Although NFTs have a variety of uses, their most well-known and widespread application so far is ensuring the ‘digital scarcity’ of digital art and collectables.
The very characteristic that gives them their name, non-fungibility, ensures that each token is unique. This makes NFTs perfectly suited to representing the ownership of digital artworks and collectable items, which are otherwise so easily copied or appropriated.
NFTs also help with tracking the provenance of digital artwork, a process that can be obscured in the ‘real world’ but is made completely transparent via blockchain records.
Just as in the world of traditional art, collectors of NFT artworks may buy individual pieces purely on artistic merit, because they are a fan of the artist, or as an investment. Unlike the traditional art world, however, many NFT artworks are produced by a technique known as generative art. Generative art uses algorithms programmed by the artist, either to produce the entire artwork or assemble an image from a number of predetermined characteristics.
Most of the best-known NFT art projects, such as Cryptopunks or Bored Ape Yacht Club, are series of thousands of algorithmically generated portraits, often used as social media profile pictures (PFPs) by their owners. Each ‘punk’ or ‘ape’ has certain traits, and each trait is assigned a certain level of rarity which usually influences the value of the NFT.
These PFP collections are hugely popular and the NFTs are highly sought after, commanding high prices on marketplaces such as OpenSea. There are a variety of reasons why one might be prepared to pay such high prices; perhaps the buyer feels a particular affinity to a certain ‘Ape’ or ‘Punk’, they may want to use it as their PFP to assert social reputation, or they could just be buying as an investment.
The cheapest sale of an NFT in a given collection, usually one with the most common traits, defines the ‘floor price’; the lowest price at which an NFT from that collection can be bought. The difference between the floor price and the price at which rare examples sell for can be enormous.
Given the speculative nature around NFTs, the launch of a new collection often generates considerable hype as speculators rush to get their hands on what could be the next big thing. Generally, when a project launches, users are able to create, or ‘mint’, an NFT for a flat fee. This is because the traits are not revealed until the token is created; and common and rare examples cost the same when they are minted.
Unless a whitelist of approved buyers is in place, most collections are minted on a ‘first-come, first-served’ basis. The chance to mint an NFT for well below the potential future floor price can lead to a battle between users to mint before the whole collection is gone. After that, the NFTs can only be bought on the secondary market, often for much higher than the mint price. This race is often referred to as a ‘gas war’ as users are willing to pay high gas fees to quickly secure an NFT, congesting the entire blockchain in the process. The potential profits to be made by ‘flipping’ an NFT on the secondary market, however, is worth the risk to many.
To combat this, a Dutch Auction model is sometimes used to launch NFT collections, in which a high ‘ceiling price’ is set, at which potential buyers who are willing to pay more can buy straight away. This price gradually drops over time until reaching the ‘resting price’, unless the collection sells out before then. This way, the extra money that panicked buyers are willing to spend in a gas war goes to the artist or project, instead of going to miners, and network congestion is reduced.
NFTs can be of benefit for artists who are able to get paid directly and have complete control over their work, without having to rely on the approval of a mainstream gallery or critics. NFT artworks can also be designed to take royalties on future sales, which get paid back to the artist over time. However, anyone can list an NFT and there have been cases of people selling artist’s works without permission. Any legitimate NFT should be verified or endorsed publicly by the artist that produced it. If not, it is essentially worthless.
This does not stop bad actors, however, and the potential to ‘get rich quick’ that NFT collections have become known for leads to endless copycat projects, scams, pump-and-dump schemes and phishing attacks. Unsurprisingly, using NFTs as rare and valuable status symbols is a quick way to become a target, just as in the ‘real world’.
As well as visual art, NFTs exist for all types of media and status symbols that can be linked to digital ownership. Examples of NFT issuers include musicians, fashion designers, and other collectables such as trading cards, which may themselves be linked to NFT-based games.