(Bloomberg) -- In February, a 10-second video clip known as “Crossroads” by the digital artist Beeple sold at auction for $6.6 million. An animated image of a flying cat leaving a rainbow trail went for almost $600,000 that same month. A video of a LeBron James dunk sold for a mere $200,000. What do all these have in common? Each is an example of a non-fungible token, and the boom in digital art they have set off.
1. What’s a non-fungible token?
Think of them as digital certificates of authenticity. A non-fungible token, or NFT, is a unique, irreplaceable identifier created by an algorithm: A distinct barcode for a digital piece of art or collectible. It’s a solution of sorts to a problem that’s long faced digital artists: how to create scarcity for an item that can be infinitely reproduced. Uniqueness is the reason (ok, one reason) that the Mona Lisa is priceless, while a signed and numbered Peter Max print of his version of the Mona Lisa is $5,500 and Mona Lisa posters are $9.95. Money is fungible, meaning that any dollar bill serves its purpose as well as any other one. Images of the same GIF or meme are fungible -- unless yours comes with an NFT declaring it to be the “real” version.
2. How do they work?
When an artist wants to sell a work, they create, or “mint,” a NFT that will from then on stand as a claim on ownership for the piece. NFTs are registered on open blockchain ledgers, making it possible to track ownership (or as they say in the physical world, “provenance”), prior sales prices and the number of copies in existence. And the security provided by blockchain technology means that selling fake tokens is all but impossible, which can’t always be said of physical works even of famous artists.
3. Are NFTs new?
Not exactly. NFTs have been around for almost a decade. Colored Coins, Bitcoins with metadata added to them so they could represent more than just the currency, were perhaps the first example. But it wasn’t until recent months that the NFT market began to take off.
4. What set off the boom in the market?
It could be just your run of the mill mania. The boom has coincided with steeply rising prices in Bitcoin and other cryptocurrencies that have padded the digital wallets of crypto investors, for many of whom digital art is just as real as a Rothko on the wall. Some are racing to get in on the ground floor of something they hope will become even bigger. Here’s why that idea might be, at least partially, grounded in reality: Since the beginning of the pandemic, the sports collectible market has undergone a similar boom. A Mickey Mantle rookie card recently sold for a record $5.2 million, and auction houses are seemingly setting new records each month as people have flocked to at-home hobbies during lockdowns. For others, growing fears of inflation are a reason to diversify their investment portfolios. And pretty clearly, for some buyers it’s primarily about bragging rights.
5. Why are artists using NFTs?
The biggest reason is the creation of value through scarcity. Take Beeple for example: Before NFTs, any one of his works, once put on the internet, couldn’t be distinguished from the original. Another upside for creators is that tokens can contain a so-called “smart contract” that guarantees that the artist can reap the benefits of the secondary market. Beeple collects a 10% royalty every time one of his tokens changes hands, a practice that sometimes happens in the physical art world, but is hard to enforce because many sales are private. On the blockchain, the buyers and sellers can still remain anonymous or pseudonymous, but transactions will always be in full public view.
6. Are they just for digital art?
Nope. NFTs can be used for anything, including physical objects. There’s also a burgeoning market for sports collectibles: NBA Top Shot is a collaboration between the NBA and Dapper Labs, the Andreessen Horowitz-backed creator of the CryptoKitties game whose popularity brought the Ethereum blockchain to a grinding halt in 2017. Top Shot sells limited edition video “cards,” essentially short highlights from NBA games, and its packs of “moments” have been known to sell out in minutes. The best moments for the NBA’s biggest stars have sold on the application’s secondary market for hundreds of thousands of dollars. The rock band Kings of Leon is even releasing an album as an NFT. Buyers of that token will of course get the music, but they also gain access to exclusive artwork and, in a bridge to the physical world, a vinyl edition of the album. Even digital assets like tweets can be sold as NFTs. Twitter Inc. co-founder Jack Dorsey has put an NFT representing the first message on the platform (“just setting my twttr”) on the auction block. And they’re playing a growing roles in gaming.
7. How so?
NFT gaming has taken off in a big way, thanks to efforts like Axie Infinity. The game, which already has more than 1 million daily users, rewards people with a cryptocurrency for defeating other characters, and lets them ‘breed’ new characters represented by NFTs that can be sold to other players. Some people in the developing world now earn a living playing the game.
8. What’s in it for NFT buyers?
Uniqueness. And security: Buying a token from a verified artist, seller or auction house allows them to purchase a work without fear of fraud or forgery. The question of authenticity has bedeviled even the most venerable of real-world art dealers: Manhattan’s Knoedler Gallery went out of business in 2011 after being sued for selling millions worth of sham paintings made by a forgery ring based in Queens. Add to that that buyers of digital assets don’t have to worry about storage or preservation or fearing that they’ll accidentally put their elbow through a priceless work. And just like digital artists now being able to turn an unwitting public good into a private one, NFTs have made it possible for fans of the medium to actually purchase the works for the first time.
9. Is this purely for entertainment?
No. NFTs are being developed for more utilitarian uses. For example, Walmart Inc. uses the technology for managing the supply chain for the food it sells. One area that is often cited as ripe for tokenization is real estate, where proving ownership of a property can sometimes be a frustratingly complex ordeal. By putting NFTs representing titles on a blockchain, the need for title insurance could be made obsolete.
10. What can go wrong?
Well obviously, the bubble can pop. And any owner of a cassette tape knows that not every technology sticks around. And any blockchain could potentially go down and theoretically orphan a slew of NFTs. But hey, there are Van Goghs, Picassos and Raphaels that may never be seen again as well. As with anything that lives on the internet, getting hacked is an ever present threat. If proper security precautions aren’t taken by exchanges or the owner of the NFT, they could wake up to an empty wallet one morning. While blockchains solve the problem of trust with their open ledgers, they don’t prohibit people from trying to pass of another artist’s work as their own. Then there’s the concern about the massive amount of energy that is expended to power blockchains, which could damper the demand for their adoption (although Ethereum supporters say planned changes to how transactions are verified will quell such worries).
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