Introduction

Cryptocurrencies, utility tokens, security tokens, privacy tokens… digital assets and their classifications are multiplying and evolving right alongside cryptographic and blockchain technology.

Non-fungible tokens (NFTs) are one of the fastest-growing sectors in the crypto industry. In this guide, we explore what they are, how they work, and how they're being used.

What is Nonfungible token?

A non-fungible token (NFT) is a type of cryptographic token on a blockchain that represents a unique asset. These can either be entirely digital assets or tokenized versions of real-world assets. As NFTs aren’t interchangeable with each other, they may function as proof of authenticity and ownership within the digital realm.

Fungibility means that an asset’s individual units are interchangeable and essentially indistinguishable from each other. It’s this information that makes each NFT unique, and as such, they **cannot be directly replaced** by another token. They cannot be swapped like for like, as no two NFTs are alike. Banknotes, in contrast, can be simply exchanged one for another; if they hold the same value, there is no difference to the holder between, say, one dollar bill and another.

Bitcoin is a fungible token. You can send someone one Bitcoin and they can send one back, and you still have one Bitcoin. (Of course, the value of Bitcoin might change during the time of exchange.) You can also send or receive smaller amounts of one Bitcoin, measured in satoshis (think of satoshis as cents of a Bitcoin), since fungible tokens are divisible.

What if we could create digital assets similar to Bitcoin but instead add a unique identifier to each unit? This would make each of them different from all the other units (i.e., non-fungible). Essentially, this is what an NFT is.

How do NFTs work?

Tokens like Bitcoin and Ethereum-based ERC-20 tokens are fungible. Ethereum’s non-fungible token standard, as used by platforms such as CryptoKitties and Decentraland, is ERC-721.

Non-fungible tokens can also be created on other smart-contract-enabled blockchains with non-fungible token tools and support. Though Ethereum was the first to be widely used, the ecosystem is expanding, with blockchains including Solana, NEO, Tezos, EOS, Flow, Secret Network, and TRON supporting NFTs.

Non-fungible tokens and their smart contracts allow for detailed attributes to be added, like the identity of the owner, rich metadata, or secure file links. The potent of non-fungible tokens to immutably prove digital ownership is an important progression for an increasingly digital world. They could see blockchain’s promise of trustless security applied to the ownership or exchange of almost any asset.

As is the challenge of blockchain to date, non-fungible tokens, their protocols and smart contract technology is still being developed. Creating decentralized applications and platforms for the management and creation of non-fungible tokens is still relatively complicated. There is also the challenge of creating a standard. Blockchain development is fragmented, many developers are working on their own projects. To be successful there may need to be unified protocols and interoperability.

Popular projects using NFTs and crypto collectibles

Many different projects already use NFTs as collectible and tradable items. Let’s go through a selection of some of the most popular ones.

CryptoPunks

Dating back to 2017, CryptoPunks is one of the earliest NFT projects in existence. Created by development studio Larva Labs, CryptoPunks are a series of 10,000 24x24 pixel art images depicting "punks" with randomized attributes, including gender, headgear and eyewear.

Originally released for free, CryptoPunks now command huge sums; at time of writing, the cheapest punks are on offer for six-figure sums, while the rarest punks, including aliens, apes and zombies, sell for millions of dollars. Even payments giant Visa has got in on the action, snapping up CryptoPunk #7610 as part of its collection of "historic commerce artefacts".

Bored Ape Yacht Club

Like CryptoPunks, Bored Ape Yacht Club is a series of NFT avatars—in this case, taking the form of disinterested-looking apes. And, also like CryptoPunks, there are 10,000 of them, each one has a randomly generated set of attributes, and a thriving community has sprung up around them.

Perhaps most importantly, owning a Bored Ape NFT makes you eligible for drops of additional NFTs, such as Bored Ape Kennel Club (a series of dog NFTs), and Mutant Ape Yacht Club (a series of, er, mutant apes). Think of it as a ticket to an exclusive club that offers perks for members.

Axie Infinity

NFT collectibles like CryptoPunks and Bored Apes are one thing, but non-fungible tokens have a wide variety of applications—one of which is to represent digital objects in video games. And the biggest NFT video game around right now is Axie Infinity, which became the most traded NFT collection ever in Q3 2021, with trading volumes over $2.5 billion.

The game itself is a Pokémon-style affair that sees you collecting cute monsters called Axies, pitting them against each other in battles, and breeding them to create new Axies. The game's "play to earn" mechanic has seen players in countries like the Philippines making a living from breeding and trading Axies. However, the game itself has a steep learning curve, and with individual Axies trading for hundreds of dollars, assembling a team to get started isn't cheap.

Decentraland

Decentraland is a decentralized virtual reality world where players can own and exchange pieces of virtual land and other in-game NFT items. Cryptovoxels is a similar game where players can build, develop, and exchange virtual property.

The Future of NFTs

The NFT space grew explosively in 2021, with trading volumes in Q3 hitting $10.67 billion, according to DappRadar—a year-over-year increase of over 38,000%. In August, top NFT marketplace OpenSea recorded trading volume of over $75 million in a single day—more than its entire trading volume in 2020.

Meanwhile, NFTs began to trade hands for eye-watering sums. In March 2021, digital artist Beeple sold a single NFT artwork for $69.3 million at auction, propelling him into the ranks of the top-selling living artists overnight. CryptoPunks, Bored Apes and Art Blocks traded hands for millions of dollars. Scenting a new market, venerable institutions such as auction houses Christie's and Sotheby's have embraced NFTs, hosting sales and (in the latter's case) launching its own NFT platform. Art galleries wrestled with the thorny question of how to display digital artwork.

Non-fungible tokens add potential to the creation of security tokens and the tokenization of both digital and real-world assets. Physical assets like property could be tokenized for fractional, or shared, ownership. If these security tokens are non-fungible, ownership over the asset is completely traceable and clear, even if only tokens representing part ownership are sold.

Further application of non-fungible tokens could be certification such as for qualifications, software licensing, warranties, and even birth and death certificates. The smart contract of a non-fungible token immutably proves the identity of the recipient or owner and could be stored in a digital wallet for ease of access and representation. One day, our digital wallets could contain proof of every certificate, license, and asset, we own.

Closing thoughts

By representing physical assets in the digital world, NFTs can be a vital part of the blockchain ecosystem and the wider economy.

The use cases are vast, and it’s quite likely that many developers will come up with new and exciting innovations for this promising technology.