Non-fungible Tokens (NFTs)

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"Everydays - The First 5000 Days" by Beeple, sold for $69.3 million

Non-fungible tokens or NFTs are digital representations of non-interchangeable assets stored on the blockchain [1]. Non-fungibility means non-interchangeable. For example, there is no difference between the fifth and hundredth dollar in a paycheque, therefore you can say Canadian dollars are interchangeable or fungible. In contrast, as an example of non-fungibility, the Mona Lisa is not the same and can not be interchanged with The Great Wave. A token is a digital representation of some asset[2]. For example, there could be a token representing a Bitcoin or a token representing the ownership of a house or painting. Current popular usages of NFTs is for representing ownership of artwork, event tickets, and in-game items.

Contents

How do NFTs Work?

Most NFTs are stored on Ethereum and such this article will mainly focus on the technology behind Ethereum [3]. Ethereum is different from a traditional blockchain such as the one Bitcoin relies on, in that it is programmable. Ethereum can be used for any type of digital asset. It is not just for cryptocurrency, it can be used for financial services, games, and other applications [4]. In extremely simplified terms, blockchains are immutable records of actions stored on multiple computers. In the case of Bitcoin the actions are financial transactions but in the case of Ethereum, the actions are smart contracts. For further discussion and background on blockchain please refer to our peers' work on Blockchain / Cryptocurrency.

Smart Contracts

Smart contracts are agreements similar to contracts in real life and the foundation of Ethereum. Let us use the following example

Alice and Bob are having a bicycle race. Let's say Alice bets Bob $10 that she will win the race. Bob is confident he'll be the winner and agrees to the bet. In the end, Alice finishes the race well ahead of Bob and is the clear winner. But Bob refuses to pay out on the bet, claiming Alice must have cheated.

Smart contracts solve this trust issue by turning the agreement into computer code such that when the conditions are met (in this case someone passing the finishing line) the code and corresponding transaction is automatically executed. Since the agreement is written in computer code, there is always a precise definition of the conditions required and the actions that will be taken [5]. So in our scenario, instead of relying on the word of Bob or Alice, they both agree to upload a smart contract to the Ethereum blockchain that will automatically execute when internet-of-things sensors detect the winner.

Legal Standing

The question arises if a smart contract is legally binding, however, the question is largely irrelevant as once the conditions of the contract have been met, the transaction automatically goes through. Whether or not the smart contract is legal has no effect once the agreement has been made and added to the Ethereum blockchain. Even with the automatic execution, legal professionals believe that smart contracts fall under the Electronic Signature Recording Act in the United States, which states that an electronic signature is legally binding as long as the medium of signing is able to be attributed to the person(s) bound by said contract. States such as Arizona and Nevada have already amended their laws to include specific mention of smart contract [6].

Smart Contract Usages

Mortgages and loans can be used as smart contracts by implementing interest payments, principal payments, or credit limits directly in the contract and having the amount automatically withdrawn from borrower's wallet.

Insurance can be implemented by combining internet-of-things and automatically filing and approving claims based on sensor data. For example, if flood a flood occurs, then a sensor could detect it and automatically pay out to the insurance holder [7].

There are many other uses of smart contracts such as gambling, games, title registration, and employment agreements. The only limit is the imagination of the writer of the contract.

NFTs are a type of simple smart contract that store a token representing some asset and the current owner of the NFT. Some NFTs even have more logic that pay the original artist a royalty every time the NFT is bought or sold [8].

Gas

To execute the code of a smart contract, the creator of the contract must offer some Ether as gas. It can be thought of as a processing fee for a transaction or a bounty to incentivize miners to process the smart contract. The more complicated the smart contract is, the more gas it costs.

Gas is determined by the following formula:

Gas units (limit) * (Base fee + Tip)

Suppose Alice wants to pay Bob 1 ETH, the transaction will cost roughly 1.00023 ETH for Alice where Bob gets 1 ETH and the person who mines the block gets 0.00023 ETH. Miners are people who offer computing resources to verify the a validity of a block or transaction in the blockchain in exchange for the gas fee[9].

The higher the total gas paid, the more priority the contract gets. This matters because if you set your gas price too low the transaction could become ignored or missed, freezing the wallet. A wallet freeze is when there is an outstanding transaction and further transactions can not be issued. If the wallet is stuck the transaction needs to be cancelled or sped up.

Both speedups and cancels involve issuing another transaction. For a speedup that simply means running the transaction again with a higher gas price and the instruction to ignore the original transaction. For a cancel, it means simply running a transaction with a higher gas price saying to ignore the original transaction. As a general rule, speedups and cancels need to have a gas price of at least 10% more than the original transaction so that they get processed first [10].

NFTs typically prioritize cost efficiency over speed compared to a payment transaction. This means that the NFT transaction may set a low gas price and wait to be executed when the Ethereum network is less busy.

Diagram of The Ethereum Virtual Machine [11]

The Ethereum Virtual Machine

To execute the code in a smart contract, there needs to be a compute to run said code. This code is executed on the Ethereum Virtual Machine (EVM): a distributed state machine. This simply means it has data ordered and segmented similar to a computer. For example, there is a program counter, stack, and memory. What a smart contract does, is run computations and execute logic that eventually modifies the EVM's state. Instead of only keeping track of transactions, the Ethereum blockchain keeps track of the EVM's state and consensus is achieved when all miners agree on the EVM's state. [12] It is important to note that the EVM is Turing Complete, meaning it can run any logic that a normal computer has, provided enough gas is supplied [13].

Demand Curve of a Veblen Good

Valuing NFTs

Since NFTs represent ownership rights of some asset, the value of the NFT is what someone is willing to pay for the asset. Binance[14] lists rarity, utility, and tangibility as factors that affect the value of an NFT. Rarity is how difficult it is to obtain an NFT. If there is only one NFT of a piece of art then people would be willing to pay more for it. Likewise, the more utility an NFT has the more value it will have. For example, if an NFT represents the ability to use some character in a game there is more value to that NFT. Finally, tangibility is the third factor mentioned by Binance. If an NFT is tied to gold, it would be more valuable than one tied to a random pebble.

Some NFTs can be considered a Veblen good. Typically when prices increase, demand for the goods decreases. However, with Veblen goods, when the price increases, the demand increases. This is typically because they are viewed as status symbols due to their exclusivity. The purchase of Veblen typically makes the purchaser feel happier due to making the purchaser feel more exclusive and important. The fact that limited quantities exist, make the good cost more. [15] Common classical examples of Veblen goods include designer handbags, luxury cars, and premium wines.

The History of NFTs

The history of NFTs can be broadly classified into three time periods: the beginnings of NFTs on Bitcoin, the proliferation of NFTs on Ethereum, and the shift of NFTs beyond Ethereum.


The Beginnings of NFTs on Bitcoin

The earliest concept tied to the beginning of NFTs is the idea of “coloured coins”, which was developed in the early 2010s [16]. Coloured coins describe the creation of an additional layer of information (metadata) to Bitcoin transactions, which effectively classifies them as tokens that can be tied to any asset. Thus, coloured coins can be leveraged for new functional purposes such as proving ownership of assets and issuing company shares.

The emergence of coloured coins led to two key projects: Mastercoin and Counterparty. While Mastercoin led to the creation of several tokens still in use today, Counterparty led to the development of NFT collectible sets that closely resemble the types of NFT collectibles available today [17]. For example, the first video game cards, Spell of Genesis, and real CryptoArt, Rarepepes, were both pioneers of each kind and popularised by Counterparty [18]. Rarepepes, a CryptoArt collection launched in 2016, resulted in 1700+ unique Rarepepe cards created by 200+ artists. As each card is modelled after the popular internet meme, Pepe the frog, the Rarepepe collection spearheaded the intersection between blockchain and pop culture.

Although coloured coin projects such Counterparty and Mastercoin found notable success, coloured coins altogether did not gain much traction. Bitcoin was not intended to support alternative tokens, so there was resistance from Bitcoin users who were worried about increasing Bitcoin transaction expenses because of the additional block space used by alternative tokens [19]. Accordingly, Bitcoin did not evolve to accommodate the inclusion of alternative tokens. A participant in Mastercoin named Vitalik Buterin viewed this as an opportunity, and eventually created Ethereum in 2014 [20].


The Proliferation of NFTs on Ethereum

Ethereum was launched in August 2015 and eventually became the platform to allow for the development and popularization of NFTs. In 2017, Cryptopunks was created, which is considered as the first real NFT project on Ethereum [21]. Cryptopunks was a collection of 10000 unique pixelated avatars. After the creation of several NFT projects, discussions about developing a new standard of NFTs to succeed the previous ERC20 token emerged. As a result, a man named Dieter Shirley developed a new NFT standard known as ERC721 that would be used starting in December 2017, when he co-created an NFT game called CryptoKitties [22]. At the time that CryptoKitties was launched, the crypto-world had gained strong momentum from the rise in popularity and prices of Bitcoin, which contributed to the increase in CryptoKitties prices. Some were sold and valued at $100k+. The popularity of CryptoKitties was a pivotal milestone in the history of NFTs as it led to a boom in NFTs of different types (e.g. games, art, virtual worlds, collectibles) and caught the attention of mainstream media.


The Shift of NFTs Beyond Ethereum

In December 2017, Opensea, the world’s first and largest NFT marketplace was created to simplify and streamline NFT trading processes [23]. Several alternative blockchains such as Flow, also emerged after learning about the limitations of Ethereum in supporting popular NFTs and games. Flow was created by the creators of CryptoKitties and rose to popularity through the launch of NBA Topshot, a collection of NBA video clips tied to NFTs [24]. NBA Topshot became one of the best-selling NFT projects in terms of volume, along with Cryptopunks, which sometimes sold for several millions of dollars. As of October 2021, Cryptopunk NFTs hold five out of ten spots on the ranking for top ten most expensive NFTs ever sold [25], while Beeple's “Everydays: the First 5000 Days” secured the top spot at $69.3m.

Top NFT Marketplaces

OpenSea Interface

OpenSea

Opensea is the first and largest NFT marketplace. In November 2021, total sales on Opensea exceeded $10 billion. A large variety of NFTs are created and sold on Opensea including cryptoart, music, domain names, virtual worlds, trading cards, collectibles, sports, and utility [26].


Axie Infinity

Axie Infinity is an NFT-based online game created in Vietnam that uses a play-to-earn model where players can earn and exchange game assets as NFTs. Total sales on the Axie Infinity marketplace passed $2 billion in September 2021 [27].

Lebron James NBA TopShot NFT


NBA TopShot

NBA TopShot is a blockchain-based platform developed by Dapper Labs where NBA fans can buy, sell and trade NBA highlight video clips as NFTs. Prices are determined by various factors such as the popularity level of the NBA players featured and the rarity of the card. As of October 2021, total sales on NBA TopShot reached approximately $700 million dollars [28].


Rarible Interface

Rarible

Rarible is an Ethereum-based NFT marketplace particularly focused on NFT art. A unique component of the Rarible platform is the RARI token, which grants owners the right to vote for new features and become involved in shaping the evolution of the platform. As of October 2021, total sales on Rarible reached approximately $230 million [29].


How Do People Make and Sell NFTs?

Buying and selling and NFT involves the use of two types of platforms: an NFT platform (marketplace) and a cryptocurrency payment platform to handle transactions.

The following are 8 general steps to make and sell an NFT [30]:

  1. Buy some cryptocurrency: To generate an NFT, one will need to pay an NFT platform in cryptocurrency to generate or “mint” an NFT. Most platforms require payment in Ethereum. To buy Ethereum, one will need to create a “digital wallet” that syncs with the NFT platform.
  2. Create a digital wallet: There are several digital wallet applications on the market such as Metamask, Coinbase, AlphaWallet, etc. For Metamask, you can create a digital wallet by downloading the application or browser extension, creating an account, then adding money to the wallet.
  3. Add money to your wallet: Through the cryptocurrency payment platform, one can directly purchase cryptocurrency. For Metamask, one can buy Ethereum with Apple Pay or debit card.
  4. Connect your wallet to an NFT platform: Once cryptocurrency has been purchased and loaded into the digital wallet, one will need to connect their wallet to their NFT platform of choice.
  5. Create an NFT: Upload the digital file that will be created into an NFT.
  6. Set up an auction: There are several configuration options depending on the NFT platform chosen that will determine the conditions for the NFT sale. For example, on Rarible, NFT creators have the option to set a “fixed price”, which would result in the sale of an NFT as soon as someone submits an offer for the selling price. Other options include “timed auction”, which will sell the NFT to the highest bidder after a specific time period, and “unlimited auction”, which will leave an NFT for sale indefinitely until the seller accepts an offer.
  7. Describe your NFT: Create a description of the NFT, which will be displayed along with the NFT listing on the marketplace.
  8. Pay additional fees: Before listing an NFT, there are several additional fees that need to be paid prior. There is usually a listing fee, otherwise known as a gas fee, which covers the computing energy needed to complete the blockchain transaction [31]. The NFT platform will also often charge a commission fee and transaction fee upon the sale of the NFT. Due to the volatility of cryptocurrency prices and other factors such as the volume of traffic on the blockchain, these additional fees are subject to great variation, which makes it difficult to predict or estimate the cost of creating an NFT.

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[32]. 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[33]. 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[34]. 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[35]. 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[36]. 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[37]. 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[38]. 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[39]. 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[40]. 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[41]. 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[42]. 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 [43]. 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[44].

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[45]. 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 [46]. Certain collections can also affect the valuation of CryptoKitties based on exclusivity and demand[47].

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[35]. 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[48].

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[49]. 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[50].

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[51]. 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[52]. 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[53]. Axie Infinity also charges fees for certain game mechanics, such as breeding Axies or selling through their marketplace[54]. 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[55]

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[56]. 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[57]. 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[58]. 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[59].

Economic Impact

Axie Infinity’s popularity in the Philippines and other emerging countries comes from the popular Play-to-Earn model [60]. 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 [61]. 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[62].

Environmental Implications of NFTs

Because NFTs are a part of the Ethereum blockchain, they share many of the same environmental implications. For example, the average transaction on the Ethereum blockchain consumes 35kWh (kilowatt hour) - the same amount of energy required to run a fridge for one month. However, this does not highlight the full scope of NFTs’ environmental impacts. Transactions that are common with NFTs such as minting, bidding, selling, and transferring of digital tokens can add up to an average of 369kWh - enough power to run that same fridge for over 10 months. [63] One researcher calculated that a single artist selling just two artworks consumed 176,773kWh creating 103,129 Kg of C02 emissions. This can be equated to approximately 21 years of a U.S household’s electricity use. [64] Based on this evidence, it is clear to see that these seemingly non-tangible things have very tangible and real-world effects. Large energy consumption creates many issues such as air pollution, climate change, water pollution, thermal pollution, and solid waste disposal. Because of this, it is crucial to analyze and implement ways to effectively reduce the vast amount of energy that is consumed by NFT and blockchain transactions.

Remedies to Alleviate the Environmental Consequences of NFTs

Proof of Stake

Currently, blockchain transactions are validated by a mechanism known as Proof of Work (PoW). Proof of Work is a race for miners to validate a transaction on the blockchain. Millions of processors are simultaneously processing the same transactions using large amounts of energy and computational power, racing to validate the transaction first to reap all the rewards. In order to validate these transactions, miners must expend vast amounts of energy to solve complex math problems through trial and error. Because miners are racing against each other, the more energy consumed, the better the chance for miners to validate the transaction first; netting them the validation fee. With many miners engaged in a digital arm’s race trying to validate the exact same transaction, it is clear to see how one simple transaction can demand so much energy.

Proof of Stake (PoS) is a solution that can potentially reduce energy consumption per transaction by up to 99%. [65] PoS gets rid of the inefficiency of having millions of processors expending energy to validate the same transaction and instead assigns one miner randomly. In this method, miners become validators and are required to put up a stake of their own Ether as collateral. Putting up a bigger stake earns a validator proportionately more chances at a turn, but also means that if a validator is caught cheating, they have more to lose. The tradeoff is that validators no longer need to spend as much money on advanced hardware but need to put up a financial stake to ensure their legitimacy.

Proof of Stake in Practice

Cardano is a blockchain platform that utilizes proof of stake consensus. This platform was founded by Ethereum’s co-founder Charles Hoskinson and hosts over 30 different coins. [66] Using proof of stake consensus, Cardano claims to be over 4 billion times more energy efficient than Bitcoin. Once a validator has been chosen to validate a transaction, the process of validation is similar to that in proof of work. However, the major difference is the economic initiative of the validator to include only valid transactions. Valid transaction is one that meets the requirements of the protocol. In proof of work, if you include invalid transactions, your block is not accepted and you have wasted computational time and energy and you don't get rewarded for it. Using proof of stake in Cardano, Instead of staking hardware and electricity, you stake Ada (a currency of the Cardano blockchain) directly. [67] If you behave honestly and include transactions that meet the protocol requirements you get rewarded and if you don't you lose some of your stake. This not only increases the energy efficiency of the platform, but also ensures security and integrity of transactions that are validated.

Second Layer

A second layer has been proposed as a method that could effectively reduce the load on the main blockchain by taking transactions “off-chain”. [68] For example, if two parties want to trade NFTs, they could open up their own channel on the second layer where they can make as many transactions as they want. Once they are done, they can settle the net result of their transactions back on the blockchain where it can be added to the verified ledger. Say these two people make 20 transactions with each other and the net result is $50 owed to person A. They only need to validate the net result. This method is essentially bundling a whole bunch of transactions into just a few that need to take place on the inefficient blockchain.

Threats and Security Implications

The Risk of Purchasing NFTs on the Blockchain

Buying an NFT is very different from buying a piece of physical art. When you buy physical art, you receive the actual art piece and have full control as to what you want to do with it - such as hanging it up in your house. When you buy an NFT however, you are buying a digital contract or token that says that you own a specific digital asset. You are not in possession of that digital asset and you do not have the same amount of control over that asset. Essentially, you are buying a certification that verifies you own the asset, but you are not actually in possession of the asset. NFTs store very little data and include information about where you can find the digital asset, but the actual artwork is still a link away. The digital asset likely resides on a website that you do not own. This creates a big risk that could potentially lead to losing the entire value of the NFT overnight. This can happen in many different ways. If the domain owner forgets to pay their hosting bill, the asset that you bought could disappear. The domain owner could also redirect the URL to point to something else which would change what the NFT contract directs you to. [69]

To mitigate these issues, many NFTs use an InterPlanetary File System (IPFS). [70] Rather than identifying a specific file at a specific domain, IPFS addresses let you find a piece of content so long as someone somewhere on the IPFS network is hosting it. IPFS uses what is known as content addressing rather than location addressing. Location addressing is where a smart contract will provide a link to where that NFT can be found. If you were to use location addressing to find a book in a library, you would ask the librarian what book is on the third floor, first row, top shelf, and three books from the right. Using content addressing, you would simply ask the librarian for the book based on its title, contents, author, or any other identifying information about the book and its content. Even if the book is moved to a different shelf or a different floor completely, you will still be able to find the book as long as it is somewhere in the library. This holds true for IPFS because as long as the NFT exists somewhere, it can be located even if the original host has altered or deleted it. This reduces the security risks of having links changed or deleted because it reduces reliance on a single domain host and spreads the reliance among many hosts. Ultimately, the risk still exists for NFT purchasers as NFTs need to be maintained whether this is by a single host or through the IPFS system. Even with this, a single hard drive crash could result in the permanent loss of the digital asset. Because NFT purchasers rely on other parties to maintain their NFTs, it is very likely that some years from now, an NFT contract may point to a missing file. This could create two situations for buyers: they are left owning an NFT with a broken link but they and the rest of the world understand what artwork it used to represent. As long as this artwork exists somewhere in the world, the NFT could potentially retain its value. Otherwise, if the artwork has gone missing and nobody can identify what artwork the NFT was originally tied to, the NFT would likely lose its entire value.

Marketplace Security

Centralized platforms like OpenSea and Nifty Gateway own the private keys of all assets on their platforms. This means if their platform is compromised, hackers can steal large amounts of NFTs. Several accounts on Nifty Gateway were compromised and the attacker was able to access purchased NFTs, exchange them for other NFTs and sell them for a profit. [71] The money was refunded to the affected investor, but their NFT was not recovered. The accounts that were compromised did not have multi-factor authentication (MFA); thus, if you are looking to create an account on a marketplace, it is recommended to enable MFA to protect your assets.

Selling Cyber Security Exploits as NFTs

Although NFTs have been most commonly used to buy and sell digital art, cyber criminals have found their own use for them: selling cyber security exploits as NFTs. [72] Hackers have been found to sell exploits such as a denial-of-service exploit that was sold to a bidder. This bidder then has full control of this exploit and can either choose to disclose the exploit, keep it a secret, or even trade it for other exploits in the future. This raises questions about ethics and identity when these exploits are put in the wrong hands. The use of NFTs as a way to monetize research efforts of exploit finders/bug bounty hunters is similar to how artists monetize their work through NFTs. Not only does this open up another distribution channel for these exploit sellers, it also increases the visibility and availability of these exploits to a wider population. Typically, exploits are sold on the dark web and are less visible to the average internet user. However, by listing these exploits on popular NFT platforms, many more users can have access to these which can increase the risk of damage that these exploits may cause.

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[73].

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[73].

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[74].

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 [75].

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 [75].

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 their tickets are authentic [75].

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[75].

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[76].

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[76].

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[77].

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[74].

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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