Over the past few months, NFTs have taken the finance and art worlds storm. Recently, a NFT for a digital art piece created by Beeple sold for $69.3 million, a record auction price for digital art. Still, many misunderstand NFTs and how blockchain technology works. Lead Analyst Jeremy Moses provides a crash course in NFT understanding:
- What is an NFT?
- How do NFTs work?
- What are NFTs used for?
- How is the art market affected?
- What other industries stand to benefit from the rise in NFTs?
- What, if any, are the drawbacks?
Understanding NFTs
NFT stands for “non-fungible token”. “Non-fungible” means that they are unique and cannot be replaced with something of equivalent value.
How do NFTs work?
NFTs are mostly part of the Ethereum (ETH) blockchain, which is a cryptocurrency. However, cryptocurrencies, such as ETH coin, are supposed to be fungible — consider how one dollar is equivalent to another dollar. Unlike ETH coin, NFTs contain extra bits of information that make them distinct. In this regard, NFTs are more akin to a one-of-a-kind trading card or painting.
What are NFTs used for?
NFTs are used as a certificate of authenticity backed by blockchain technology. They can be used for anything digital, but most of the excitement and hype around NFTs are around their usage to sell digital art. NFTs are unique in that they are able to provide a form of ownership of a piece of digital media, even as the actual file itself can be freely copied and distributed.
NFTs in practice
NFTs have rapidly provided a windfall for companies and individuals in the Art Dealers industry, as they provide a way to have auctions and provide ownership for digital art, previously a more problematic proposition. Additionally, as NFTs can be used for anything digital, operators in the E-Commerce & Online Auctions industry also have a chance to benefit from the rapid boom in this digital commodity.
Companies in the Data Processing & Hosting Services industry can also benefit from the boom in NFTs, as blockchain requires a large amount of computational and storage power. Additionally, NFTs are financial assets with the potential for rapid returns, providing opportunities for companies in financial industries seeking high-growth assets, such as the Private Equity, Hedge Funds & Investment Vehicles industry.
There’s always a trade-off
The so-called “proof-of-work” blockchains, which are what are primarily used for NFTs, run a complex series of computational problems to prove authenticity. This requires high energy inputs and release a significant amount of carbon emissions, leading to criticism regarding the environmental impact of this digital commodity.
Some NFT marketplaces have responded by offering the option of contributing to carbon offset programs. There are also alternatives to the dominant “proof-of-work” blockchains currently used by Ethereum. Such alternatives, including “proof-of-stake” models, would have a smaller carbon footprint. These models are able to create proof of authenticity by having users contribute small amounts of cryptocurrency as a “stake”, rather than through the computationally-intense calculations that “proof-of-work” models use. Additionally, companies that run blockchain operations may try to purchase more electricity from industries that produce renewable energy, such as the Wind Power and the Solar Power industries.
Some good points, some bad points
NFTs present a unique opportunity for revenue growth for a wide variety of industries. However, companies and individuals seeking to get involved in the NFT market will likely need to monitor backlash due to the environmental impact of these assets, along with the inherent high risk of a relatively novel financial instrument.
