Building Web3: Non-Fungible Tokens (NFTs)

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Under the Hood: What Are NFTs?

At their simplest, NFTs are units of data stored on a blockchain. And today, the primary blockchain for NFTs is the largest smart-contract-enabled blockchain in the world: the Ethereum Network.

The original standard for representing NFTs on the Ethereum blockchain was the ERC-721 token and the newer ERC-1155 token allows for the bundling of multiple fungible and non-fungible tokens into one smart contract. You can think of ERC-721 tokens as representing a single unique asset and ERC-1155 tokens as representing a unique class of assets; fully-fungible assets, by comparison, are represented by the ERC-20 token standard, for a single asset.

Ethereum, as a base layer for NFTs, has a powerful network effect: its size translates to the most security, the most users, and the most liquidity between platforms. But that size comes at a price: until the Ethereum network transitions to a Proof of Stake (PoS) consensus model, the power consumption and transaction costs of its Proof of Work (PoW) consensus model may be higher than most users and builders would like.

Some natively PoS blockchains, which have lower costs and faster transaction speeds but smaller user bases, have developed their own NFT ecosystems, but these come with their own programming standards and varying levels of interoperability with the Ethereum blockchain. Which blockchain platform becomes the dominant one for NFTs or whether a broader, multichain ecosystem develops remains to be seen.

NFTs work best with digitally native assets, functioning as a certificate of authenticity that’s publicly viewable on a transparent blockchain. Every time the asset changes hands, that information is logged on the blockchain, too, which creates an auditable form of provenance, whether for a piece of art or a title of ownership.

Combined with smart contracts that trigger when certain conditions are met, NFTs can be programmed to dispense royalties back to the previous owners of (or the original creator of) the NFT. Going further, NFTs can, themselves, be fractionalized, allowing collective ownership of a single asset.

“Whether you’re talking about a certificate, a deed, a title, or a copyright, it’s about authentication and ownership, and the possibility of transferring that ownership,” Dr. Ozair says. “These are big questions, and they’re the basis of NFTs.”

Critical Thinking: What NFTs Aren’t

It should go without saying that most collectibles-based NFTs, in their current state, aren’t a prudent investment. Even hardcore NFT enthusiasts expect an overwhelming majority of NFTs in the collectibles market to be close to worthless over the long term.

But the broader ideas of digital ownership and authenticity can also sometimes obscure the more technical limitations of NFTs: many of today’s NFTs aren’t nearly as permanent as their proponents claim them to be.

NFTs securely log ownership of a digital asset in a blockchain, but the asset itself is often stored off-chain. A startling number of today’s NFTs are cryptographically secure signatures assigned to very non-secure URLs. Those URLs may link to a web-hosted digital file, but that means that the associated NFT remains at risk of link rot: if the server hosting the link to the digital file goes dead, the NFT associated with it goes dead, too.

This system of off-chain storage began as a shortcutting method to avoid overwhelming the blockchain with massive amounts of data and it’s been maintained out of the same concerns, along with a mix of laziness and greed. As the hype dies down and the space matures, it’s unlikely that engineers will take the same technical approach to NFTs, but for the moment, it’s very much buyer beware.

“Today, many people are just creating an NFT and launching it,” Dr. Ozair says. “But you have to think very carefully about the business aspect, about the system structure, about what goes into the code, and about how the code is executed. If you want to apply NFTs to sophisticated business use cases, it takes a lot of work.”

NFTs are at the cutting edge of blockchain applications, and critical questions remain around possible regulation, fraud, and energy inefficiency. For the layperson, NFTs may still be too complex to be worth the hassle of further investigation. But for an engineer, removed from the fog of hype and speculation, NFTs present an intriguing new toolkit to help build out the future of Web3.

Beyond the Hype: The Future of NFTs

The use cases for NFTs have already moved well beyond the ownership of static pieces of art. Gaming is a natural evolution: Fortnite players spent an estimated $50 million on a single set of ‘skins’ for their characters in May of 2021, and the adoption of NFTs in gaming allows users to own, trade, and sell their digital assets.

Even after a marketwide cryptocurrency selloff in May 2021, NFT-powered gaming platform Axie Infinity is boasting eye-watering growth figures: over 300,000 daily active users (DAUs) log on to Axie Infinity every day, and contribute to what is now one of the largest Discord servers in the world.

But what happens when NFTs are put to work in the traditional business world? That’s the question that IBM and IPwe are attempting to answer by using NFTs to create a transparent, liquid market for intellectual property and patents. Notably, IBM is the world’s largest holder of patents, and representing those as NFTs would allow them to be more efficiently categorized, transferred, programmed, fractionalized, and even borrowed against.

Currently, only 2 to 5 percent of the intellectual property in the patent market is officially valued, combining to a total of $180 billion—IPwe believes an NFT system could unlock what amounts to a trillion-dollar market.

NFTs are an incredibly young technology and their biggest applications are still being sussed out. But divorced from speculations about price and markets, engineers can use NFTs to tackle major questions of the digital era, particularly around the issue of what Ethereum creator Vitalik Buterin calls the most important scarce resource: legitimacy.

“I think the ultimate utility for NFTs will be in digital identity,” Dr. Ozair says. “With every transaction, we need to authenticate who we are and today, there are all kinds of fraud associated with that. But NFTs have the potential to create real authenticity around personal identity, which can be used for any type of transaction.”

In June of 2021, Sir Tim Berners-Lee, inventor of the World Wide Web, sold an NFT representing the source code of his creation, calling NFTs “an ideal way to package the origins behind the web.”

To the layman, that source code is little more than a string of inscrutable words and symbols, but to many engineers, it represents the birth of several generations’ worth of possibility. NFTs are another iteration of that possibility and their best uses are just beginning to be discovered.

“When it comes to something like blockchain technology and NFTs, I believe that almost anything you can imagine, can happen,” Dr. Ozair says. “So if you have an imagination and you’re enthusiastic about innovation and technology, just run with it.”

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