For most people, the first web3 thing they hear about is Bitcoin or some type of cryptocurrency. Later on they may hear about NFTs. I consider this less than ideal because it puts people in a position where they are trying to wrap their heads around this ephemeral concept of “computer money” while holding many preconceived notions of money and how currency operates, without ever asking the question or understanding how it is possible to own a digital item in the first place. I believe the NFT concept is a much better vehicle for communicating an understanding of digital scarcity and digital ownership. Once those become established, then functioning cryptocurrencies become, at least, conceivable.
NFT stands for non-fungible token, which is undoubtedly the most useless information you have learned today. For most people, knowing that an NFT is a non-fungible token does not help them understand what it is in the least.
Let’s start by trying to understand the problem and then we can hopefully understand how NFTs provide a solution.
Most of the first, popular NFTs were images. Here is a copy of a Bored Ape NFT:
This NFT last sold in May for the nominal price of $167,406.82. Yes, you read that correctly, $167,406.82. Someone paid the equivalent of $167,406.82 for a funny picture of a monkey (ape technically). Now, there is a little more to it than that, but for now we will just consider the image aspect of it.
This was created by a group called the Bored Ape Yacht Club. It is an internet thing that I will come back to later.
Notice that I said this is a copy of the Bored Ape NFT. How many copies of this image could I make? As many as I want? I could copy and paste all day long and create exact copies, indistinguishable from one another. This brings up an issue that has long plagued the digital space - scarcity.
The ability to make a practically infinite number of copies of digital items is a double edged sword. It can be a good thing in certain situations. Consider a newspaper company pre-internet. If they want to increase readership, they would need to print and deliver more physical copies of the paper. But, with an e-edition the cost of producing more copies shrinks to almost zero.
When a resource is scarce, it has the potential to be valuable. When a resource is not scarce, it has a hard time maintaining its value.
The answer to this problem of scarcity is tokens. I am going to define a token as a unique identifier within the blockchain record. This is no doubt a simplification, but for our purposes will be sufficient. This unique identifier is called a Token ID. I own one token. It’s Token ID is:
101000168114517301845714934034627847521128029555374486290085665473944735509871
No other token on the entire ethereum blockchain record has this same number attached to it. It is unique and therefore scarce. This Token ID is listed under my public key on the blockchain record which means I am the person who has control over it. I own it.
This same thing is true for the Bored Ape NFT above. Many people may have copies of the image associated with the NFT, but only one person has control of the unique Token ID for this particular NFT.
When a digital item is “minted” as an NFT, it is assigned a Token ID. This unique Token ID allows for something like scarcity to function. I call this “digital scarcity”. Of course this scarcity only exists in the context of the blockchain where the ownership records for the NFT exist.
Why would anyone give up their real American dollars to purchase an NFT? One answer is that the NFT has some utility attached to it. Many NFTs function in much the same way a membership card functions. Your ownership gives you access to digital spaces that others cannot access. This is the case with the Bored Ape above. The Bored Ape Yacht Club is an online community that you gain access to by owning a Bored Ape NFT. The specific types of utility that can be attached to an NFT are wide open. They may give the owner voting rights withing an online organization, prove ownership of some digital item, or give some functionality within a video game.
Why are some of them valued so high? The best physical analog for an NFT is a baseball trading card. Recently a Micky Mantle card auctioned for close to $10 million. I didn’t hear anyone bemoaning the fact that that someone paid $10 million for a piece of cardboard. The reason is because that piece of cardboard holds culturally imbued value. The same is true of some NFTs. The catch is that most people are not a part of the culture that imbued the value to the NFT and therefore have trouble wrapping their mind around how it could actually be valuable. For many people trying to understand how a monkey picture could be worth any appreciable amount of money is similar to Christopher Columbus understanding that a piece of paper with a picture of a baseball player on it could be worth a ship full of Spanish doubloons.
If you own an NFT, there is a uniquely identifiable digital asset assigned to your public key on the blockchain. This token may carry with it culturally imbued value, much like a collectable item does in the physical world. Among other things, it may also be used to gain access to certain digital spaces or give the owner voting rights within an online organization.
The big takeaway is that this token idea creates the possiblity for a digital “item” to be owned. This ownership only makes sense within the context of a blockchain record where all parties involved agree upon the truth and legitimacy of the blockchain record. You own something not because you posses it, but rather because the blockchain record says you are the owner. Being the owner means you control the private key associated with the public key where the NFT is assigned.