What is an NFT?

(Non-Fungible Token)

What does NFT stand for?

NFT stands for non-fungible token. In short, non-fungible means distinct and unduplicatable, while a token is a digital asset stored on a blockchain.

Although these three letters changed the concept of digital ownership for many, they continue to cause confusion and frustration for others.

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What are NFTs?

NFTs are blockchain-based digital records of ownership and authenticity associated with a piece of media.

An NFT is more than a multimedia file (like a .gif or .jpeg) ⁠— it is a public record of historic information associated with that media. In this way, NFTs are more similar to a painting’s bill of ownership and certificate of authenticity than the painted canvas itself.

NFTs are different from fungible assets like $20 bills, shares of a stock, or other units which can be substituted for each other with no change in value.

While one $20 bill is worth the same amount as any other $20 dollar bill and one new tennis ball can be exchanged for another without disrupting a match, NFTs have distinct qualities that make each unique and verifiably different from all other NFTs.

Why are NFTs important?

An NFT serves as proof of ownership, delivering a highly tamper-resistant way to mathematically verify that a certain blockchain address owns that item.

An NFT also serves as a certificate of authenticity which ensures that any form of media (artwork, document or other digital file) can be traced back to its origination (and thereby be proven not to have been tampered with since).

NFTs explained

Taking a picture of a work of art hanging in a museum does not make the photographer the owner of the painting, nor does it make the captured image the original work of art.

We know this because there is consensus among intermediaries such as curators, scholars, collectors and the public about which is the original, which is a copy and who is the rightful owner.

The same is true of NFTs and this is what gives an original NFT – rather than its right-click-saved copies – provable scarcity and value. But rather than relying on the judgment of individuals to verify authenticity or ownership, NFTs use the consensus-building power of blockchain technology.

In short, NFTs use objective mathematical proofs, rather than subjective trust in an individual or organization, to verify ownership and authenticity.

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An extremely brief history of NFTs

Despite their recent rise to prominence, NFTs date back to the earliest years of blockchain technology.

The concept of NFTs was introduced with Colored Coins in 2012. Stored on the Bitcoin blockchain, Colored Coins offered a way to represent ownership of real-world assets such as real estate or shares of a stock. Years later, Digital artist Kevin McCoy’s “Quantum” ⁠– a hypnotic loop of a pulsating, multicolored octagon – was minted on the Namecoin blockchain and is widely regarded as the first NFT.

After the viral popularity of collections like Rare Pepes on the Bitcoin-based Counterparty platform, Ethereum advanced NFTs’ viability with CryptoKitties and the ERC-721 standard in 2018. This paved the way for other smart-contract-enabled blockchain networks such as Solana, Polygon, and Tezos to help further the adoption and circulation of NFTs.

To date, NFTs have been most widely used to track the ownership and authenticity of digital art and collectibles. Some of the earliest NFTs, such as CryptoPunks, represent artifacts from the first moments of a cultural shift in the concept of ownership. The decentralized ownership use cases for NFTs in other realms beyond art, from the verification of sensitive financial documents to exclusive access to pop culture experiences, continue to grow.

How do NFTs work?

NFTs, and the blockchain networks they exist on, employ concepts from cryptography and computer science to securely maintain and share information. They do this directly between individuals without the need for centralized oversight and verification.

If you already knew this, you might want to read Kraken Intelligence’s report, Redefining Digital Scarcity, which covers the technical differences of NFT marketplaces like OpenSea and Rarible, as well as NFT token standards like ERC-721 and ERC-1155.

But if you are just starting your blockchain and NFT education journey, you are in the right place.

Blockchains use public-private key cryptography and hashing to share encrypted information across a distributed network of users. This information is stored in “blocks” which are “chained” together by including information from the previous block in each new block. This approach of including information from the previous block in each new block allows for a complete audit trail back to the creation of the blockchain. It also makes it easy for the network to identify if a block of information has somehow been tampered with.

Rather than maintaining these blocks of chained information in a single location, blockchains distribute copies of this information across a network of computers, each of which is individually referred to as a node.

Blockchains use a sophisticated computer program, referred to as a consensus algorithm, to maintain agreement on the information that is committed to the network and shared across participating nodes. This gives blockchains their defining characteristics of being:

Decentralized

Blockchains rely on a shared set of predefined rules, rather than a human intermediary, to maintain agreement on the validity of information they store.

Distributed

Information stored on a blockchain is not kept in a single location, but across a network of computers, which share the same copy of historical data.

Immutable

Information kept on a blockchain cannot be changed, only added to, which allows for a complete and highly tamper-resistant source of truth for all.

Check out the Kraken Learn Center’s complete guide to What is Blockchain Technology? for a thorough overview.

NFTs are built using smart contracts, programmatic rules committed to and executed on the blockchain. The smart contract behind the NFT serves as tamper-resistant proof that the media associated with the NFT was created by a specific person or organization. It also proves the rightful owner of the item.

Ultimately, the deterministic rules of the smart contract managing the NFT allow individuals to sidestep the oversight of error- or fraud-susceptible centralized intermediaries.

Ethereum, Solana, Cardano, Flow and Tezos are just a few of the smart-contract-enabled blockchain platforms that support the creation and maintenance of NFTs. While each blockchain functions in a different way, they all deliver a decentralized, distributed and immutable way of maintaining a shared record of truth.

How to make an NFT

On most blockchains, NFTs are created by interacting with a smart contract.

Many smart contract templates for creating NFTs are available from a variety of open sources, including the blockchain platforms that support NFTs, prominent creators within the space and NFT marketplaces.

NFTs are created and registered on the blockchain through a process known as minting. Nearly any piece of media, from a single line of text to an entire virtual reality experience, can be minted as an NFT. Through the minting process, the cryptographic address of the NFT’s creator and key pieces of identifying information known as metadata are added to the blockchain. The NFT is created and the digital media file the NFT represents is often uploaded to an external location (more on that in the next section).

The smart contracts that create NFTs require a gas fee to be paid to network participants, known as validators, who maintain the truthfulness of the NFT’s state of ownership. Gas fees incentivize the validators to act honestly and stay in agreement with others on the network.

Securing and storing an NFT

NFTs are secured and maintained much like prominent cryptocurrencies such as Bitcoin, Polkadot and Algorand. A complete record of an NFT’s historical transactions and sequence of owners is copied and shared across participating nodes. Each node contributes to ensuring the security and accurate record-keeping of that NFT.

The consensus algorithm ensures all participating nodes across the network stay in agreement. Consensus algorithms, such as proof-of-work and proof-of-stake, ensure that new transactions are recorded and stored accurately by practically eliminating the potential to tamper with the network or its contents.

While an NFT’s metadata, chain of custody and record of authenticity is stored on the blockchain, the media an NFT represents is often not. Because storing large image files directly on a blockchain can be expensive, many choose to store the media file an NFT represents off-chain and point to it via a link stored within the NFT on the blockchain.

It is important to fully understand where the media associated with an NFT is stored and maintained, which is defined within the smart contract powering the NFT, not by the method an individual chooses to custody an NFT. While centralized media storage solutions offer convenience, they could make the media more vulnerable to modification or deletion. Decentralized alternatives, such as Arweave or the Interplanetary File System (IPFS), have emerged as potential solutions that address many of the vulnerabilities associated with centralized media storage services.

NFT transactions

NFTs can be bought, sold and traded directly between individuals or through a marketplace that facilitates such transactions. Many NFT marketplaces also offer bidding functionality, rather than only a fixed price, to enable better price discovery.

Because non-fungible items have no equivalent, NFT markets are generally considered less liquid than more fungible asset markets like those for cryptocurrencies or financial securities. Just like pieces sold in the traditional art market, an NFT’s value is derived almost entirely from what another secondary market participant is willing to pay for it.

The programmability of NFTs also offers an innovative way to compensate digital content creators, rather than the latest owners, for creativity and intellectual property. The smart contracts powering NFTs can be programmed to grant fees to different predetermined blockchain addresses. The original creator of an NFT can choose to include a creator earning, a cut of the sale price that compensates the original creator each time that NFT is resold.

What are NFTs used for?

Art & Collectibles

While nearly any digital file can be represented as an NFT, the most common use cases today are collectible, digital artworks. Prior to NFTs, the most significant critique of digital art or collectibles was that ownership of a piece of art or baseball card was almost impossible to track online and relied heavily on fraud-susceptible intermediaries.

NFTs have further legitimized digital art as a medium and a valuable form of expression in modern culture. NFTs from so-called “blue chip” collections (e.g., CryptoPunks, Bored Ape Yacht Club and works from digital artists such as Beeple) have set sale price records not only for NFT marketplaces, but for traditional art auction houses as well.

Community Membership

Many NFT collections offer exclusive real-world perks, rewards or experiences to their holders, creating additional value.

Those holding NFTs from certain collections often connect with other owners to network, develop relationships and share in their passion for the project, all while fostering a deeper sense of community membership.

Additionally, several decentralized autonomous organizations (DAOs) have come together to share in the fractional ownership and collective management of NFTs they have determined to be culturally significant.

Music

Musicians are using NFTs to reduce the influence of record labels and the wider music industry, which mediates and monetizes the relationship artists have with their fans. Just as unique images can be committed to the blockchain as NFTs, unique clips of audio can also be created, transacted and stored on the blockchain as NFTs for fans to own and enjoy.

Scores of musical artists across genres and generations, including Kings of Leon and 3LAU, are using NFTs to foster new experiences with their music and offset their reliance on the intermediaries of the music industry.

Gaming

Blockchain-based platforms like Decentraland, Axie Infinity and The Sandbox use NFTs to offer unique in-game experiences and reward players with bespoke items that have real-world value. Within these games, NFTs can represent distinct plots of virtual land, characters, abilities or wearables, each with their own attributes and market value. NFTs, and the cryptocurrencies native to many blockchain games, are also key parts of the play-to-earn economy, rewarding players’ in-game achievements with items that have a value outside of in-game marketplaces. NFTs allow players to take ownership over their gaming accomplishments and reap bespoke rewards that have real-world value.

DeFi

NFTs are also seeing innovative use cases with decentralized finance (DeFi) protocols as a way to maintain tamper-proof records of ownership without intermediaries. Important financial documentation, such as a proof of ownership of a piece of land or a business’ tax filing could be created as an NFT and used within a DeFi protocol to reliably execute a peer-to-peer blockchain transaction. Beyond their proof of ownership and authenticity use cases, NFTs can also be used as collateral for users to borrow against. Both traditional and blockchain-based lending services are exploring how the value of an NFT can be used to fund new financial products and services.

The Metaverse and Web3

NFTs are fast becoming a fundamental building block for the next generation of the internet, where more immersive online experiences can be delivered through the bespoke ownership properties of NFTs.

NFTs have the potential to empower a more decentralized and anonymized blockchain-based internet architecture, often referred to as Web3. While the full scope of NFTs’ potential within these realms is still emerging, NFTs will likely continue to play a crucial role in developing Web3 and the metaverse. Many feel art is only the first of many areas to be revolutionized by the potential of NFTs, with e-commerce, land ownership and even personal identity use cases soon to follow.

Proof of Attendance Protocol

Proof of Attendance Protocol (POAP) is an open source project that uses NFTs to track attendance of real world events. After providing a simple badge design and metadata associated with an event (such as the event’s name, location and date) POAPs can be distributed to create a tamper-proof digital record of participation that is easily shared and verified.

POAP enables event organizers to offer more personalized experiences for their communities. This type of non-fungible token has the potential to expand into other areas such as tracking credentials from academic institutions and professional organizations, as well.

Fashion

From boutique luxury brands to fast-fashion powerhouses, companies around the world are exploring the power of NFTs.

Several prominent brands are launching NFT collections of clothing fit for the metaverse, while others like Louis Vuitton are developing entire games centering around collecting NFTs and engaging with the brand.

NFTs deepen connection with customers while placing a spotlight on inspiring new artists. Gucci, Dolce & Gabbana, Nike and Adidas are just a few of the tastemakers that have tapped into the power of NFTs to create trendsetting experiences.