Non-Fungible Tokens, or NFTs are cryptographic tokens that represent the ownership of digitally scarce goods like art and collectible items.
The term Fungibility is used in economics to describe the characteristic of goods or commodities where each unit of the item is of the equal value and is undisguisable from each other. You can read more about fungibility here.
Non-fungibility on the other hand denotes that the asset is unique and has individual properties, just like a unique piece of art or collectible.
What are the properties of an NFT?
- Unique: Each Non Fungible Token is unique and has the necessary information proving it in it’s meta data.
- Provably Scarce: By design, only a limited number of NFTs are in circulation and are unique. The number can be verified on the blockchain, hence its provability.
- Indivisibility: Most NFTs cannot be split into smaller units / denominations. So purchasing a fraction of the token isn’t possible. Similar to standard tokens, Non-Fungible tokens guarantee the ownership of the asset and are easily transferable and fraud proof.
- Although NFTs can be implemented on any blockchain that supports smart contract programming. Some of the well known examples are ERC721 or ERC-1155 standard.
What is ERC-20, ERC-721 and ERC-1155?
ERC-20 is a well known standard for creating tokens on the Ethereum blockchain. Some of the well known examples are stable coins such as USDT, DAI, etc. ERC 20 allows for creating fungible tokens. All of the tokens mentioned, are indistinguishable and it doesn’t matter if you receive USDT or any stable coin and the value of the token is still the same.
ERC721 is a code standard for creating non fungible tokens. It allows for the creation of smart contracts that can be used to create distinguishable tokens with different properties. For example, Cryptokitties, a game that allows anyone to collect and breeding of Virtual kittens.
ERC 1155 is the next step in creating non-fungible tokens. This standard allows anyone to create a contract that supports fungible and non-fungible tokens and it was created by ENJIN, a project focused on creating games on the blockchain.
There are several blockchain powered games that use these non-Fungible tokens like Gods Unchained and Decentraland where users can earn, mine and purchase in-game collectibles using them.
Similarly, there are blockchain-powered domain registrars and digital art marketplaces that use NFTs as a backbone for their service.
NFTS & Decentralized Finance
NFTs can even unlock the full potential of the Decentralized Finance applications. Currently, Majority of DeFi lending protocols are collateralized. One of the interesting ideas is to use NFTs as a collateral. Where each NFT that derives it’s value from the art, tokenized real estate, collectible, etc can be used as a collateral and the required amount can be borrowed.
Recommended Reading: What is DeFi?
Though this idea seems great, the only hiccup is that, on lending & borrowing platforms like AAVE and Compound the value of supplied collaterals can be easily measured by integrating price trackers that aggregate price from different sources to determine the value of the collateral. But when it comes to NFTs, the markets for certain tokens are illiquid and determining the actual value becomes hard.
For example lets take a scenario where, someone buys an NFT using ETH at the market value and later if there is no interest in the NFT, automatically, the value would drop beyond the initial level, making it highly volatile.
To manage this, some of the NFT collateralized lending platforms use a different Peer to Peer (P2P) lending model.
Borrowers can offer an NFT as a collateral and lenders can choose which NFT they can accept before issuing the loan. The NFT that is used as a collateral is held by an escrow contract that check if the payments are made regularly and if the borrower defaults on payments after certain number of times, the NFTs are transferred to the lender.
Beyond Lending on DeFi, Non fungible tokens can be used in other financial products such as Insurance, bonds and options.
NFTs related trades are growing at a faster pace, where nearly $100 Million worth of NFT backed trades executed, it is something to lookout for to earn a passive income.
Would you invest in some of the popular NFTs that are around? Let us know in the comments below.