What is an NFT? Non-fungible tokens explained

You may have heard of NFTs, but do you know what they are and how they work?

NFTs, or non-fungible tokens, are unique digital assets that have gained significant attention in recent years.

Think of an NFT as a digital certificate of ownership for a piece of art, a collectible or even a piece of music. This unique feature allows NFTs to represent ownership of digital assets in a way that is secure, verifiable and resistant to fraud.

This article will explore what NFTs are, how they work and their potential applications in the digital world.

NFT stands for non-fungible token. In short, non-fungible means it cannot be exchanged like-for-like with another asset.

While one $20 bill is worth the same amount as any other $20 dollar bill, NFTs have specific qualities that make each unique and verifiably different from all other NFTs.

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

NFTs are blockchain-based digital records of ownership and authenticity associated with a piece of media. More specifically, each NFT contains unique metadata linking them to a file that lives elsewhere on the internet, functioning like a digital certificate of ownership.

In this way, NFTs are more similar to a painting’s bill of ownership and certificate of authenticity than the painted canvas itself.

Some NFT collections now exist on-chain to improve security, meaning both the NFT and the associated media file are stored directly on the blockchain. This ensures that the NFT remains valuable even if the original file is lost or compromised.

In essence, NFTs are like bearer bonds: Whoever owns the NFT owns the specific file it's connected to.

NFTs offer a unique set of advantages that make them valuable for various purposes. These include:

• Proof of ownership: Delivers a highly transparent and tamper-resistant way to verify that a certain blockchain address owns that item.
• Certificate of authenticity: 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).

By combining these two features, NFTs offer a powerful way to establish ownership and authenticity for digital assets, making them valuable for collectors, artists, and businesses alike.

Taking a picture of a work of art hanging in a museum does not make the photographer the owner of the painting. Similarly, owning a digital copy of a piece of art doesn't give you ownership of the original.

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 individuals to verify authenticity or ownership, NFTs use the tamper-proof, transparent and immutable power of blockchain technology. 

Blockchain provides a secure way to verify ownership. This means that there's indisputable proof of who owns an NFT, making it highly resistant to fraud and tampering.

Despite their recent rise to prominence, NFTs date back to the early years of cryptocurrency.

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, by “coloring” in individual satoshis with unique data. 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.

NFTs have primarily been used to track ownership and authenticity of digital art and collectibles. CryptoPunks, one of the earliest and most influential NFT collections, pioneered programmatic NFTs. 

Beyond art, NFTs are used to verify sensitive financial documents and grant exclusive access to pop culture experiences. Their decentralized ownership use cases continue to expand.

NFTs exist as permanent digital entries on a blockchain, which serves as a decentralized digital ledger. These tokens represent ownership and authenticity of digital assets without the need for centralized oversight or verification.

If you already knew this, you might want to read Kraken’s Redefining Digital Scarcity intelligence report, which covers the technical differences between NFT marketplaces.

NFTs are created, or "minted," using specific token standards, such as ERC-721 or ERC-1155, on Layer 1 blockchains like Ethereum and Solana. These standards ensure that each NFT is unique and verifiably different from other tokens on the blockchain.

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

Each NFT contains metadata that links to details about the asset it represents. This metadata can include information like the creator, ownership history, and a link to where the actual file (e.g., a .gif or .jpeg) is hosted. Metadata is essential for verifying the authenticity of the digital asset and clearly defining ownership rights.

While some NFTs are connected to files hosted elsewhere on the internet, newer collections are moving toward being fully on-chain. This means that both the NFT and the associated file live permanently on the blockchain, enhancing security and immutability.

NFTs are built using smart contracts, which are programmatic rules committed to and executed on the blockchain. These smart contracts primarily track and manage the ownership of an NFT, providing tamper-resistant proof of ownership and transfer.

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

On all blockchains, NFTs are minted using smart contracts.

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.

To break it down, here are the main aspects of how NFTs are made:

• Minting: The process of how NFTs are created and registered on the blockchain. This includes recording the NFT’s cryptographic address and key pieces of identifying information, known as metadata, on the blockchain.
• Metadata: During the minting process, key information about the NFT is encoded, including the creator’s cryptographic address and identifying details about the digital asset. The identifying information about the NFT includes the creator's details, a description of the digital asset, and links to the media file, which is often stored externally.
• Validators: The smart contracts that create NFTs require a gas fee to be paid to network participants. Gas fees incentivize the validators to act honestly and stay in agreement with others on the network.

The NFT is then created, and the digital media file it represents is often uploaded to an external location.

Ethereum, Solana, Cardano, Flow and Tezos are just a few of the smart-contract-enabled blockchain platforms that support the creation and trading of NFTs.

For an even deeper understanding of the various steps and factors to consider while making an NFT, check out our article How to make an NFT.

NFTs rely on blockchain technology to ensure the integrity and security of their ownership records. A complete record of an NFT’s transaction history and sequence of owners is securely stored on the blockchain, with each participating node contributing to its accuracy and protection from tampering.

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.

The smart contract specifies which public wallet address is associated with the NFT. This information is independent of how an individual chooses to custody the 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.

To store an NFT’s media file on the Interplanetary File System (IPFS), users can upload their file through platforms like Pinata or Filecoin. The file is assigned a unique cryptographic hash, which is linked to the NFT’s metadata on the blockchain. This decentralized approach ensures the media remains accessible and secure, reducing the risks of modification or deletion associated with centralized storage.

For more, check out our article How to keep NFTs safe.

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 are unique from one another — even seemingly identical — NFT markets are generally considered less liquid than more fungible asset markets like those for cryptocurrencies or financial securities. 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.

The programmability of NFTs also offers digital content creators an innovative way to potearn life-long passive income from future sales of their works. 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.

Note: Not all exchanges or NFT marketplaces support creator earnings, so creators should verify platform policies before minting and selling their NFTs.

NFTs are here to stay.

New and exciting collections and applications hit the NFT market daily, creating an ever-more-diverse marketplace to explore.

Create your account to curate your NFT collection with the most secure, most convenient, all-in-one platform: Kraken NFT.