What is an NFT? How Non-Fungible Tokens work

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Depending on who you ask, Non-Fungible Tokens - usually shortened to NFTs - are a version of digital snake oil, a potentially crucial part of the metaverse, or a crypto-inspired innovation central to the future of conveyancing.

Whatever your view, it’s fair to say that NFTs have enjoyed more than a fleeting moment in the sun. What’s more, in recent years they’ve transcended the realms of tech evangelism and moved into the mainstream accompanied by celebrity endorsements and high-profile sales along the way.

Despite this push, a cursory online search in connection with NFTs tends to generate results about a subject that remains awash in jargon and hype.

To pierce the myths, here’s a simple look at what NFTs are, how they work and what the future could hold for them.

What is an NFT?

If you’re familiar with the world of cryptocurrencies, then the chances are you’ve also come across the concept of NFTs.

In essence, an NFT is a way to prove that you own something digital.

If you bought an expensive piece of art, you’d be able to touch it or hold it and perhaps display it in your home.

Any attempt to copy or reproduce it, no matter how good a facsimile, would never be the genuine article. It’s like owning a print of the Mona Lisa compared with owning Leonardo Da Vinci’s actual masterpiece.

The potential problem with digital art, and any other digital file, is that people can create identical digital copies. Copying is as simple as right-clicking an image and saving it to your device.

So why would somebody pay for a digital asset that an infinite number of others could also own by saving it to their devices?

The answer is that NFTs provide a method of authenticating the original, true version of the file, and its legitimate owner.

NFTs can be associated with any kind of digital file, but one of the most popular over the last couple of years has been social media profile pictures. In particular, the Bored Ape Yacht Club collection of unique, programmatically generated profile pictures - cartoons of monkeys that have sold for as much as £2.9 million.

But NFTs aren’t just for digital art. Someone paid £2.2 million for an NFT of the first tweet ever posted on Twitter, for example. It’s even been proposed that digital copies of property deeds could use NFT technology to more efficiently and securely authenticate ownership.

How do NFTs work?

NFTs harness the same technology that cryptocurrencies use to prove who owns Bitcoins, Ethereum tokens and other crypto assets.

Blockchain technology provides a record of transactions that is decentralised - that is, held by many ordinary people, all at once - and cannot be changed. It’s that immutable record of transactions that makes NFTs useful as a way to prove who owns a digital asset.

Once an NFT has been purchased, the sale is recorded on the blockchain. The record of the transaction cannot easily be changed, which means the NFT-owner can point to the record of their purchase on the blockchain to prove their ownership.

In the end, a Bitcoin is as much a digital file as a digital cartoon - they’re both just lines of computer code. However, there is a fundamental difference between cryptocurrencies and NFTs, and that’s in how each asset is valued.

Any one Bitcoin has the same value as any other Bitcoin at a given moment in time. Each NFT is unique, however, meaning no two have the same value just because they’re both non-fungible tokens.

Think about it like this: a £5 note in your wallet is worth the same as £5 in someone else’s wallet. However, two televisions can be worth completely different amounts of money - they don’t have the same value by virtue of both being TVs. In this example, the £5 notes are to cryptocurrency what the televisions are to NFTs.

What’s next for NFTs?

If you consider the figures, it’s possible that NFTs have already had their day.

Consider the statistics on sales of NFTs. These peaked in August 2021, according to data from nonfungible.com, at just over 200,000. For the same month this year, there were around 40,000 sales.

The average value of NFT sales is also trending downwards. Average sales peaked at £5,500 in May this year, but fell to around £300 at the end of August.

The slump could either reflect the so-called ‘crypto winter’ which saw prices of crypto assets fall across the board, or a general waning of interest in NFTs.

Under the UK’s previous Chancellor of the Exchequer Rishi Sunak, the Royal Mint was asked to “produce an NFT for Britain”, as part of his ambitions to make the UK a global hub for crypto asset technology.

Sunak has since been replaced (briefly) by Nadhim Zahawi and now by Kwasi Kwarteng as part of the new Liz Truss administration.

Kwarteng used to be the Secretary of State for Business, Energy and Industrial Strategy. His former department has previously spoken positively about crypto and NFT technology. But the new Chancellor has yet to say anything specific about the Royal Mint project, or NFTs in general.

The other big change in the field is that the Ethereum blockchain is undergoing a fundamental change that will drastically reduce the amount of energy it uses. This is a sustainability boon for any platform built on the Ethereum blockchain technology, which could have a knock on effect that helps the NFT market.