Non-fungible Tokens (NFTs)

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Contents

Background

What is Blockchain?

Short and sweet, a blockchain or, Distributed Ledger Technology (DLT), is a type of database. It is a database that chains together and stores encrypted blocks of data then to form a chronological ledger which cannot be altered. The ledger or, also referred to as an asset, is decentralized and uses cryptographic hashing, providing instant access to the public’s eye. The ledger tracks and stores changes made to it which aids in establishing it as a credible and reliable technology. Furthering this notion, it is also near impossible to alter the history of the ledger.

A blockchain collects information together in groups, or as blocks, that hold sets of information. Blocks have certain storage capacities and, when filled, are chained onto the previously filled block, forming a chain of data known as the “blockchain.” All new information that follows that block is compiled into a newly formed block that will then also be added to the chain once filled[1].


How does Blockchain work?

A blockchain is comprised of three main concepts:
Composition of a Block

Blocks

Every chain consists of multiple blocks that contain information about transactions:

  1. The data about the transaction within the block.
  2. When a block is created, a randomly generated nonce is created which is a random whole number that can only be used once. This 32-bit nonce is used as an authentication protocol.
  3. Attached to a nonce is a 256-bit number wedded hash which helps to determine valid transactions[1].

Miners

Through the mining process new blocks on the chain are created from miners.

In each blockchain, every block is authenticated with its own unique nonce and hash. Every block also references the hash of the previous block in the chain which it is attached to. This goes to show that the mining process is extraneous and takes measures to ensure each transaction is valid and authenticated. Miners must use special software to validate transactions by solving complex math problems that initiate a nonce that prompts an accepted hash. This process is complicated as the nonce is only 32-bits and the hash is 256-bits. This means there are nearly four billion potential combinations that must be mined before the correct match is mined. Once the correct match is mined, the miner is said to have found the “golden nonce”, and the block is then added to the chain.

It can be seen that blockchain has been created to achieve utmost security and validity. Once a block has been created, it cannot be taken back. Changing a block that has already been mined requires re-mining of that block, and every other block that comes after it. This makes it almost impossible to manipulate blockchain technology. A miner is rewarded financially when a block is successfully mined. This occurs when the block is accepted by all of the nodes on the network[1].

Nodes

Decentralization is one of the most important concepts in blockchain technology. The blocks are not owned or controlled by any one computer or organization. Instead, the blocks are a part of a distributed ledger through the nodes connected to the chain. The nodes can be any electronic device that maintains an updated copy of the blockchain and ensures the network is fully functional.

In order to achieve trust and verification, every node has a unique copy of the blockchain. Any newly mined block has to be algorithmically approved for the chain to be updated. Blockchains are completely transparent, which means that every action in the ledger can be checked and viewed. Every participant who is involved in a transaction is given a unique alphanumeric identification number that shows their transactions. The key point here is that the identity is private.

Blockchain uses extensive checks and balances in order to maintain trust and integrity among users. There is no need for a financial intermediary or government regulation who must ensure the transactions are valid or trustworthy, the whole system in of itself is built on trust[1].


Types of Blockchain

Public Blockchain

One of the main problems with centralization is security and transparency. Public blockchain solves this issue by using a distributed ledger that cannot be altered or manipulated. Using a peer-to-peer network, the information is stored across different locations. Proof of work and proof of stake are two agreement methods used to authenticate and verify the data.

Anyone with internet access can access the public blockchain to become an authorized node. This is allowed due to the non-restrictive and permission-less nature of the public blockchain. Once authorization is complete, the user can access past and current blockchain records and conduct mining activities. Once a transaction is validated, it cannot be changed or manipulated. Due to the open source nature of the code, users can also search for any bugs and propose changes to make improvements to the network.

The advantages of this are increased trust, independence, and transparency. The disadvantages are potential performance issues, security threats, and scalability. The blockchain technology has features that are applicable to industries far reaching cryptocurrency alone[2].

Private Blockchain

Blockchain
A private blockchain operates just like a public blockchain with the use of peer-to-peer connections, decentralization, and validation. However, private blockchains are controlled by a single entity. These private blockchains are typically controlled by a company or organization within a smaller network where access to the blockchain is limited and private. These private blockchains are also known as permissioned blockchains or enterprise blockchains since invitations must be granted in order to join the network.

Increased access control, enhanced performance, and privacy are some of the main advantages. Some of the disadvantages are authenticity and trust since the blockchain is private. Users of such private blockchains are typically supply chain companies and asset ownership organizations[2].

Hybrid Blockchain

A hybrid blockchain combines elements of both private and public blockchains. It lets organizations set up a private, permission-based system alongside a public permissionless system, allowing them to control who can access specific data stored in the blockchain, and what data will be opened up publicly.

Typically, transactions and records in a hybrid blockchain are not made public but can be verified when needed. Confidential information is kept inside the network but is still verifiable. Even though a private entity may own the hybrid blockchain, it cannot alter transactions.

When a user joins a hybrid blockchain, they have full access to the network. The user's identity is protected from other users unless they engage in a transaction. Then, their identity is revealed to the other party.

Some advantages to this are increased access control, performance, and scalability. Disadvantages are transparency and upgrading. Some uses of hybrid blockchains include but not limited to medical records and real estate[2].

Consortium Blockchain

The fourth type of blockchain, a consortium blockchain, is similar to a hybrid blockchain in that it has private and public blockchain features. However, it is different in that multiple organizational members collaborate on a decentralized network. Essentially, a consortium blockchain is a private blockchain with limited access to a particular group, eliminating the risks that come with just one entity controlling the network on a private blockchain.

In a consortium blockchain, the consensus procedures are controlled by preset nodes. It has a validator node that initiates, receives and validates transactions. Member nodes can receive or initiate transactions.

Some advantages to this are increased access control, scalability, and security. One disadvantage is transparency. Some uses of consortium blockchains include but not limited to banking, research and supply chain[2].


Where is Blockchain used?

Blockchains are not only effective at storing data on monetary transactions, but they also have the capability of storing data on other types of transactions. Some of the main areas upon which blockchain is being implemented and used currently are in banking and finance, currency, healthcare, property, smart contracts, supply chains and voting.

Some major companies that have already incorporated blockchain into their businesses include Burger King, KIK, IBM, Walmart, Microsoft, and many others. For example, FedEx, who is one of the world’s biggest logistics management companies and handles billions of dollars worth of cargo every year. FedEx has now become the first big shipping giant to incorporate Blockchain Technology into their supply chain management. So far, they are using Blockchains to track high-value cargo and are soon planning to extend the functionality to almost all their shipments. In addition to that, they are also helping to develop the Blockchain based industry standards for supply chain logistics establishing themselves as pioneers in this field[3].

Advantages of Using Blockchain

One advantage of blockchain is the accuracy of the chain. Due to the fact that transactions on a blockchain network are approved by thousands of computers, this significantly reduces the amount of error in the information. The next advantage is cost reductions. There are cost reductions inherent in the technology for both the consumer and vendor. For example, to send an e-transfer through a bank, you may incur a transaction fee. Or if you are a vendor and someone bought a product you were selling and paid for it on their credit card, you, the vendor, would incur a fee from visa for processing the transaction. Blockchain reduces the overall costs associated with transactions. Next we have decentralization. Through decentralization, the risk of information being tampered with reduces dramatically. In fact it's virtually impossible to tamper with. Next is efficient transactions. Transactions placed through third parties often incur significant time delays, often days long, whereas through a blockchain can be verified in a matter of minutes. Another advantage to blockchain is transactions are private as blockchains do not reveal any personal identifying data. The next advantage is secure transactions. Transactions are secured and due to inherent characteristics of the chain it makes it extremely difficult to change information about transactions. Finally, we have the advantage of transparency, where most blockchains are open-sourced software and information is available for everyone to see. Also, anyone can use the technology granted they have the means to do so[4].

Disadvantages of Using Blockchain

Although blockchain technology has many benefits, there are still some pitfalls which appear to constrain its adoption. One disadvantage is the technological cost. It costs thousands of dollars to purchase the equipment in order to mine cryptocurrency where through the process transactions are validated. Moreover, these computers draw a ton of power driving up electricity costs for those who mine. Next is the speed inefficiency. Bitcoin for example can only handle around 7 transactions per second whereas visa can process about 24,000 transactions per second. Illegal Activity is another disadvantage for blockchain because of the confidentiality aspects it boasts. Through cryptocurrencies like Bitcoin, illegal activities may be conducted such as the purchase of drugs on the dark web while being for the most part untraceable. Lastly, we have regulation. There are concerns of government regulation in the crypto space however, due to the wide adoption of the tech it would become near impossible[4].


What is Cryptocurrency?

Cryptocurrency or for short “crypto” can be used as a fiat currency for the purchase of goods or services. But crypto differs from fiat currency in many ways. To start with, it is a decentralized digital currency which makes it trustworthy and it is considered to be more secure than fiat as it uses cryptography as a means of security. The operation of most cryptocurrencies does not require a central institution (such as a bank or government), but runs through a distributed ledger technology called blockchain. Cryptocurrency has a clear monetary policy, whether it is a fixed token limit or allowing the creation of new tokens according to predetermined rules[5]. Some businesses have issued their own cryptocurrencies, often called tokens, and their purpose is to be specifically traded for the goods or services that the business offers. A good comparison would be casino chips that are used within the location of the casino[6].

History of Cryptocurrency

David Chaum
Wei Dai

Before Bitcoin

The history of digital money began with the cryptographer David Chaum. In 1983, he used encryption to develop a system called eCash that was used mainly for micropayment from the US banks in the late 90s. 12 years later, Chaum developed another system called Digicash, that used encryption to hide the information of economic transactions, thus making them confidential. However, in 1998, the term "cryptocurrency" appeared for the first time. That year, Wei Dai used a cryptographic system in an attempt to develop a new payment method that is decentralized[7].

After Bitcoin

In 2009, Bitcoin was launched, which is the first cryptocurrency that is based on blockchain. The developer/s of Bitcoin are still unknown and could be an individual or a group of people that go under the pseudonym “Satoshi Nakamoto”. Until today, Bitcoin is the most successful and popular cryptocurrency. But many more competitive coins were developed, and are still being developed, following the protocol and design of Bitcoin. These other cryptocurrencies are called “Altcoins” and some examples include[7]: -Ethereum (ETH); -Litecoin (LTC); -Cardano (ADA); -Polkadot (DOT); -Bitcoin Cash (BCH); -Stellar (XLM) and many more. As a result, nowadays there are numerous cryptocurrencies and the interesting part is that they are all based on the principles of the first coin, namely Bitcoin. Although the total value of all cryptocurrencies is constantly chaining due to its high volatility, it is currently exceeding one trillion dollars, from which Bitcoin represents more than half. This illustrates the significance of Bitcoin.


Cryptocurrency categorization

In general, cryptocurrencies could be categorized as coins and tokens.

Coins

Coins vs. Tokens
Coin is a currency that is native to its own blockchain. It is a virtual currency that can be used as a payment method, and it is exclusively traded in encrypted currency through its own blockchain. Some cryptocurrencies, such as Bitcoin, have a limited supply. Therefore, its value is affected by the basic principles of supply and demand. The Bitcoin protocol also builds and supports several newer cryptocurrencies. A good example is Litecoin, which is one of the most popular altcoins[8].
Altcoins

The term "Altcoin is a combination of the two words alt” and coin” where alt stands for alternative and coin for cryptocurrency. In general, Altcoins are cryptocurrencies that are not Bitcoin. They share characteristics with Bitcoin, but are also different from Bitcoin in many ways[9]. For example, some altcoins use different consensus mechanisms to generate blocks on the blockchain or verify transactions. Or, they differ from Bitcoin by providing new or additional features (such as smart contracts or low price fluctuations).

Tokens

The main purpose of cryptocurrency tokens, although they can be used as a payment method, is used in the broader ecosystem of the blockchain platform. In many cases, cryptocurrency tokens are created to promote user interaction and innovation within the online community. Blockchain tokens can be issued as a form of reward for participating in activities within the blockchain platform. The most common cryptocurrency token platform is Ethereum[8]. (Typically, cryptocurrency tokens created with the Ethereum platform are called ERC20 tokens, which can be stored and distributed between Ethereum addresses).

Regulation

In terms of regulation, the supply of cryptocurrency tokens is not set by a central agency or a government. The verification process of a transaction as well as performing and recording it using blockchain technology is done on a public ledger without the intervention of a third party. The problem with regulating Bitcoin and other cryptocurrencies is that they operate through P2P networks. Despite the usual government's success in regulating websites and networks there are numerous cryptocurrencies which makes it more difficult. The main difference with cryptocurrency is that the transaction can be done through an exchange, or you can use your cryptocurrency wallet for direct trading. China decided to take a different approach by closing its own exchanges and escorting cryptocurrency miners abroad through land use regulations. But as expected, this did not have a huge impact on the price of cryptocurrencies. The first policy that the government could implement to regulate cryptocurrency is to tax any legal currency used to withdraw cryptocurrency. The main limitation is that this must apply to a specific coin and fiat currency, and the owner of a cryptocurrency can simply switch to another fiat currency to transfer the cryptocurrency and withdraw them. In addition, compared with traditional fiat currencies, many early adopters and hardliners prefer to use cryptocurrency as a medium of exchange for basic goods and services.

Currently, the Securities and Exchange Commission (SEC) which investigates investments include cryptocurrencies under their jurisdiction. Additionally, cryptocurrency also falls under the jurisdictions of the Commodity Futures Trading Commission (CFTC) and the Internal Revenue Service (IRS). As a result, cryptocurrency is subject to either income or capital gains tax[10].


How Cryptocurrency Works?

Cryptocurrency Transaction Process
Many cryptocurrencies are based on the blockchain technology of a decentralized network that records cryptocurrency transactions. This information is time-stamped and published to the ledger so that other blockchain stakeholders can verify every transaction and as a result it can never be changed. In order to conduct transactions on the blockchain, users agree to pay a small fee, which helps to ensure the security of the blockchain. Here is an example of a transaction: Suppose you want to send a small amount of Bitcoin to your friend. You use your Bitcoin wallet to create a transaction and request that Bitcoin be sent to your friend's wallet. After that you agree to pay a nominal transaction fee for the process. After submitting a transaction request, your transaction will be combined with other transactions in one block on the Bitcoin blockchain. The miner verifies the block and once the miner verifies the block, it is posted to the blockchain to complete the transaction. Through this process, cryptocurrencies can be sent to anyone around the world with relatively low transaction fees. Not only is the transaction typically completed in a few seconds or minutes, it also costs only a fraction of the fees that would be paid with traditional remittance services[11].

Cryptocurrency Mining

Cryptocurrency Mining Network
The building foundation of the high security of cryptocurrency lies in the verification process. When a blockchain transaction is created, it needs to be encrypted and verified for accuracy before it can be added to a block. Without this process being completed, the blockchain can’t continue adding transactions to the following blocks. This verification process is completed by miners. They use high computing power to solve complex mathematical equations needed for a transaction to be verified and added to a block. Usually, the first miner that comes to the right solution of the problem is rewarded with a small amount of cryptocurrency as a compensation for the service. This implies that miners gain cryptocurrency without actually buying it with real money, besides the costs they have for electricity and equipment[12].

The Reward Process for Miners

Conditions for Winning a Block
A miner is eligible to be rewarded with a quantity of cryptocurrency when 1MB worth of cryptocurrency transaction/s is verified. Theoretically, 1MB of transactions can be just one transaction or many. It depends on the amount of data that the transaction requires and takes to be verified. But verifying 1MB of transactions is not enough for a miner to receive a reward as there is another condition - the miner has to be the first to solve, or get the closest answer, to the mathematical problem. This requires a lot of computing power which is usually quite expensive. The whole process is also called proof of work[12].

Another Purpose of Mining

But Mining serves another purpose as well. It is the only way to release new cryptocurrency into circulation due to the reward that miners receive. Aside from the coins minted via the genesis block (the very first block, which was created by the founder), every single one of those cryptocurrencies came into being because of miners. In the absence of miners, Bitcoin as a network would still exist and be usable, but there would never be any additional cryptocurrencies[3]

Cryptocurrency Wallets

A crypto wallet is similar to a traditional wallet in the way that you hold money or other assets in them and are able to use those assets to transact. The way crypto wallets differ is that they are accessed online using a private key and transactions are sent to cryptographic addresses, both of which are unique to each wallet. There are three main types of crypto wallets: exchanges, hot wallets and cold storage[13] .

Exchanges

Exchanges operate similarly to banks because they hold a reserve of cryptocurrencies that users then pull from when they transact their crypto. There are many crypto exchanges available today with the most popular examples being Coinbase and Binance. Exchanges offer easy to use solutions for buying, exchanging and holding cryptocurrencies. For crypto beginners, exchanges are the easiest way to get started so they are the most popular method for people to store their crypto. However, there are downsides to exchanges. Every crypto exchange is targeted by hackers looking to steal cryptocurrency with many exchanges being the victims of theft. For example Binance had $40 Million of Bitcoin stolen in 2019, Coincheck lost $530 Million worth of crypto in 2018, and Mt. Gox, the leading crypto exchange at the time, was infamously shut down in 2014 after $450 Million worth of Bitcoin was stolen. Centralized Crypto exchanges also lose the essence of cryptocurrency’s original purpose because intermediaries have control over each account’s assets. Accounts could be subject to restrictions on trading and withdrawals at a company's discretion, which is the antithesis of decentralization[14].

Software Wallets

Software wallets comprise web wallets, desktop wallets and mobile wallets. All of these wallets are considered ‘hot wallets’ because they are connected to the internet. For example these wallets can be downloaded directly to your desktop, such as Daedalus for Cardano, or accessed through a Chrome extension, such as MetaMask for Ethereum. These wallets provide users with their own private key that gives them complete control over their funds and provides more security than exchanges. A private key should not be shared with anyone because it provides access to a wallet’s funds for transacting. Software wallets give better security than exchanges but still pose their own risks if your computer is infected with viruses or malware that could access your funds.

Cold Storage

Cold storage wallets are hard drives that generate a private key that are used to access the funds in the wallet. The most popular hardware wallets are Ledger Nano S and Trezor wallets that are made specifically to hold particular cryptocurrencies. Cold storage wallets are not connected to the internet and therefore have the highest degree of security. However, this makes them the most difficult to manage and transact with. It is more complicated to add and transact funds in cold storage so this method is best used for long term storage of assets.

Transaction Fees

Transaction fees of Proof of Work (PoW) cryptocurrencies like Ethereum and Bitcoin are based on the demand for block space at the time of transaction. When there is high transaction volume, users must pay more to ensure that miners will use their computing power to verify the transaction. In times of high volume this leads to fees that are too high for everyday transactions. In addition PoW networks rely on miners to outcompete each other to verify transactions on chain the fastest to receive a reward. This causes inefficiencies and limits transactions per second. Some networks, such as Cardano and Polkadot, adopted the Proof of Stake (PoS) protocol, which relies on a lottery system to determine who verifies transactions. PoS is more efficient and is easier to scale to more transactions per second, reducing costs of computing power.

The Ethereum network is adopting the PoS protocol with its ETH 2.0 upgrade to make the network more efficient and decrease transaction fees. ETH 2.0 is also implementing sharding and roll-ups, which allow many small transactions to occur off of the main chain on sharded chains. These smaller transactions are then all recorded on the main chain at once which is more efficient. These protocols on ETH 2.0 can potentially bring Ethereum from about 10 transactions per second up to over 100,000 transactions per second, massively reducing computing power requirements and transaction fees[15].

Network Governance

On-Chain governance is a system for managing changes and updates to a cryptocurrency network and its protocols. There are three stakeholders on a crypto network: developers, miners/validators and users. In an informal governance system, such as Ethereum or Bitcoin, changes are proposed through a combination of an offline core group of developers and through online code modifications. Critics argue that this is a form of centralized governance that goes against the ethos of cryptocurrencies. Informal methods can lead to issues such as hard forks. Hard forks are radical changes to the network protocol that can change the validity of certain blocks on a chain, and require all nodes to update to the latest version of the chain. This often leads to disagreements about changes, causing some developers to spin off to new cryptocurrencies. For example Bitcoin Cash spun off of bitcoin because of a disagreement about block size. Ethereum Classic split from Ethereum due to disagreements on how to handle a hack.

In a formal system, all changes are proposed online through code updates by developers. A core group of developers is then responsible for coordinating consensus between stakeholders. A successfully implemented formal system is Tezos’ self-amending ledger. Developers propose changes to the protocol which is then voted on by nodes on-chain. Nodes holding more coins have more voting power. Protocols that gain enough voting support are rolled onto the test network. If successful the changes are then implemented onto the main net[16].

Smart Contracts

Stable Coins
A smart contract is a digital contract held inside a blockchain. The contract is self-executing and written into lines of code. Each contract is immutable, distributed and trustless, resulting in reliable contracts without intermediaries. This is possible because smart contract settlements are decentralized verified on-chain the same way crypto transactions are verified. Decentralized validation provides quicker, cheaper and more accurate contract settlements. Smart contracts can be used in all sorts of industries. A few examples are executing insurance settlements, increasing supply chain transparency, digital records management and decentralized finance[17].

Decentralized Finance (DeFi)

Decentralized finance (DeFi) is a term used for financial products and services that are available through the internet and that are executed and recorded on the blockchain through smart contracts. DeFi does not rely on central authorities such as banks, centralized exchanges or brokerages to transact money or financial products. DeFi aims to give people full control over their finances with no restrictions on account minimums, no specific trading hours and no discretionary access to loans. Products and services that are slow and prone to human error can be quicker, cheaper and more transparent using DeFi[18].

Currently, the best example of DeFi is Uniswap, a decentralized exchange. Uniswap is an automated market maker built on smart contracts that allows users to transact coins and tokens via liquidity pools. Liquidity providers add liquidity by placing their coins or tokens in a smart contract that can be used to transact by others. In return liquidity providers earn a percentage of transaction fees. This automated protocol allows Uiswap to offer over 8,000 trading pairs and generate $2-3 Million in fees daily without any centralized intermediary[19].

Stable Coins

Stable coins are collateralized digital tokens that are meant to take the volatility out of cryptocurrencies. Cryptocurrencies are subject to large swings in value which make them unpredictable to use for daily transactions. Stable coins are tokens pegged to an asset, usually US dollars, that are less volatile. The entity behind a stable coin will set up a reserve where the asset backing the stable coin is securely held as collateral. Assets used as stable coin reserves can be fiat money, other cryptocurrencies, commodities or other assets. Whenever a stable coin holder cashes out their coins an equal amount of the collateral asset is removed from the reserve. One of the most popular stable coin issuers is Maker which issues the stable coin Dai that is pegged to the US Dollar. Dai is backed by Ethereum and is viewable publicly on the Ethereum blockchain. Dai’s properties and transparency make it a key component in many decentralized applications in DeFi. Using Dai, people are able to borrow, lend and invest digitally while eliminating the volatility of cryptocurrencies.

Other popular stable coins include Tether (USDT) and USD Coin (USDC), both of which are pegged to to US Dollar value. Tether is the most popular stable coin because it is a trading pair with most cryptocurrencies. Its main use case is quickly moving money between exchanges to take advantage of arbitrage opportunities. However, tether does not have the same transparency as Dai and is centrally backed by commercial paper. Tether also faced a lawsuit over allegations that Bitfinex, a crypto exchange and sister company of Tether, used Tether funds to cover an $850 Million shortfall.

USDC is a stable coin issued by the partnership of CIrcle and Coinbase. USDC is an Ethereum based token backed 1:1 by US Dollars. The funds are managed by a centralized authority that is audited monthly to ensure proper reserves. USDC’s purpose is to represent US Dollars on the blockchain. This makes USDC easy to move across various crypto exchanges which is useful for investors in developing markets looking for stable digital assets.

There are also some drawbacks to stable coins. If the reserves are stored in a bank off-chain, like with Tether and USDC, there is counterparty risk. Investors are trusting that the centralized issuer actually possesses the amount of reserves to match the tokens 1:1. Cryptocurrency was created to make finance decentralized and trustless. However, in some stable coins an institution has control over investors' funds and are able to stop transactions from occurring[20].

Uses of Cryptocurrency

The two most popular uses of cryptocurrencies are money transfer and storage of wealth.

  1. Money transfer: Sending and accepting payments at low cost and high speed is one of the most well-known applications of cryptocurrency. The increased interest is shown by retail banking clients, fintech, venture capital funds, institutional investors and distributed ledger technology.
  2. Storage of wealth: Unlike cash, digital payments behave like a secured alternative store of wealth, which is censorship-resistant. This means only the authorized people with the private keys can access wallets, unlike traditional banks that are vulnerable to hacks, thefts, and malpractices. As a result no personal digital wallet can ever be frozen by authorities.

NFT Industries

Art

The art NFT industry allows for creators to monetize their artwork to people by selling unique artwork to users, with options to claim royalties when the NFT is resold. The process helps to reduce the fees associated with selling traditional art, as well as cutting out other middle-men that are normally associated with selling traditional art[21]. Essentially, it has allowed for the emergence of virtual art galleries and auction houses to exist.

The rise of art NFTs have brought a resurgence of purchasing of art from people around the world. Art NFTs are seen as a way to bypass traditional art barriers and share pieces of artwork with everyone. Sales of NFTs have now taken the place of sales of contemporary art and has allowed for purchasing to be much more accessible[22]. The surge of popularity has seen people going from museums and auction houses to virtual marketplaces when buying new pieces of art, with total sales of art in 2020 rising up to $2.7 billion[23]. With reduced barriers to entry in the world of art, anyone is free to create and sell as they please.

Concerns

A common issue within the art NFT industry is proof of ownership regarding the art created. There are often issues with people stealing art and minting NFTs without securing permission from the original artists[24]. With virtual art, it can be difficult to track down the original artist without adding in a watermark or having a link to a website confirming ownership.

For traditional digital artists, this is a regular everyday struggle, as they can often find their art stolen and used by companies without permission. Companies like virtual art program Krita have openly stated that they are openly against NFTs and condemn the concept[25]. Other companies have taken initiative to try to counteract this, such as Adobe developing a system called Content Credentials, which allows creators to attach proof of creation within the image[26]. This proof is then able to be displayed on NFT marketplaces such as OpenSea, allowing users to check if you are the original creator of the work.

Kings of Leon's NFT Album 'When You See Yourself'

Music

Music NFTs traditionally come in the form of music files. In addition to receiving a music file, artists can also add in extra goods to provide additional value to listeners such as concert tickets.

The increase in creation of music NFTs a result of the dwindling revenue that comes from current music streaming services[27]. For traditional music releases, profits have to be split with priority payments going to staff, resulting in the artists receiving whatever is leftover. As methods of music consumption changed from buying albums to listening online, money for the artists began to dwindle over time. With music NFTs, artists can now earn much more from their art by allowing the fans to decide what to pay.

American band Kings of Leon released an album both physically, and as an NFT which came with extras such as vinyl, concert tickets, and animated goodies. With the release of it, they were able to generate over $2 million in sales[28]. However, this is not typical behavior for all music NFTs. However, this is not typical behavior for all music NFTs. Like the normal music market, those who already have large followings are the ones who can make the most money.

Collectibles

NFT collectibles come in various forms, from trading cards to virtual cats[29]. These collectibles are often released in limited collections containing a set quantity that follow a theme, resulting in scarcity and high demand. The desire for these collectibles comes from the fact that no two are alike, and can be easily verified as well.

Bored Ape Yacht Club

Bored Ape Yacht Club is a limited collection of digital art NFTs resembling cartoon monkey avatars[30]. Each Bored Ape is randomly-generated via a program, with over 170 possible traits that can result in a multitude of different designs. As of 2021 only 10,000 Bored Ape NFTs exist, leading to its high prices. Owning a Bored Ape can allow for owners to gain exclusive perks, such as membership for online servers and in-person meetups. Notable owners include celebrities such as NBA player Stephen Curry and Jimmy Fallon[31]. The culture surrounding the ownership of an ape is akin to being part of an exclusive club with likeminded people, all excited about the future of NFTs [32]. In 2021, owners of Bored Ape NFTs were invited for an exclusive yacht party that was limited to owners and famous NFT holders.

CryptoKitty #303: MegaFlowtron, valued at 250 ETH

CryptoKitties

CryptoKitties are digital cat art NFTs, created by Dapper Labs in 2017. Each cat has unique traits and characteristics, with some traits being more rare than others[33].

What makes CryptoKitties unique is that they can be bred with one another for the chance to pass on certain traits and create new design variations of CryptoKitties. Cost for breeding your own kitties is about 0.04 ETH, as well as an additional transaction fee[34]. Kitties can also be set up to breed with other user’s CryptoKitties, allowing them to attain desirable design traits for their personal collections. Depending on the rarity of traits and potential to create new Kitties with rare appearances, prices of CryptoKitties can jump up to $300,000 [35]. Certain collections can also affect the valuation of CryptoKitties based on exclusivity and demand[36].

Gaming

Gamification has allowed for NFTs that can be used to play online cryptocurrency-based games. These can take place in the form of tokens, playable characters, or even trading cards. Stances on NFT-based games are currently divided among traditional video game developers. Valve Corporation has taken to banning all blockchain and NFT-based games from Steam, its video game distribution service, citing that they don’t allow for items that have real-world value to existing on their platform[24]. However, EA has stated that they see potential in including NFTs as a part of game franchises, specifically in their FIFA franchise, which makes use of in-game card packs to acquire virtual players in the game[37].

Play-to-Earn

The most common games tend to take on a Play-to-Earn model, where players can earn in-game tokens and NFTs, which can be sold on markets and converted to crypto-currency[38]. These types of games tend to require an initial investment to play, which requires players to purchase something such as a character or vehicle to start playing. Like Bitcoin, a game usually will set out a set number of cryptocurrency tokens that can be obtained from playing, to incentivize long-term engagement within the game. These tokens can then be sold on other crypto exchange platforms for other cryptocurrencies. This model is popular due to its ability to generate income while playing, making it an attractive venture for people looking to get into the world of NFTs.

Gameplay in Axie Infinity

Axie Infinity

Axie Infinity is an NFT game focused on raising virtual NFT creatures, called Axies. Originally launched by Sky Mavis in 2018, the player base has grown to 2 million active players around the world[39].

Each Axie contains a set of unique traits, which helps them to gain advantages for in-game combat. Playing Axie Infinity rewards players with Smooth Love Potions (SLP) or Axie Infinity Shards (AXS) through pitting them against other players though in-game arenas or have them complete in-game tasks[40]. These tokens can be sold on cryptocurrency markets, and can then be converted into real revenue for players. Some players will use the crypto earned from playing to further invest into the game, purchasing more Axies. Axies can also be bred in-game, to create new Axies with different traits.

The company funds operational expenses through having players buy certain items in-game with ETH, such as virtual land or Axies[41]. These in-game items can then be used by players to earn AXS or SLP. Currently, Sky Mavis has set a limit of 270,000,000 AXS in existence, with current supply sitting around 59,985,000 AXS[42]. Axie Infinity also charges fees for certain game mechanics, such as breeding Axies or selling through their marketplace[43]. As the game continues to grow the company will look to add in new features to both generate income and enrich the gaming experience for players. However, certain investors see risks in AXS as it still holds the same volatile properties of regular cryptocurrency[44]

How to Play

To play, one needs to have a minimum of three Axie NFTs to form a team. This requires an initial investment of around $200 per Axie to play, with totals costs going up to $1,500. Axies can be purchased from various NFT marketplaces or through the game itself[45]. Players can also purchase plots of land as NFTs, which allows for them to unlock more gameplay features, such as the option to battle against virtual enemies[46]. For players who aren’t able to spend the upfront cost to play, they can look to apply for Axie Scholarship programs, where one can acquire a scholarship in which other players lend a team of Axies to play with[47]. Players who receive scholarships are required to share a portion of their income with the initial sponsor, the player who will regularly buy Axies in order to loan out teams to players[48].

Economic Impact

Axie Infinity’s popularity in the Philippines and other emerging countries comes from the popular Play-to-Earn model [49]. For some players, the game is an opportunity to earn an income that exceeds what they would normally earn through working a regular minimum wage job in their home country. For others, it’s the first time in their lives earning an income. About 25% of players have never had a bank account before, making Axie Infinity their first experience in managing their own finances and earning money [50]. It’s impact has gone to the point where the Philippines government has taken notice of players earning an income through virtual activities, and has begun to make a push towards figuring out how to tax this new stream of revenue coming in for its citizens[51].

Volatility in Cryptocurrency

Volatility of Daily Log Returns
Volatility is a natural part of market activity. In financial markets, volatility is the rate of change in the price of an asset. There is indeed a level of healthy volatility, where the price changes within a certain range of prices within a certain time period. Then there is extreme volatility, where the price changes are sudden and drastic which is unhealthy for the market. Unhealthy volatility is created due to market chaos, uncertainty, and trade positions that are highly leveraged.

Cryptocurrencies are definitely one of the most volatile assets. The price of bitcoin rose 125% in 2016, then rose again by over 2000% in 2017. More recently in 2021, the crypto market crashed by more than 50% within a few weeks.

Bitcoin and cryptocurrencies have grown to become one of the largest asset classes in the world. As they continue to become mainstream, and big institutions and governments continue its adoption, the extreme volatility of the market should decrease, or atleast stabilize to normal levels[15].

Crypto Market crash of 2021

The crypto market has fallen sharply in price from the all time highs that were reached in mid April. Bitcoin reached an all time high of $65,000 in April, before tumbling to $35,000 just a few weeks later. The overall cryptocurrency market has lost around $1 trillion in value due to the crash.

This crash may seem abnormal and scare new investors away. However, after considering the market's history, crashes like these are a common occurrence. Bitcoin has crashed by 80% on more than three different occasions since 2012. Comparing that to the current crash of 50%, this is a rather mild crash. The crypto market is affected solely by supply and demand, which makes the prices extremely sensitive to news. Stocks for example are much more stable as the price is affected by various factors such as balance sheet performance, cash flow analysis, future business prospects, interest rates, mergers and acquisitions, and economics.

The recent market crash of cryptocurrencies were fumed by China banning coin mining, Tesla suspending bitcoin as payment for its vehicles, and overall environmental concerns regarding the mining process. Amid the recent crash, and more extreme crashes in the past, bitcoin and the overall market has always recovered[52].

NFT Resale Market

As countless NFTs are being sold through various marketplaces, an important question still stands: Do they hold their value? For the NFT market to continue and not become a bubble, there needs to be a functioning and establish secondary marketplace. It is hard to determine if an NFT is being resold in most pre-existing marketplaces and it is hard to determine if they are being sold at a loss or a profit[53].

During the first three months of 2021, Crypto Art noted that the secondary market has drastically increased. The secondary market on SuperRare, the second biggest NFT marketplace, has grown to become 36% of its sales. This growth is beneficial for the NFT ecosystem by providing more opportunities for liquidity. However, as the number of items on the market grows, there is an increase in competition and a small market of willing buyers, which may limit the secondary market growth[53].

As the market grows and prices potentially increase, the original creators of an NFT may lose out on potential profits. However, creators can attach stipulations that they get proceeds after each time it is resold. This means NFTs creators can still receive financial gain if the value of their NFT increases. Football teams in European leagues have been using similar contract clauses when players are transferred, but NFTs don’t require one to have to track an asset as closely due to the use of blockchain[54].

Future Use Cases

As NFTs are a relatively new technology, their current use cases are limited. However, some organizations and industry experts are coming up with future potential use cases that could revolutionize how we conduct transactions, apply to jobs and support not-for-profits. All of the examples besides the not-for-profit and virtual world are ideas that have not been executed yet. There are opportunities for pre-existing businesses or start-ups to take advantage of these new innovative applications of NFTs to revolutionize how we conduct transactions. Using NFTs does not mean they can only be used in a financial context, but rather they can be used to share and own your data.

Healthcare

Sending and sharing health records to different medical providers is a costly and time-extensive procedure. With NFTs you can send confidential information and can encrypt some of the data held within the NFT to ensure privacy remains. Recipients such as doctors can require a code to decrypt the NFT which can allow them read-only, single-use access to ensure that you are owning your medical records and controlling who can view them. Through this method, they can also be instantly delivered instead of waiting for processing time [55].

Employment and Education

People can claim many different accomplishments on their resumes, including education. The burden is on companies to ensure that someone they are interested in hiring has achieved the credentials they have claimed. Third-party background checks are often costly and timely. However, NFTs can guarantee the authenticity of an applicant’s educational achievements. Universities can issue an NFT code with a degree that employers can use to verify that someone has the degree they said they did, verify their GPA, the time they studied at that school and so on.

Much like guaranteeing education, NFTs can be used to prove an applicant’s work history. This is valuable for companies that go out of business or are acquired, which means it may be harder for someone to verify if you actually were in the role you were in. NFTs can prove that you worked at the company for the time and in the role, you have included in your resume.

NFTs can be used to verify the signature of someone on important documentation. As some people use online signature generators, it is harder to verify the authenticity of someone’s signature. When employers ask for references or reference letters, there is a chance that someone could falsify these records. In the context of references for employment, it can be used as follows: If an applicant applies and says that Drew Parker is a reference, an employer can certify that this is in fact Drew’s signature. Drew could also create an NFT of his signature and he can send tokens to those students he is willing to be a reference for [55].

Resale Market

As the resale market for tickets increases with websites such as Stubhub, it is hard to verify if a ticket is authentic until you are at an event and are having it scanned. One way to verify the authenticity of the ticket would be if the concert tickets are issued as NFTs. This is especially valuable if you are travelling for an event and want to ensure authenticity before paying for accommodations and flights. NFTs can help customers ensure the legitness of the tickets they have purchased[55].

Many designer goods currently come with verification codes printed discreetly on the item or verification cards. However, counterfeit items are becoming increasingly realistic and harder to tell apart from authentic items. Many counterfeit items are also coming with authenticity cards designed to look identical to the cards issued by the designer. Secondary markets are predicted to grow as there is an increased focus on sustainability within the fashion industry as well as, counterfeit goods are often created in deplorable and unethical conditions. NFTs can ensure that customers are buying authentic items. It can also increase the value of the resell market as buyers may be less hesitant since the authenticity is guaranteed with an NFT[55].

Not-For-Profits

As the threat of climate change increases, not-for-profits (NFP) focused on conservation are looking for unique ways to gather funds to protect different groups and species. Porini Foundation, Nature Seychelles and the International Union for Conservation of Nature worked to help protect 59 endangered magpies. The birds were made collectible with NFTs, which led to the tokenization of magpies in a digital, NFT format. The revenues are being used to work to remove the magpie from the endangered list[56].

This is an example of one not-for-profit utilizing NFTs to increase their funds through a sponsored model, as with these NFTs you are “owning” a digital copy of this bird. Other NFPs can create NFTs that help further their mission in a unique and digitalized format. An example of applying this to different organizations is creating an NFT to sponsor a child or giving of a gift done by organizations like Plan International Canada[56].

Intellectual Property Law

Another potential use is in intellectual property (IP) law. These laws govern ideas as patents and trademarks. NFTs can be used to represent proof of ownership, however, there may be a conflict between pre-existing contracts and NFTs. It is also difficult to see how some different disputes would be resolved by courts or governed by various laws. As courts and governments can take a while to adopt new technologies, it is likely it will be some time before this application of NFTs is utilized[57].

Virtual Worlds

More of our lives may be spent in virtual worlds or in different metaverses. It is likely that when we purchase things in these virtual worlds, that they will be bought and sold as NFTs. An example of this is Decentraland which is the first fully decentralized world and controlled via the DAO, which owns smart contracts and assets in this world. NFTs could replace this to allow consumers to buy different items in the Decentraland[54].

Authors

Brian Le Celia Fan Jake Dinoto James Duong Liv D'Agostini
Beedie School of Business
Simon Fraser University
Burnaby, BC, Canada
Beedie School of Business
Simon Fraser University
Burnaby, BC, Canada
Beedie School of Business
Simon Fraser University
Burnaby, BC, Canada
Beedie School of Business
Simon Fraser University
Burnaby, BC, Canada
Beedie School of Business
Simon Fraser University
Burnaby, BC, Canada

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