalty payment.
Ultimately, the ownership conveyed depends upon the terms of the smart contract. If the creator does not specify any contractual terms, copyright ownership of the digital asset is not transferred along with the NFT. For example, the NBA Top Shot grants the buyer “a worldwide, non-exclusive, non-transferable, royalty-free license to use, copy, and display” the top shot for both personal and commercial use.
Features of NFTs
Some of the key features of NFTs include:
- Uniqueness: Since no two NFTs can be identified they cannot also be interchangeable. The metadata acts as proof of authenticity of each NFT because it cannot be altered or deleted.
- Ownership: The NFTs are created on a blockchain through an associated account. The creators of the NFTs have control over the private key of the account. The creators of an NFT retain complete copyright ownership of the NFT. Further, the NFTs can only be transferred or sold using the private key.
- Indestructible: Because all NFT data is stored on the blockchain via smart contracts, each token cannot be destroyed, removed, or replicated.
- Scarcity and Immutability: Smart contracts allow developers to place hard caps on the supply of NFTs and enforce persistent properties that cannot be modified after the NFTs are issued.
- Indivisibility: Indivisibility implies that a buyer cannot divide an NFT into smaller tokens, and you need to purchase the whole NFT for owning an item; however, the concept of fractional ownership is also emerging. Under, fractional ownership creators offer multiple tokens as a representation of a single NFT.
- Easily Transferable: NFTs are purchased and sold on special marketplaces.
NFT Use Cases
NFTs in art: For artists, being able to sell artwork in digital form directly to a global audience of buyers without using an auction house or gallery allows them to keep a significantly greater portion of the profits they make from sales. Royalties can also be programmed into the smart contract so that the creator receives a percentage of sale profits each time their artwork is sold to a new owner.
NFTs in gaming: NFTs provide gamers with a way of owning unique in-game items and assets. In some games such as Decentraland and The Sandbox, with the help of NFTs, players can now create and monetize structures like casinos and theme parks in virtual worlds
NFTs in real estate: NFTs can be used to transfer land deeds, provide proof of ownership and even keep track of changes in property value over time using timestamps. Proppy, a Europe-based real estate startup, offers a transaction platform where each NFT is sold with access to ownership transferred paperwork. The first Propy-hosted NFT auction sold an apartment for 36ETH or $93,000 at the time of sale.
NFTs in collectibles: NFTs are often associated with collectors due to their ease of verification and authentication. The creation of counterfeit copies is the one that many collectors face when it comes to physical collectibles. From the time an NFT is minted, it can be tracked on the blockchain. The blockchain allows buyers to view an NFT’s entire transaction history, including the date it was created, who created it, and where it’s been since. This allows collectors to easily verify an asset’s authenticity.
NFTs in the fashion industry: Virtual apparel and accessories are sold in the form of NFTs. Some of the NFT clothes and accessories can also be redeemed for a real pair of clothing. Uniswap socks, for instance, are NFTs on the Ethereum blockchain that can be traded like normal NFTs, save for the fact that they can also be redeemed for a real pair of socks.
NFTs in Metaverse: Metaverse is a digital 3D universe that gives users and businesses endless opportunities for porting real-world assets and services. NFTs represent ownership of objects in the Metaverse, including in-game assets, virtual avatars, and real estate properties. Metaverse has NFT-based marketplaces through which the users can buy digital assets using their virtual avatars. Further, events held in Metaverse, like music concerts use NFTs ticketing technology to distribute tickets to desired audiences.
Are NFTs regulated?
The FATFs’ Updated Guidance for a Risk-Based Approach to Virtual Assets (VAs) and Virtual Asset Service Providers (VASPs), stated that though NFTs or crypto-collectibles generally fall outside the virtual asset definition they may be considered such if used for payment or investment purposes in practice.
The U.S. Department of Treasury, recently, published a study on the facilitation of AML/CFT through art trade. According to the study, platforms that support the sale and purchase of NFTs, as well as virtual mediums like metaverses can be regulated as money services businesses (MSBs) under the Financial Crimes Enforcement Network (FinCEN) regulations. These service providers, therefore, will be subjected to existing KYC/AML regulations.
On February 15, 2022, the Monetary Authority of Singapore (MAS) in a written response to questions posed by the parliament on the subject of NFTs, MAS announced that it will not be regulating activities related to NFTs in the near future. However, the regulator also stated that will keep an eye on the NFT space. “Should an NFT be structured to represent rights to a portfolio of listed shares, it will like other collective investment schemes be subject to prospectus requirements, licensing, and business conduct