The Growth of NFT Markets: Opportunities and Challenges
The non-fungible tokens (NFTs) market is exploding at the moment. In under five years, it has grown from nothing to a capitalization of over US$35 billion. Jefferies, the New York-headquartered multinational investment bank, projects that the market will cap at over US$80 billion by 2025.
Meanwhile, we are increasingly witnessing NFT art pieces being auctioned at extremely high prices. For example, in early December 2021, The Merge, an NFT art piece created by an artist who goes by the pseudonym Pak, sold on NFT marketplace Nifty Gateway for USD 91.8 million.
Even traditional art auction houses are getting involved. In March 2021, Christie's, the British auction house founded in 1766 and one of the most prominent houses globally, facilitated the sale of the NFT art piece titled Everyday – The First 5000 Days by Beeple for US$69 million.
The roots of NFTs
The history of NFTs goes back to the early days of Bitcoin. In March 2012, Yoni Assia, the co-founder of the Etoro trading platform, published a blog post explaining the concept of colored coins. He stated that the idea came to him while exploring the potential of MasterCoin, another blockchain.
It occurred to him that while all bitcoins were inherently the same, it was possible to give a coin unique characteristics by adding to it some metadata. This coin could then not only become unique but also serve a particular function. Assia called coins on the Bitcoin blockchain with unique metadata ‘colored coins.'
What that means exactly is that a particular coin on blockchain could be given details of a real-world asset, and then it could represent it in transactions. For example, details about a real estate property or a vehicle could be added into a colored coin, giving it the capacity to serve as a digital land title or car logbook.
There is a small community of bitcoin enthusiasts still committed to improving the functionality of colored coins. Those in this community believe that the Bitcoin blockchain, owing to its robustness, offers the best security when it comes to managing different kinds of real-world assets compared to other blockchains. Meanwhile, other blockchains have come along and made it even easier to create and manage unique assets on the blockchain.
In 2014, two developers, Kevin McCoy and Anil Dash, created Quantum, a piece of digital art on the Namecoin blockchain. The Quantum is often cited as the first NFT to ever be minted. However, it was only in 2021 that the creators decided to auction the artwork.
The Ethereum era
When Ethereum was launched in 2015, it brought new capabilities of designing, launching, and managing other forms of assets on the blockchain. This was especially possible thanks to Ethereum’s smart contract feature.
However, the term 'non-fungible tokens' (NFT) did not become widespread in use until 2017. That is when the community around the Ethereum project, in particular developers, decided to come up with the rules on how to build and run non-fungible assets on the blockchain. These rules were called the ERC-721 standard.
The ERC-721 standard is similar to the ERC-20 standard, which guides the creation and management of fungible tokens and cryptocurrencies on the Ethereum blockchain. But what exactly does it mean for an asset to be fungible?
All units of a particular asset created under the ERC-20 standards are the same and can be interchanged easily. They are fungible. For example, it does not matter what particular ETH is sent to you, just like it does not matter what $100 bill is given to you as long as it is legit. One $100 bill can replace another, and the nature of the transaction is not considered to have changed.
Meanwhile, each unit of the asset created under the ERC-721 is unique from the rest, and one cannot replace another. They are non-fungible. In this case, it matters which particular asset you receive, like it matters what particular land title is given to you. Each title has a different name, property size, property location, and other details. If a title in a transaction is replaced with another, the transaction is considered to have significantly changed.
Other blockchains have their own standards for creating, issuing, and managing NFTs. For example, Binance Chain has the BEP-721 standard.
The first NFTs that went viral were Cryptokitties, virtual cats on the Ethereum blockchain one can buy, breed like they would real-world cats, and sell. The rarest breeds cost more than those that are a little more common. The project was launched in late 2017. Its presence was felt when its transactions clogged the Ethereum blockchain making it harder for other transactions to go through, and shone the light on the urgent need to scale blockchains so that they could be suited for mass adoption. Since then, we have seen the development and launch of all kinds of different types of NFTs. They range from artworks, in-game assets to ownership of real-world assets.
We have also seen the development of marketplaces where these assets are generated and easily traded. The biggest NFT marketplaces include:
- Nifty Gateway
- Axie Marketplace
- NBA Top Shot
- Theta Drop
Meanwhile, the list of blockchains that support NFTs is also growing. Other blockchains that support the creation of NFTs include Binance Chain, Cardano, Tezos, and Solana. They differentiate themselves from Ethereum and each in many ways. The most highlighted is being eco-friendly. The majority of the alternatives are designed not to consume as much energy as Ethereum to mint and manage NFTs.
The rise of the Metaverse
The second phase in the growth of the NFT market might be what has been called Metaverse, a name taken from Snow Crash, a 1992 science fiction novel by the American writer Neal Stephenson.
While there is not yet an agreed simple definition of a Metaverse, it is generally considered 3D virtual worlds that easily interface with the real world. These virtual worlds also have social connections and interactions as a critical component.
Many believe this is where the internet is moving to next. Indeed, major technology companies seem to be preparing themselves to take a central role in facilitating the mainstreaming of the Metaverse. In October 2021, Facebook, the company, rebranded into Meta, a sign that they want this new technological architecture to be part of their DNA.
In the Metaverse, ownership of assets is a critical component, and that is where NFTs come in. In the virtual world of the future, people can buy and sell anything from land to art pieces. They can also grow crops and breed animals. They can even do work that impacts the real world.
Opportunities in NFTs
It is still early days in NFT, but we can already see a lot of opportunities the technology provides to individual users, businesses, and communities. So far, the most success has been witnessed in digital art such as memes, pictures, and videos.
We are also witnessing some startups combining traditional financial services with NFTs. For example, ClubSwan creates and issues payment cards whose designs are secured on the blockchain as NFTs.
Why is it revolutionary to have digital art as NFT? Indeed, we can own and consume digital art even without blockchain.
NFT is revolutionary for digital art because the technology helps us overcome the double-spend problem.
The reason physical art pieces can become very valuable is not only because of the painting or sculpting but also because when you buy one, you are almost assured it is the only piece and copy of its kind in existence.
However, when the art piece is digital, it can be multiplied to infinity. That is because when you send someone a copy, you retain a copy, which you can send to more people. The people who receive a copy can also send it to others and still have copies. The sharing of digital art can easily lead to millions or even billions of copies in circulation.
It is impossible to tell the original copy from all those copies. While you can pay US$100 million for a rare physical painting, you will be hesitant to pay such an amount for a piece of digital art that everyone can easily receive a get a copy of through WhatsApp. Thanks to blockchain technology, however, now a digital art piece can be owned by only one person at a time, just like physical art pieces.
Blockchain technology has made it possible for a digital piece of art to have the same qualities as a physical piece of art. When you sell a digital piece of art as NFT, you don't retain a copy. There is also a clear provenance to verify the rightful owner at each point. This means the art can be owned by one person at a time, making it just as unique as a physical painting.
Besides managing digital art, NFT can facilitate ownership of real-world assets such as land through digitized documents. Already a few startups are building solutions that will make land titles NFTs on the blockchain. Even the United Nations Development Programme (UNDP) is building land registries on the blockchain.
What that means, with the right legal environment, buying an NFT can translate to buying the actual physical property attached to it.
Another area where NFTs prove revolutionary is in the gaming industry. Most video games involve players owning virtual weapons, skins, and even land. However, with the games hosted on servers owned by the companies that run the gaming environment, the players don't fully own these assets.
If the assets are created on the Blockchain as NFTs, the players have true ownership. That means no authority can take the assets away from them. Even when the servers are shut down, the players can easily move their assets to other gaming platforms.
Even though the NFT concept is powerful and solves many critical problems in various industries, it will not be a smooth journey to mass adoption for it. This application of blockchain technology has to overcome several challenges. The following are some of the challenges:
- The right legal environment
For some of the use cases of NFTs to be viable, laws must be changed, and in some cases, significantly. For example, for land titles as NFTs to be enforceable even outside of the blockchain, those transactions must be recognized by the existing legal system.
Still, concerning the legal environment, the law should recognize sharing and transfer of NFTs, especially regarding digital art as also sharing and transferring the copyright.
Today, a transfer of NFT does not necessarily convey copyright transfer. It does not prevent the creator from designing an identical piece or even claiming the art copyright they have already transferred to others on the blockchain. In that sense, today's NFT is merely proof of ownership separate from copyright.
- Impact of NFT on environment
Today many are uncomfortable getting involved with NFTs because they have been made to believe they contribute significantly to the destruction of the environment. This is a narrative that has to be overcome through innovation and creating awareness. The origin of this narrative is the fact that Bitcoin, the first application of blockchain technology, consumes a significant amount of energy through the Proof of Work (PoW) consensus protocol.
While the mainstream media has stuck on this part of what blockchain technology is about, the technology itself is moving on for the most part. Most of the newer blockchains are designed to use the less energy-intensive consensus protocols, particularly the Proof of Stake (PoS).
Indeed, the Ethereum blockchain where the most activity around NFTs is happening is in the process of transitioning to the proof of stake consensus. While NFT is becoming more detached from blockchain contribution to greenhouse emission, the narrative that it is a major contributor might take a while before it is abandoned. Meanwhile, it is still a challenge to overcome.
- Scams and poor execution
The NFT industry has to overcome the association with scams. Given that most people don't understand how NFTs work but are getting signals that it is the new way to make fortunes, they easily become victims of frauds on the internet who hide behind the technology.
Also, poor positioning and placement of NFTs could make it difficult for the mainstream to embrace them. For example, in December 2021, Ubisoft, a leading video game company, announced plans to make NFTs available on their platform. This news was not well received by the players.
Nicolas Picard, VP at Ubisoft's Strategic Innovations Lab, attributed the backlash to the announcement from players to the lack of understanding of the problem NFTs could solve or the value they could add to their experience.
Despite all these challenges, NFTs are here to stay. The technology has a lot of value to offer across industries.
Image courtesy of Pixabay.
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