All tokens are not created equal
Over the last few weeks there has been a lot of hub-bub around the internet about the ~$69 million sale of a digital art piece by Beeple titled “Everydays: The First 5,000 Days”. The number, for obvious reasons, tickled my juvenile meme ridden mind; in fact, my first response when I read the article was ‘nice!’. But jokes aside, non-fungible tokens (NFTs) are a rapidly growing idea within the crypto community that is definitely going to impact our lives in the coming decades. They are one-of-a-kind digital assets that allow for digital scarcity and built in ownership records. However, before thinking about NFTs, it might be worth understanding the differences between “fungible” and “non-fungible” entity.
What is Fungibility?
A fungible item or token is a physical or digital entity that is interchangeable with another unit of the same item. An example of a perfectly fungible item is elemental/commodity gold that gets typically traded in the form of a gold bar. Since all gold atoms are essentially identical, gold in this form is perfectly fungible. However, when gold is forged into a piece of jewelry it becomes less fungible because the design/shape gives it uniqueness that directly affects its interchangeability. Similarly, any dollar note is equivalent to another dollar note of the same value just like one Bitcoin is equal to another Bitcoin. So, if you lend your buddy a $20 note, you wouldn’t need them to repay you with that same $20 note; any $20 note will suffice and thus cash could be thought of as fungible. But, if one looks at the situation a bit more carefully, cash (or digital currency) might not be perfectly fungible like commodity gold because depending on the source/history of the cash its fungibility might be different. For instance, a stolen $10 does not have the same value as a legally obtained $10 dollars, especially when the people involved in the transaction know about the history of the cash. However, in the vast majority of the cases cash could be considered as fungible as gold because typically it’s very difficult to keep a detailed history of cash transactions. Now, let’s look at some examples of less fungible items and their value; In the digital world, your IDs such as twitter handle, email address etc are less-fungible and their value may depends on the reach, platform etc; In the real world, paintings, jewelry, collectable cards etc are great examples of less fungible items and their value depends on their rarity. I have chosen to classify these as “less-fungible” rather than non-fungible because while these items are technically one of a kind, it is still possible to forge them or be hacked. So, it would be safe to say that all physical or digital items exist within a fungibility spectrum with things like elemental gold being on “Perfectly fungible” side of the spectrum while physical collectibles being closer to the “non-fungible” side. The mere existence of this spectrum begs the questions, what are perfectly non-fungible items?
Non-fungible tokens are a kind of flexible digital record (token) that allows unique physical or digital assets to be represented within a blockchain. Blockchains themselves are a list of records, called blocks, that are cryptographically linked to each other, often carrying details about time and nature of the transaction that links them. This interconnected nature of the record as well as the blockchains being distributed among several different nodes gives it a high degree of security making it almost invulnerable. Currently, most, but not all, NFTs are issued via the Ethereum blockchain; although the market for blockchain platforms continues to develop and evolve. NFTs are useful because the underlying content, or physical item, is linked to a single token contained in a smart contract on a distributed ledger (blockchain) and, as such, ownership can be irrefutably authenticated; others may have copies of the same content but only one person can own the token that authenticates ownership. The main properties of NFTs make them different from other non-fungible digital assets like domain names or twitter handles are,
Unique: A NFT typically contains within its code information that details the key properties of itself that makes it different to others. For instance, a NFT for a piece of digital art might have coded information about each individual pixel or NFTs owned by a player within an online game might contain details that allow the game client to understand which item the player owns.
Traceable: Each NFT has a record of transactions on-chain, from when it was created, including every time it changed hands. This means each token can be verifiably authentic, a feature that is obviously very important for owners and prospective buyers.
Indivisible: NFTs mostly cannot be transacted as fractions of a whole. Just like how one cannot purchase half of a painting or jewelry, NFT cannot be split into smaller sub-unit.
Programmability: NFTs are fully programmable, much like other digital assets and tokens built on smart contract blockchains. This programmability need not be useful in all cases but can allow interesting features to be coded into NFTs, for instance CryptoKitties have breeding mechanics coded directly into their tokens. But, this programmability is particularly interesting because it allows NFTs to have the best traits of decentralized blockchain technology to be combined with non-fungible assets. For instance it allows the complete decentralization of NFT transactions, making it possible to truly own and control your own NFTs (and associated assets).
Taken together these properties of NFTs can begin to explain the astronomical value of certain NFTs. Succinctly put, NFTs allow easy tracing and verification of, real or digital, assets through the creation of indestructible records within publicly accessible ledgers. This capability is particularly powerful in a world where assets, particularly digital assets, are infinitely reproducible. Imagine having a small mark of authenticity on images, videos you see on the internet that verifies its authenticity, similar to how there is a logo on nike shoes or certificate of authenticity that comes with fancy watches. Such a technology can also enable sale of assets, the kind that I mentioned in the beginning of this essay. There are basically two types of NFT sales, one includes an underlying asset with the NFT merely acting as a method to verify the authenticity of the said asset while the other involves the sale of the NFT exclusively.
The first one is easiest to understand since the underlying asset primarily determines the price and the NFT is just a cool way to verify the ownership as well as potentially distribute benefits. For instance, an investor paid ~$200k to purchase a segment of the digital monaco racetrack in the F1 delta time video game, the NFT representing the piece of the digital track allowed the owner to receive a 5% dividend from all of the races that take place on it including entry fee tickets to this digital track. This is a great example in which the NFT facilitated the purchase of a digital asset whose value is determined by the popularity of the game as well as the revenue that could be generated from the games on the track. In this case the NFT is merely serving the same role that a property deed plays in the real world. This is analogous to the Beeple artwork sale that pushed NFTs into the public spotlight, over the last few weeks, after being sold for ~$69 million dollars at a Christie’s auction. Reminder, NFTs by itself didn’t push up the price in this situation; the value really came from the ownership of the artwork and the NFT was simply used as a way to verify that ownership. If the new owner was interested they could license out this artwork and make money off it because they own it.
The second type of NFT sale is where things get a bit weird since only the NFT is being sold and the buyer gets nothing other than a digital token. A great, possibly ridiculous, example of such a sale is the nyan cat gif that was sold for a few hundred thousand dollars. The NBA has had massive success with the rollout of their own similar NFT program that allows fans to purchase tokens related to famous clips throughout the game’s history. There are several other similar sales one can find in NFT marketplaces that have cropped up over the last few months. The really interesting part of such sales is that the purchaser of the NFT does not have any rights over the digital asset, they can’t license it out, control its use or even use it themselves for commercial applications. So, how does this make sense? Where is the value in all of this? Well, the best way I make sense it it is by comparing it to collectible trading cards that feature a particular player; if you own a card even ones that might be worth millions of dollars you don’t own any rights to that player, you merely own a physical, cardboard rectangle, that people think is cool. However, even when NFTs are viewed like this, they differ from things like trading cards in a crucial way, unlike physical entities that need to be kept in a secure location, insured or protected from damage, NFTs exist digitally and don’t suffer from any such issues.
We are still in the very early days of NFTs and it’s already finding several interesting use cases with a few examples being; (a) Tokens to new kinds of digital collectibles like CryptoKitties and CryptoPunks, (b) Tokenization of digital real-estate in virtual worlds like Decentraland and Cryptovoxels, © Enabling a thriving digital art ecosystem in which the copyright of the artist is protected while their artwork is monetize in several ways, (d) Tokenizing traditional collectible items such as trading cards, stamps, coins or even shoes. While these use-cases are all really interesting I am personally much more interested to see NFTs being used in two other specific situations. The first one would be the tokenization of Electronic health records which I believe would resolve several issues with the existing approach. In addition to increasing security, ensuring authenticity, health records as NFTs would enable patients to own their data while also controlling how it is shared, viewing who is accessing it and maybe even licensing access to it to produce economic gain for themselves. The second is the use of NFTs to track samples and experiments. Specifically, the successful execution of clinical trials involves coordinating samples and experiments conducted by different people, often across geographically separate locations. One of the main challenges there is the complete traceability along the entire chain of custody of samples, and experiment, while maintaining a high level of data integrity and security. In both these situations NFTs can be applied to what I believe would be wonderful results. It also helps a lot that the market for both these applications could be in the multiple billions dollars.
Disclaimer:AG is part of the junior faculty at MIT, he is also co-founder of Palamedrix as well as involved in a few other stealth startups. The views and opinions expressed here belong solely to AG and shouldn’t be attributed to any organizations he work for or interact with.
Originally published at https://nanothoughts.substack.com.