Nonfungible tokens’ past, present and future explained
Nonfungible tokens — better known as NFTs — brought the cryptocurrency industry closer to the mainstream than ever last year. Though NFTs as we know them have existed since 2017, they exploded in popularity and went fully mainstream in 2021.
Major brands like Adidas, Nike, Gucci and Budweiser launched collections, while the world’s most renowned auction houses, Sotheby’s and Christie’s, held NFT art sales.
After an impressive year — during which NFT weekly trading volumes twice hit highs near $1.12 billion — the market has since cooled to levels last seen in July 2021.
But what exactly are NFTs? What are their applications beyond million-dollar JPEGs? Will this buzzy blockchain phenomenon have long-term value? Or are we seeing the bursting of the NFT bubble?
OKX Insights is here to fill you in. In this article you’ll discover:
- What defines NFTs: unique, blockchain-based data strings associated with files that include digital art, sports collectibles and in-game assets.
- Why most NFTs run on the Ethereum blockchain. You’ll learn how Ethereum’s breakthrough ERC-721 protocol allowed the creation of unique, irreplaceable (nonfungible) tokens.
- Which three features make NFTs unique and adaptable for multiple applications: Proof of ownership, interoperability and reduced counterfeit.
- How the public’s obsession with digital collectibles fueled explosive NFT growth. Between 2019-2020, the NFT market tripled, with total value of transactions increasing by 299% year on year to more than $250 million. Sales catapulted to $40 billion in 2021, a year that saw a Beeple NFT collage auctioned at Christies’s for $69 million and a bundle of 101 Bored Yacht Club NFTs sell for $24.4 million a few months later.
- When — if ever — NFTs will resurge. The NFT market was bolstered by VC funding in 2019, reshaped by decentralized finance, gaming and the art world in 2021 and has experienced a downturn in sales in recent months, as the overall crypto market turns bearish. The landscape continues to shift.
Fungible tokens and nonfungible tokens — what you need to know
People have been using fungible tokens for millennia. A “fungible” item is something that can be replaced by an identical something. Currency is a perfect example.
In ancient Rome, a denarius was a fungible token. Any denarius could be exchanged for another. Today, the same is true of a dollar — or a Bitcoin.
Nonfungible tokens, by contrast, are not equally exchangeable. Airline tickets provide a good example. All tickets are printed on the same paper, cut to an identical size and use indistinguishable typeface and ink. Yet, no two tickets are alike. Destination, flight time and passenger seating make each ticket unique. You can’t replace a cabin class ticket to the United States with a business class ticket to Japan.
The rise of the internet brought a new, digital class of nonfungible assets — think of domain names, e-tickets and social media account handles. Like their analog counterparts, digital nonfungible assets possess unique characteristics and are not interchangeable.
But the first generation of digital nonfungibles had limited use cases.
The blockchain changed all that.
The great disrupter: Blockchain-based NFTs
Although on-chain nonfungible digital assets existed before 2017, a new Ethereum token standard for NFTs was proposed via the project’s GitHub repository that year. ERC-721 enabled unique features beyond those of earlier Ethereum-based tokens, facilitating the tokenization of art, collectibles, intellectual property and more.
Before ERC-721 was accepted in early 2018, most Ethereum assets followed the ERC-20 token standard. The ERC-20 standard enabled the creation of identical tokens that today power thousands of decentralized applications. Examples include Uniswap’s UNI and the Shiba Inu ecosystem’s SHIB.
But ERC-721 tokens are different: They can’t be divided or fairly exchanged for another. And this gives these nonfungible tokens extraordinary and highly versatile properties. Today, the vast majority of NFTs are built on Ethereum’s ERC-721 standard.
NFTs — three groundbreaking benefits
Blockchain-based nonfungibility delivers three major benefits that have fueled NFT innovation and growth:
- Proof of ownership
- Reduced counterfeit risk
Combined, these factors create a platform on which to value an NFT. However, they are not the complete picture. Just like in physical artwork, scarcity, historical significance, community appeal and other factors make some NFTs more valuable than others and elevate the most sought after to the level of the so-called “blue chip.” For example, if there were 100 million Bored Ape Yacht Club NFTs, their average price would be considerably lower than it is today, regardless of the hype surrounding the collection.
While naysayers like to criticize NFTs — particularly those representing digital art — on the grounds that they can “right click and save” any online picture, on-chain tokens enable functionality beyond simply admiring the composition of pixels comprising an image.
At a base level, a creator choosing to represent their work using an NFT is effectively signing a piece. That doesn’t stop other people from looking at it or even setting it as their own profile picture. However, it does prevent them from enjoying some of the more innovative features NFTs enable. For example, an artist might airdrop an invite to an exclusive event to those individuals who have previously supported them by buying an NFT of their work.
Proof of ownership is coded in NFT DNA
Building on the ERC-20 standard, ERC-721 adds a metadata field enabling NFTs to represent artwork, collectibles, music, in-game assets and more. Like the ERC-20 standard, however, ERC-721 tokens are transferable between Ethereum addresses. The blockchain itself enshrines NFT ownership in much the same way that it does with fungible tokens like ETH.
As a public record of all previous transactions, the blockchain also provides a transparent history of NFT ownership. Every previous buy, sell and transfer is viewable on-chain.
Usually employing the ERC-721 standard — or later token standardizations — an Ethereum NFT is compatible with much of what is built on the network. This enables NFT interoperability with smart contract-based applications.
In the gaming world, this interoperability proves especially useful — and lucrative. It enables game developers to incorporate concepts found elsewhere in cryptocurrency, like staking to earn passive income, while ensuring the token holder retains ownership. Unlike traditional in-game items, digital goods represented by NFTs are not bound to a particular title. If an owner chooses, they can sell the item at an independent marketplace, use it in an entirely different game or even take a loan using it as collateral at an on-chain lending application.
Reduced counterfeit risk
NFTs’ record of ownership also helps reduce the risk of counterfeiting. The tokens’ provable authenticity is especially useful in the art world. By referencing its history, it’s easy to confirm whether the claimed artist did indeed create the token that references a piece. While there have been many examples of people minting NFTs of works of art they did not create, their provenance is easily checked on-chain. If the artist’s blockchain address created the token, the buyer can be assured of its authenticity.
A brief history of NFTs
For a snapshot of NFTs use cases — and a sense of how they may evolve in the future — it helps to look at their history thus far.
2012–2017: Early collectibles
Bitcoin-based Colored Coins
Introduced in 2012, Colored Coins are arguably the world’s first NFTs. Built on the Bitcoin network, Colored Coins are implemented in a number of ways — but as a high-level explanation, they are essentially tiny fragments of BTC that have little monetary value but are marked with metadata, making each potentially unique. The tokens could represent any number of real-world assets, such as stocks, bonds, property, other cryptocurrencies and more.
While Colored Coins laid the conceptual groundwork for today’s NFTs, the Bitcoin-based tokens were quickly eclipsed by applications built on Ethereum.
The beginnings of the CryptoPunk craze
Early 2017 saw the creation of CryptoPunks — collectible pixel artworks featuring a range of charmingly louche characters. Deployed on Ethereum, the collectibles were produced in a limited edition of 10,000 tokens and were free to claim. Each of the unique tokens stored its essential properties and proof of ownership on the blockchain. Although they were not the first NFT project launched on Ethereum, CryptoPunks created a blueprint for subsequent collections to follow — and, years later, there has been no shortage of projects attempting to cash in on the hype the Punks created.
The cult of CryptoKitties
Following on the heels of CryptoPunks, CryptoKitties took the early NFT space by storm throughout late 2017. Started as a blockchain experiment, the game quickly went viral.
Fusing the power of tokenization with the collectible appeal of Beanie Babies, CryptoKitties are unique digital cats that owners can breed. The distinctiveness of the Kitties’ offspring is determined by an on-chain algorithm written within a closed-source smart contract.
CryptoKitties’ breeding and trading mechanisms — combined with the internet’s general fondness for felines — made them instantly popular. Users could buy cats, breed them to make their own purr-fect Kittie and sell rare Kitties for profit. A frenzy of trading activity on secondary markets drove Kittie prices sky-high.
But the CryptoKitties craze exposed a weakness that continues to plague Ethereum to this day: its lack of scalability. The rush to breed Kitties led to dramatic increases in daily transactions on the Ethereum network. Coinciding with late 2017’s bull market top, the congestion forced miners to raise the maximum gas limit permitted per block controversially. In January 2018, daily Ethereum transactions reached a new record high of 1.35 million.
At their peak, CryptoKitties buying, selling and breeding made up 25% of Ethereum activity, creating a pool of pending transactions. From late November to early December 2017, the average number of daily pending transactions rose from less than 2,000 to around 11,000.
Users who wanted prompt transactions — and who could afford it — paid higher gas prices for miners to prioritize their transactions.
2018: VC investments fuel NFT growth
As CryptoKitty fever cooled in 2018, NFT action shifted to new use cases.
Spinoff CryptoKitties games emerged early in the year. Built on top of CryptoKitties by third-party developers, KittyRace lets owners race their CryptoKitties against each other, with winners scoring ETH prizes. Another game, KittyHats, allowed users to accessorize their Kitties with an array of fedoras, berets and other whimsical hats. And Wrapped Kitties let owners convert CryptoKitties into fungible ERC-20 tokens that could be traded on decentralized exchanges.
Venture capitalists soon entered the NFT space with an eye for lucrative opportunities. In 2018, CryptoKitties’ developer, Dapper Labs, received two rounds of funding totaling $27 million from investors, including Andreessen Horowitz and Samsung Next.
Legacy art auctions dip a toe in NFT waters
Noting decentralized art exchanges’ domination of NFT art sales, traditional art auctions sought their own piece of the pie, streamlining their operations with blockchain technology.
In November 2018, auction house Christie’s took the lead in art auction blockchain technology with Artory. The new service provided digital certificates to art buyers in a sale that generated $300 million for artists’ works, including those by Georgia O’Keeffe and Edward Hopper.
Later, on Oct. 8, 2020, Christie’s launched its first NFT auction for the Bitcoin-inspired artwork “Block 21,” which sold for $131,250. The following year, both Christie’s and Sotheby’s took a more central role in the emerging NFT sector with high profile sales of CryptoPunks, Bored Apes and the acclaimed digital artist Beeple.
2019: Tokenization of intellectual property
The possibilities — and profitability — of tokenized intellectual property soon attracted the interest of enterprise and sports companies.
The racing world’s NFT fast track
In 2019, the auto racing giant Formula One partnered with Animoca Brands to develop a blockchain-based racing game called F1 Delta Time. On May 24, the game issued its first one-of-a-kind virtual F1 car, the “1-1-1.” After a four-day auction, the digital collectible was sold for 415.9 Wrapped Ether — then worth $113,000 — making it the highest NFT token sale of 2019.
Riding on the success of F1 Delta Time, Animoca Brands and Dapper Labs secured a licensing agreement with MotoGP with a plan to issue another blockchain-based racing game in the near future.
Sports NFTs and tokenized Trekkie swag
Seeing the appeal of digitized sports collectibles, trading-card company Panini America entered the NFT arena. In January 2019, the company launched blockchain-based sports trading cards featuring players from major professional leagues and associations.
Legacy brand Star Trek also made its NFT debut in June 2019. With an eye on the lucrative Trekkie fan base, blockchain game developer Lucid Sight introduced the cult classic franchise’s iconic starships and other collectibles onto the blockchain.
2020: NFT entrepreneurship in DeFi, gaming and art
In 2020, the worlds of decentralized finance, gaming and art awoke to the possibilities offered by NFT technology.
DeFi meets NFT
As NFT activity heated up in 2020, the crypto space also saw the explosion of decentralized finance. A vast range of DeFi products and services came to market in 2020, with the total value locked to DeFi applications growing from less than $700 million in January 2020 to almost $16 billion in December 2020.
NFT harvest for yield farmers
In spring 2020, DeFi credit markets began offering coin owners an enticing new way to earn passive income. Called liquidity mining — now often referred to as yield farming — the practice enabled traders to contribute crypto assets to liquidity pools and lend out digital currencies to generate returns.
Ever on the lookout for new liquidity investment opportunities, yield farmers soon turned their attention to NFTs.
Rarible’s community-centric coin
The community-owned art marketplace Rarible was a pioneer in NFT yield farming. In July 2020, Rarible released RARI, a governance token enabling holder participation in protocol decision-making.
RARI tokens are distributed weekly, with 50% of the rewards going to NFT buyers and 50% to sellers on the platform. An immediate success, RARI’s price soared 814% in its first two months, leading to Rarible’s capture of 81% of 2020’s overall $7 million NFT market.
MEME: The tweet that launched a token
Rarible’s spotlight was quickly stolen in September 2020 by MEME, a project that integrated DeFi and crypto-collectibles with its token of the same name. What started as a tweet satirizing yield farming, MEME was born just hours later — with trading volumes hitting $1.2 million the same day.
Notwithstanding the project’s slogan “Don’t buy MEME” — or maybe because of it — MEME’s popularity snowballed, with MEME reaching a market cap of $48 million by late September 2020. Since then, the MEME team has also collaborated with digital artists to allow users to stake their MEME to become eligible to mint NFT artwork.
Got game: NFT in-game assets
With its digitally native players and competitive incentives, gaming was another industry ripe for NFT disruption.
Traditionally, gamers play with in-game assets stored on a centralized server. The game’s developers allow gamers to use the assets, but users don’t actually own their items.
With its ability to record ownership and other details, the blockchain upends gaming’s developer–user power dynamic, enabling users to take possession of their own in-game items.
While a completely decentralized blockchain game could be slow and clunky for players, gaming companies considered using the technology to process gaming transactions while retaining the actual gaming mechanics on a centralized server.
Yat Siu, the founder of Animoca Brands, believes that gaming companies can now offer genuine economic benefits to players through NFTs. “NFTs confer true digital ownership and make it possible to deliver real property rights to gamers,” Siu told OKX Insights. “This is similar to offering trading and virtual banking services for your gaming assets.”
Siu also commented on the increased integration of gaming NFTs within the DeFi ecosystem:
“Because NFTs are, in essence, real assets, you can start applying real-life principles — such as loaning or renting the assets. In F1 Delta Time, we allow for the staking of race cars, which can be rented to other players for use in the game.”
Animoca rewards its most successful players. Siu notes that the remuneration is “calculated on the amount you stake, so we are combining yield farming with some fun. Everyone who stakes our REVV token can get a yield, but the best players get a better yield! We have seen players band together and form teams, with some providing financing and letting those who know how to play the game better to race and share profits.”
The art of the deal: NFTs and the art world
Historically accessible only to the rich and privileged, the art world got a blockchain-powered shake-up in 2020, too.
Poor pricing transparency, murky authentication and fraud have long plagued art marketplaces. In fine art circles, more than 50% of all art is forged or not attributed to the correct artist, according to a 2014 report by the Fine Arts Expert Institute.
Art’s ambiguous provenance is most frequently the fault of improper art transaction documentation. Artists and private collectors sometimes do not document art transfers with formal legal agreements. Buyers seldom conduct proper due diligence on the artwork they purchase.
In correspondence with OKX Insights, blockchain artist CryptoZR explained the complexities of art authentication — and the differences in documenting traditional versus digital art.
“The provenance of traditional artwork is conducted offline, which often requires the assistance of third parties. […] Experienced artists, exhibitors and commentary experts can help to determine the authenticity of the artwork,” says CryptoZR. But for blockchain artworks, “the provenance process is conducted online.”
Using blockchain technology, each transaction in an artwork’s history is recorded in a block, which appends to the previous block. Resistant to censorship by design, these transactions can be traced back to the original transaction in which the token was created.
This provenance transparency helps establish trust among buyers, sellers and collectors.
The blockchain has also supported the creation of new artwork communities and marketplaces. According to CryptoZR:
“Traditional artwork had a mature ecosystem for centuries — ranging from the artwork’s creation and auction mechanisms to art exhibitions and galleries. The advent of blockchain led to the rise of a tokenized art market, decentralized art exchanges and virtual artwork exhibition, which brings a new ecosystem to the art industry.”
As well as establishing authenticity and provenance, NFTs may prove a democratizing force in the art world. Traditional art is available almost exclusively to wealthy patrons and investors. Tokenized artwork, with its expanded world of creators and possibilities for fractionalized ownership, opens art collection to a broader and more diverse range of collectors. It also eliminates the need for intermediaries, creating a closer relationship between artists and collectors.
Decentralized art exchanges
As interest in tokenized art surged in 2020, marketplaces rose to meet demand. As well as eliminating overhead costs of real-life art galleries, digital platforms like Blockchain Art Exchange and Ethereum-based platform DADA offer buyers the convenience of cryptocurrency as a payment option.
Primarily driven by decentralized art exchanges, online art sales are forecast to grow from $7.9 billion in 2020 to $9.32 billion by 2024.
NFTs in 2021, 2022 and beyond
With the groundwork laid in previous years, NFTs hit the mainstream in 2021 in a big way. Having launched publicly in late 2020, NBA Top Shot introduced the niche to users outside of typical cryptocurrency circles. January 2021 saw monthly volume for the licensed digital basketball collectibles surge to more than $40 million, up from less than $900,000 during the previous month. Volume peaked in February that year at $224 million and remains in the tens of millions today.
The hype wasn’t limited to NBA Top Shot, though. With its own monthly volume rising into the millions during late 2020, CryptoPunks exploded into 2021 as wealthy buyers sought to secure a piece of NFT history. Among them were rap star Jay-Z and even legacy payment processor Visa.
Within a plethora of copycats inspired by CryptoPunks was the Bored Ape Yacht Club — a generative art project featuring 10,000 unenthused primate portraits — which Yuga Labs launched in April 2021.
Whether it was the quirky art style — which contrasted the largely pixel-art profile picture projects before it — the instant utility of being able to scribble on the online clubhouse’s bathroom walls, or something else entirely, BAYC quickly drew mainstream attention. Already sold on the concept of NFTs, thanks to NBA Top Shot, basketball stars were among the club’s first celebrity members. As of early 2022, Paris Hilton, Eminem, Jimmy Fallon, Shaquille O’Neal, Post Malone and several other A-list stars have joined BAYC.
BAYC’s success appeared to validate the value proposition of collections outside those officially licensed by existing franchises or those with historical significance, leading to another speculative mania. During the summer months this year — even as crypto’s fungible token markets bled — profile-picture projects like Pudgy Penguins found relative, albeit brief, success in a market hungry to spot the “next BAYC.”
Further validating not only CryptoPunks and BAYC but NFTs generally were high-profile sales held by established auction houses. Sotheby’s and Christie’s both sold NFTs at various events during the year. Perhaps the most significant sale came in February 2021, when “Everydays: The First 5,000 Days” by Beeple went under Christie’s hammer. A final sale price of just over $69 million made the Wisconsin-born digital artist’s piece the third most expensive by a living artist ever.
In addition to various celebrities picking up NFTs from the most sought-after collections, mainstream brands entered the NFT space during the year. Perhaps most significant of all was Nike’s late 2021 acquisition of digital sneaker firm RTFKT. Part of a broader metaverse push, the sports brand’s CEO, John Donahoe, commented on the move:
“Our plan is to invest in the RTFKT brand, serve and grow their innovative and creative community and extend Nike’s digital footprint and capabilities.”
Another major development for NFTs away from strictly digital artwork for the explosive growth of the GameFi title Axie Infinity. Created by blockchain gaming startup Sky Mavis in March 2018, a shift from the Ethereum blockchain to the designated Ronin sidechain in 2021 enabled users to play the game and enjoy its play-to-earn functions without the burden of excessive fees. This move saw Axie adoption grow massively, particularly among users left struggling for work during the COVID pandemic.
Axie Infinity characters are each represented by an NFT, and a gamer must hold at least three to participate. As of the time of writing, Axie Infinity’s in-game assets have generated more than $4.14 billion in trade volume, making it one of the most successful NFT projects ever.
NFTs and their haters
As NFTs picked up mainstream momentum during 2021, it became clear that not everyone was convinced. Indeed, opposition to the technology forced some companies to reconsider their NFT plans.
In November 2021, the digital-communication platform and meeting place for many NFT communities, Discord, teased a MetaMask integration via Twitter. Immediately, anti-NFT Discord users let the company know that they were not supportive of the move, with many posting screenshots of them canceling premium memberships to the platform. Later the same week, Discord announced that it did not plan to integrate NFTs after all.
Those opposed to NFTs often cite the ability to save an exact copy of any digital artwork as justification. While it is true that anyone can “right click and save” digital images, the argument ignores the additional utility many NFTs have. Some grant their holder the right to represent themselves as their NFT in metaverse worlds. Others provide access to exclusive content in Discord servers. Some enable real-world benefits like discounts at partnered companies or invitations to events. Similarly, the argument ignores the fact that NFT sales can provide a revenue stream for digital artists who may have typically struggled to monetize their work.
Another bone of contention raised by NFT haters is the environmental impact of the Ethereum network’s current proof-of-work consensus mechanism. Requiring high-powered computer systems to support a network, proof-of-work does indeed consume a lot of energy. However, such reasoning glosses over the fact that Ethereum is in the midst of an ongoing upgrade to a proof-of-stake consensus mechanism, which will reduce the network’s energy consumption dramatically. Additionally, NFTs on Solana, Flow, Wax and other networks have never relied on proof-of-work but rarely receive due consideration from those most opposed to the technology.
While the NFT sector continues to expand regardless of criticisms, it will be interesting to see if Ethereum’s pending update will successfully appease naysayers. Following the merge — scheduled for later in 2022 — the network will operate only with a proof-of-stake consensus mechanism. It will, therefore, be challenging to make a solid anti-NFT case on environmental grounds alone.
Are NFTs here to stay?
Despite the backlash from particularly vocal NFT naysayers, 2022 is already shaping up to be another strong year for NFTs. Monthly volume at OpenSea, the most popular NFT marketplace today, hit an all-time high of $5 billion for January, helped in part by the success of newer projects like the anime-inspired Azuki collection. Launched on Jan. 12, 2022, Azuki is already closing in on a total volume of 120,000 ETH in its first 40 days alone.
Naysayers often focus on NFTs’ digital art application and miss the bigger picture. NFTs are increasingly finding utility beyond what some consider overpriced JPEGs. Event ticketing, for example, is rife with counterfeiting. Representing a concert ticket with an NFT would make forging tickets impossible as only those NFTs issued by the organizer’s contract would grant entry to a venue. Startups like GUTS Tickets and Mintbase are developing NFT ticketing systems. The clear advantages of such a system make them likely to see widespread adoption and, if abstracted into the background, end-users may not even realize they are using a blockchain-based token at all.
Music represented by digital tokens is another area that currently looks primed for mainstream adoption. Last year, indie rockers Kings of Leon released their latest album via NFT. Then, this February, rap star Snoop Dogg announced that Death Row, the iconic record label founded by Dr. Dre and Suge Knight, would be releasing music via digital tokens. As reported by Fortune, Dogg commented:
“Just like we broke the industry when we was the first independent to be major, we want to be the first major in the metaverse.”
Given the extensive application of unique digital tokens — which, after all, is all that an NFT is — it seems doubtful that the technology will drift into obscurity. From in-game items to digital tickets and metaverse wearables, NFTs enable new forms of interaction and digital representation. Dismissing the technology entirely because you think digital artwork and collectibles are currently overvalued would be akin to writing off the internet in its early days because a speculative bubble formed around URLs like Pets.com. As the technology matures and provides new utility not previously possible, NFTs will likely become a part of everyday life, just as once farfetched ideas like online shopping have today become the norm.
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