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1DT Explorer: Non-Fungible Tokens

Gunnar Jaerv
Gunnar Jaerv 8 March 2021

One of the biggest selling points for tokenization on the blockchain is the fungibility of tokens.

Fungibility means like-for-like interchangeability: a buck’s a buck; a Euro is the same, for all intents and purposes, as any other Euro. Buildings and artworks can be converted into tokens which can then be exchanged easily because of this fungibility (as well as other, related issues like portability).

So at first glance the concept of deliberately non-fungible tokens is counter-intuitive. In fact, they represent a new form of value authentication on the blockchain.

What is a Non-Fungible Token (NFT)?

Non-fungible tokens are tokens that aren’t interchangeable like for like. They’re one-offs. The point is that they serve as a certificate of validity. A token is a representation of a record of ownership or provenance. In this case, you can think of a non-fungible token as less like a dollar bill and more like a deed. Deeds have standard form, just like cash (and like digital tokens too) but they aren’t one-for-one interchangeable. You could think of NFTs as being like your driver’s license — again, state-issued in a standard form, but definitely not interchangeable with anyone else’s.

Or you could think of them like game cards. Card games like Magic: The Gathering and Pokémon are hugely popular, and not just in playgrounds. Rare cards are worth thousands. But the card is just a piece of cardboard; stealable, damageable, vulnerable. You could convert it into a token — a certificate that says you have the card. You could replicate the card’s physical appearance and keep the real card in a safe. But then, who knows for sure if you have the real thing or not? You’d need a trusted intermediary to sign the certificate, an inspection regime to make sure you didn’t take out the certificate then sell the card, and so on.

Imagine these cards being digitised, and the problem moves away from a specialized collector’s market and begins to affect the actual game. How can you play Pokémon when, rather than catching ‘em all, you can just effortlessly and endlessly replicate them? That’s the big problem with any kind of scarcity online: the cost to replicate almost anything is near-zero and distribution costs are also extremely low. It also erases the ‘one-of-a-kind-ness’ and historicity that we associate with valuable or important items, like artworks. A highly-accurate reproduction of the Mona Lisa is easily available online, but if the real thing were endlessly replicated, wouldn’t that change how we feel about it? (To say nothing of eliminating its market value.)

That’s where NFTs come in. NFTs are tokens, built the same way as other tokens; in fact, one popular token standard, ERC-721, was built for CryptoKitties. (It’s now been joined by protocols including ERC-1155 and ERC-998.)

We’ve been talking about collectible cards and other relatively trivial types of value for a reason; among the first NFTs to gain traction, in 2017, was CryptoKitties. CryptoKitties was “the world’s first blockchain game”, allowing users to collect and breed rare cats using a custom token protocol. Each CryptoKitty was a nonfungible token — unique, non-replicable, indestructible, and transferable only with the user’s permission. The craze briefly took off, and an estimated $7 million dollars was spent on CryptoKitties, with the most expensive sale being a single CryptoKitty going for $140,000.

Since 2017, the world of nonfungible assets has developed rapidly. Modern NFTs are used to create digital scarcity and verify ownership and provenance.

What are the likely use cases for NFTs?

The gaming and arts industries show the first major use cases for NFTs. Let’s look at gaming first.

In-game economies are huge. Many MMORPGs have player numbers that would rival the populations of countries — World of Warcaft has over two million players, more than the population of Estonia — and their internal economies would put smaller national economies to shame too. Players perform work in-game — mining for gold, fighting enemies, or building and selling trade items — in return for in-game money. In some cases, they also locate and sell scarce or unique objects in the game. There are people who run businesses in which they employ others to work full-time at this.

As such, ownership of ingame assets encounters similar problems to those we’re familiar with in the real world. Who really owns it? Is it what they say it is? Is our deal final? Trust and accurate information can be in short supply, just as in the real world; and there’s a clear use case for NFTs here.

Imagine a player who spends several hours mining for gold in a MMORPG. They don’t necessarily enjoy this for its own sake — it’s what gamers call “grinding”, working at tasks to acquire new abilities and equipment they can use to play game storylines or go on quests with friends. In fact, this is pretty analogous to work in the real world! The resulting “gold” may only be digital but it represents several hours of the player’s time and is the key to her ambitions and plans; she doesn’t want to lose it. When she buys something rare and useful in the game, the purchased item can be minted into an NFT and held securely. The NFT can be sold, in some cases for BTC.

In the arts, increasingly-digital artworks have a fungibility problem their real-world counterparts don’t face. A copy of the Mona Lisa isn’t the same as the real thing: it’s a photo or a scan or a print, sometimes in incredible quality; but the brushstrokes and the oil and the canvas aren’t there. A copy of a digital artwork can be identical to the original in every way, down to the pixel. At the same time, some digital images suffer seriously by being reproduced in physical substrates. They may be 3D, interactive, or too highly-detailed to survive the process of transfer to a conventional print. So how can creators maintain scarcity and ensure they actually get paid for their work?

NFTs provide a solution. The artwork itself can be minted as an NFT, meaning it’s encrypted and only accessible to the verified owner. It’s transferable, so it can be sold, but ownership is verified by consensus on the blockchain so it’s as extremely secure as any other blockchain-based asset.

This isn’t a potential use case, and neither is it restricted to technically-innovative minor artists. Grimes sold $6 million worth of digital art as NFTs in a series of 10 pieces on February 28 this year; Chris Torres’ remastered GIF of the infamous Nyan Cat meme fetched $500,000 at auction just four days earlier. NFT art marketplaces like SuperRare offer unique pieces across price points.

NFTs in digital worlds

We spoke earlier in this piece about MMORPGs, online digital worlds that are used for everything social. Users can adopt the identities they want, fly in space, fight dragons and visit exotic locations; but they can also socialize, trade and build. These latter activities might be the real draw.

Social games like these seem to offer two possibilities: worlds where the world’s internal economy uses NFTs for security for scarce items and for extra-game trading and ownership, and worlds where actual real-world business gets done.

Let’s take the first possibility. Blockchain-based MMORPGs are already on the market, though their user bases are dwarfed by the big hitters like World of Warcraft and Second Life.

Second Life has been on the market since 2003, and it’s not technically a game: the social and building aspects of the experience are paramount and there are no villains, quests, or conflicts built into the world. What there is, is an in-game currency that users can earn, use to buy and sell things in-game — and exchange for real-world currencies. At the moment, a thousand Linden Dollars can be exchanged for about US$3.13, and vice versa.

What’s more interesting to us is that the in-game market is alive with assets and items that people will pay high prices in Linden Dollars for.

You can buy jetskis, L trains and yachts, complex avatar modifications and an enormous range of other accoutrements. There’s even a thriving trade in-world in digital antiques, and the Second Life economy has boomed since COVID partially closed the real one. Inside Second Life, NFTs are used to verify authenticity and ownership — but they’re managed by Second Life, not a blockchain.

In newer, currently smaller worlds, though, NFTs are a much bigger deal —and they’re blockchain-oriented from the start. NFTs from these virtual worlds are among the top 25 NFTs traded, and include Decentraland, Cryptovoxels, and the site of the most NFT trading activity, SANDbox. Some online virtual worlds, like MegaCryptoPolis, take the idea of buying land and farming to the blockchain and encourage users to stake and farm yield in-world.

Which brings us to using virtual worlds for real business. This has been happening for a long time; WoW and other MMORPGs are favorite hangouts for political dissidents, gray-area and criminal actors of all kinds, and people who — for whatever reason — want an accessible yet hard-to-trace on/off ramp for digital assets, exchanging BTC for Linden Dollars in-world before cashing out in USD.

But what if these virtual worlds could become virtual business environments? Consumers already contrast virtual worlds with standard online experiences, saying, “Buying on Amazon is not the same as going into a shop and looking at clothing, and you could do that on Second Life.”

What if businesses could transport a host of information, time, and personal involvement—centric activities into a Second Life-style virtual environment?

“A corporate executive spends the morning exploring a tradeshow floor, viewing videos and presentations on new products and networking with companies, vendors, and other attendees from around the world. In the afternoon, they teleport to the grand auditorium for a keynote presentation, followed by a post keynote breakout session in which the executive plans to present their latest corporate findings to a stakeholder audience. As they teleport into this new room, they are greeted by a host of avatar stakeholders, including the top 10 CEOs to whom they hope to present. Grateful for everyone having the time to meet, the executive’s avatar begins presenting, using collaborative tools.” -Deloitte

This idea is far from outré — it’s being proposed by Deloitte, not by a wild-eyed techie with a vision. Other use cases include academic and professional conferences, learning, sports spectatorship and more (potentially including financial activities in an official capacity too).

There are challenges to the idea. Some are about adoption; many workers are openly or covertly resistant to new tech in the workplace and companies are often constrained by cost, risk or legacy solutions. Others are technical: large gaming programmes are currently required for many virtual worlds, and connection speeds need to be high to make the whole experience worthwhile.

(It’s also just one potential solution to an increasingly connected world that’s facing travel restrictions for quite a while; Microsoft has plans for holographic teleconferencing, for instance.)

And the addition of a blockchain layer poses the scalability and speed problems that major blockchains like Ethereum are still in the process of solving.

But once they do, NFTs could become a reality as personal or organizational business signifiers and contracts in business-oriented, blockchain-based virtual worlds. In the meantime, they’re among the fastest growing classes of digital assets and a major target for DeFi.

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