Everything You Need to Know About NFTs

Everything You Need to Know About NFTs

In this article, we’re digging beyond the NFT hype and covering everything you need to know about NFTs.

Introduction

Non-Fungible Tokens (NFTs) are taking the world by storm. Celebrities such as Steve Aoki and Jay-Z are proudly displaying their NFTs as their profile pictures on Twitter. Mainstream brands like Adidas and Nike have entered the space. Adidas raised $23M by launching their own NFT collection, which acts as an access pass to exclusive physical and digital Adidas drops. Nike acquired RTFKT, a virtual design studio in the NFT space, to make headway into the metaverse. NFTs are getting auctioned off at Sotheby’s and Christie’s for millions of dollars. 

With the ever growing mainstream adoption of NFTs, it’s becoming increasingly difficult to ignore this rising wave. In this article, we’re digging beyond the hype and covering everything you need to know about NFTs. 

What are NFTs?

Non-Fungible Tokens or NFTs for short are crypto tokens that are unique and represent a non-interchangeable set of metadata that’s stored on a blockchain. Fungible tokens, on the other hand, are interchangeable. Tokens such as Bitcoin and Ethereum are examples of fungible tokens. 1 Bitcoin = 1 Bitcoin and users are indifferent between the exact bitcoin which they are purchasing or receiving. Each NFT is uniquely identifiable and in most cases users would care about the exact NFT that they are purchasing or receiving.

Blockchains are digital ledgers that are distributed and decentralized. They are made up of blocks of data that are chained together in chronological sequence. The most commonly used blockchain for NFTs today is Ethereum. We’re also starting to see the rise of niche blockchains such as Flow and Ronin that are built with NFTs and gaming in mind. 

The metadata for the NFTs are found in smart contracts which are stored in the blocks on a blockchain. A common misconception about NFTs is that the image displayed or JPEG that represents the NFT is stored on the blockchain. While that is true for a small handful of projects (Anonymice, Chain runners), most projects store the image on an external storage platform (IPFS, Arweave) and the metadata on the blockchain contains the link to that image. The cost of storing an image on the blockchain is extremely high due to the file size of an image, making it uneconomical for projects to be fully on-chain.

What Problems do NFTs Solve?

The internet solved problems of the physical world by digitizing everything. It’s easier than it has ever been to have infinite scale and connect with a global audience. The cost of distribution has been massively reduced as well - newsletters vs newspapers. However, it lacks the benefits of the physical world. Ownership and scarcity is almost non-existent and the ability to authenticate digital assets is much harder compared to physical goods. As much as “right-click and saving” a NFT is a meme, it’s reflective of the current state of the internet. There are no ownership rights and little value accrual for digital assets. 

At its core, NFTs offer proof of ownership that is missing in digital economies today. It has created the ability to combine benefits of the digital world: a global audience, scale and distribution, with benefits of the physical world: ownership and authenticity. 

Before the rise of NFTs, it was difficult for digital assets to accrue and capture value. This makes it extremely cheap as a user but bad for creators. It’s difficult to trace and attribute real ownership on the internet today and NFTs fix that. Creators are more accurately rewarded for their work and are able to extract a larger proportion of the value that they create. Users benefit by being able to gain ownership over digital assets and have the ability to easily trade and value them. Being an early fan of the world’s biggest band today gives you no added benefit but with NFTs there’s the potential for consumers to be rewarded just by doing the things that they already do on a daily basis. 

NFTs Use Cases

Art

The most popular use case of NFTs are NFTs as collectable art pieces. NFTs have given artists a way to easily sell their art to a global audience while ensuring ownership rights. Art NFTs can be broadly split into two categories: Non-Generative Art and Generative Art.

Non-Generative Art

Non-Generative art pieces are what we commonly think of when we think of art. They are created by human beings without the aid of an autonomous computer system. Digital artists are able to list their work on NFT marketplaces and anyone from anywhere in the world can view and purchase their work. In the traditional market today, artists are only able to earn from the initial sale of their work. NFTs give artists the option to embed royalties into the smart contracts of their work. This gives them the ability to get a more equitable share of the value of their art work. NFTs make it easy to verify authenticity and ownership of art pieces and this is a huge benefit that the technology brings. Notable names in the space: Beeple, pplpleasr, ferocious, Pak.

Photograph NFTs are a rising use case for NFTs. Photographers are selling their work as NFTs and gaining similar benefits as artists who sell their work as NFTs. Justin Aversano is one of the most prominent names in the space. He made history when one of the NFTs from his “Twin Flames” collection was auctioned off at Christie’s. Popular marketplaces for such NFTs are Opensea, SuperRare, Foundation, Rarible and Nifty Gateway.

Generative Art

Beyond art drawn and created individually by artists, the rise of art NFTs has largely been due to generative art. Generative art is art that is created via the use of an autonomous computer system, usually an algorithmic computer program. Profile picture (PFP) collections such as CryptoPunks and Bored Ape Yacht Club (BAYC) were created with the aid of such programs. The creators do up the individual traits and the program randomly combines and creates unique characters by incorporating those traits. There are fully generative collections that are entirely done up by the computer program, with no human input beyond creating the algorithm. The most popular collections under this category would be sub-collections of Art Blocks such as “Chromie Squiggle” by Snowfro and “Fidenza” by Tyler Hobbs. OpenSea is the leading marketplace for generative art NFTs and LooksRare is a popular newly launched marketplace.

Types of Art NFTs

Credits to the respective artists Justin Aversano, Beeple, 309 Labs, Tyler Hobbs

Gaming

Art NFTs is the use case that has gotten mainstream attention, however, there is a collection that surpasses all art NFT collections in terms of sales volume. Axie Infinity, a NFT game, currently holds the crown (excluding wash trading on LooksRare). The integration of NFT technology with gaming has led to the creation of a new paradigm in gaming: Play-To-Earn/Play-And-Earn/GameFi. 

Read our full guide on Blockchain Gaming >

Top NFT Collections by Sales Volume

Source: DappRadar's NFT Page as of 03 Feb 2022

Axie Infinity was 2021’s breakout star and kickstarted the rise of Play-to-Earn (P2E). The game generated over $1.3B in revenue in 2021 and has over 2.5M daily active players. Unlike traditional games where the publisher earns revenue by selling assets to their players, Axie Infinity does so by taking a cut on marketplace transactions and breeding fees. Breeding is done by players to create new Axies. The team is incentivized to make the best game possible to grow the user base instead of being incentivized to sell assets to their users. 

Axie Infinity’s Cumulative Revenue

Source: Nansen as of 21 Jan 2022

The integration of NFTs in games offer players similar advantages as art NFTs, it gives players the ability to truly own their in-game assets. In-game items and even the characters themselves can be NFTs. In the case of Axie Infinity, the Axies that you are required to have in order to play the game are NFTs and in-game currencies are cryptocurrencies. In traditional games, money that flows into the game typically gets stuck within the game as players are unable to extract value from the game. NFT games give players control and ownership over their assets and they’re able to sell and cash out if they decide to do so. 

Flow of Value in Traditional Games vs Blockchain Games

Source: Nansen's State of the Industry Crypto Report (2021)

Music

Music NFTs are an emerging use case for NFTs. Just like Art NFTs, Music NFTs are key for artists to capture a larger portion of the value that they create. Artists typically only receive around 12% of the revenue that they create for the music industry. Daniel Allan, a producer/artist, sold a music NFT that he produced for 1.1 ETH on Opensea, an amount equivalent to 1.2M streams on Spotify. 

True fans are also empowered by this trend. They are able to support and own a copy of the work that their favorite music artist has created, directly from the artist. This creates new ways for artists to engage their fans at levels not easily achievable by existing methods. By being able to own original copies of an artist’s work, fans are able to have a stake in the future success of the artist. The artist gets rewarded more equitably and as a fan you get to participate in the upside of supporting an artist during their early days. Sound.xyz and Catalog are two projects that provide a platform for artists to sell their work directly to their fans. 

Sound.xyz’s Homepage

Source: sound.xyz as of 27 Jan 2022

Sports Collectibles

Sports NFTs are a growing and thriving use case of NFTs. Similar to baseball trading cards, sports NFTs allow fans to build a collection of their favourite teams and players. The two most popular projects currently are NBA Top Shot and Sorare. Both have official partnerships with the relevant organizations and have official licenses.  

NBA Top Shot essentially creates GIFs of key moments during NBA matches and bundles them randomly into digital card packs, with each moment being an NFT. Card packs are separated into different rarities depending on the player, significance and virality of the moment. The rarer the moment, the lesser the supply. Packs start at $9 for a pack of commons and go up to $999 for legendaries. Users are able to trade the NFTs on the NBA Top Shot’s official marketplace. A legendary dunk from Lebron James during the 2020 finals where they won a championship sold for $230k and is the highest sale so far. 

Sorare is what you get when fantasy football meets NFTs. Player cards are NFTs and rewards are paid out in ETH. Users are able to trade player cards over the Sorare marketplace. The benefits of Sorare are similar to that of NFT games, ownership over in-game assets and freedom to cash out and extract value from the game.

NBA Top Shot Marketplace

Source: NBA Top Shot as of 28 Jan 2022

Access Passes

Due to the ease of authentication and ability to verify ownership, NFTs can act as access passes. An example of such a collection is Flyfish club, which acts as a membership pass to a private dining club and Adidas’s collection that gives holders exclusive access to physical and virtual merchandise from the brand. While there are collections built with the sole purpose of being a membership pass, this use case is an overarching theme across many collections and all forms of NFTs can act as an access pass of sorts. 
Gary Vaynerchuk’s Flyfish Club NFTs

Source: Flyfish Club on OpenSea as of 28 Jan 2022

One key factor contributing to the rise of Art NFTs is the community supporting the project. Holders of the NFTs get exclusive access to certain discord channels and there’s a sense of camaraderie within the community. Large projects (BAYC) have had physical meetups and exclusive parties for people who own their NFTs. Holding certain NFTs might give you early access to launches of new NFT collections from the same team or via partnerships with new projects. Similar to the Adidas NFT, some collections (BAYC, Creature World) have released their own physical merchandise and holders of the NFT were given early/exclusive access. Music artists and games are able to offer holders of their NFTs similar perks.

Decentralized Autonomous Organizations (DAOs) and gaming guilds are another area where NFTs can act as access passes. Ownership of the relevant NFTs will give you exclusive membership access and can serve as a voting token. Yield Guild Games is an example of a gaming guild that uses NFTs in such a manner. Holders of the NFT are able to access exclusive features on the website and sign up for various programs in the guild. 

Creating NFTs

There are tons of ways to create an NFT, you can do it manually or with the aid of systems created by NFT marketplaces such as OpenSea and Rarible. Beyond the technicalities of creating a NFT, an important thing to consider is the blockchain that you want to build your NFT on: Ethereum, Solana, Avalanche, Polygon and the list goes on. Different blockchains have different trade-offs and communities which can have a large impact on the success of your project. 

OpenSea has a great guide on how to easily create your own NFTs on Ethereum using their platform here.

Buying NFTs

The largest marketplace in terms of transaction volume is OpenSea and it will likely be where your NFT journey begins. While most popular NFT collections today are built on Ethereum, there are thriving projects on other blockchains such as Solana, Terra and Polygon. Other popular marketplaces are LooksRare and Rarible for Ethereum/Polygon, Magic Eden and Solanart for Solana and Random Earth for Terra.

You will need to set up a crypto wallet that is compatible with the blockchain that the NFT project is built on in order to interact with the marketplaces. The most commonly used wallets are MetaMask for Ethereum, Phantom for Solana and Terra Station for Terra. Once you’ve gotten a wallet set up, transfer ETH/SOL/LUNA to the wallet from a centralized exchange of your choice and you’re good to go!

Read our complete guide to buying your first NFT >

Choosing NFTs for Investment

When looking to buy an NFT as an investment piece, it’s important to evaluate the project holistically and not solely rely on how it looks. Similar to picking out crypto projects to invest in, the quality of the founding team, proven ability to execute and deliver and roadmap of the project are important factors to consider. Perhaps the most important and most difficult factor to measure is the strength of the community that the project has managed to build. NFTs derive their value largely from their communities and projects with strong communities will be able to withstand bearish periods. We’ve even seen cases where communities have rallied and revived projects by delivering in areas where the founding team has failed. Most recent example of such a case was Pudgy Penguins.

The only way to truly gauge the strength of a community is to be in the trenches with them, the quality of the members are more important than the quantity. Join the discord group, hang around in the channels, get a sense of the vibe of the members. If conversations mainly revolve around floor price and the environment is toxic, it’s likely not a project you want to bet on. 

With the number of NFT projects being released everyday, it’s almost impossible to keep up with all of them. One strategy is to follow smart money and pay attention to projects that have piqued their interest, Nansen NFT dashboards, along with some other NFT Analytics tools, help with that. You’re able to check transaction data of specific projects in “NFT God Mode”, minting data on “Mint Master” and get an overview of smart money activity over the last 24 Hours on “NFT Smart Money”.

Read our deep dive on how you can use Nansen to invest in NFTs >

Some of the NFT dashboards that are available on Nansen:

NFT God Mode Dashboards for BAYC

Source: Token God Mode as of 03 Feb 2022
Source: Token God Mode as of 03 Feb 2022

Breakdown of Latest Mints on Mint Master

Source: NFT Paradise Mint Master as of 03 Feb 2022

24 Hour Smart Buy/Sells on NFT Smart Money

Source: NFT Paradise NFT Smart Money as of 03 Feb 2022

Common Criticisms of NFTs

“Why pay thousands for a JPEG that I can simply right click and save?” 

Well yes, you can get a copy of the art work by doing that but it will not be equivalent to owning the actual NFT. Just like how counterfeit luxury goods will never get close to the valuation of the original, even if the materials and build quality is exactly the same, a “right-click save” version of an NFT will never have the same value. Counterfeits or in this case, “right-click save” versions, will only add value to the original piece. It creates a feedback loop - Original item gets copied > gains virality and traction > value goes up > item gets copied more. The more a particular image is seen across the world, the more viral, the more iconic and the more valuable the original copy gets. The thing that propelled the Mona Lisa to fame was the virality the painting had when it was stolen, not the fact that it was drawn by Leonardo da Vinci. Being plastered on the front page of newspapers around the world made it internationally recognizable and a household name.

You can argue that the reason why physical counterfeit items aren’t worth the same as the original is due to the fact that it’s not 100% the same item. That is true for physical goods and it’s the same for NFTs. The concept is more difficult to grasp since NFTs are fully digital and on the surface a copied JPEG is 100% identical to the original, however, just like physical goods, it’s what’s beneath that truly matters. A “right-click saved” version will not have the same underlying data on the blockchain. It will not entitle you to the same benefits and rights that owning the real NFT gives. It will not grant you access to the events or places, access to the community of individuals who own the NFT, ability to resell the piece on a marketplace, access to the in-game experiences etc. 

The implementation of NFTs doesn’t mean that users will have to pay more, it simply means users have a choice. Don’t wish to pay thousands for a JPEG? Sure, download it for free and use it if you want to. Those that want to support their favourite creators by purchasing and owning their work now have the ability to do so in a manner that's more equitable than existing methodologies. Looking at the volumes on OpenSea (~17B sales volume in 2021), it’s clear that there’s a sizable amount of capital that’s interested in doing just that. 

“NFTs are bad for the environment”

While it’s true that Proof-of-Work (PoW) blockchains such as Ethereum are energy intensive, many newer blockchains and even Ethereum itself is switching to Proof-of-Stake (PoS). PoS blockchains such as Solana consume much smaller amounts of energy and are potentially carbon neutral. On top of that, it is unlikely that NFTs lead to additional energy usage as other applications, such as DeFi, would likely take up any spare transactional capacity on the blockchains if NFTs did not exist. 

The Future of NFTs

The NFTs of the future may look completely different from the ones we see today. While NFTs have established themselves as a viable and value-adding tool for artists, we’re only at the beginning stages of utilizing the technology. 

Given that their primary function is that of ownership tokens, NFTs can be tokenized representations of any asset, both physical and digital. Housing deeds, school certifications, identity cards, are just some of the potential items that can be improved by having tokenized versions. As blockchains are immutable and data is easily verifiable, institutions can verify a person’s academic certifications and past employment history seamlessly if it was all stored on the blockchain. 

NFTs will not exist as an asset in a silo but can be integrated with DeFi protocols to create a fluid crypto ecosystem. Imagine a world where you’re able to draw loans from DeFi protocols such as Aave or JPEG’D using the NFT as collateral. Currently, NFTs are relatively illiquid assets and the high price point prevents smaller players from partaking in the upside of certain collections.  Fractionalization of NFTs will help increase liquidity of the space as well as allow smaller players to get a share of the upside. A NFT index that tracks the total market capitalization of NFTs can create new avenues for investing and open up the space to investors who want exposure to the sector but don’t want to hold on to specific NFTs.

Popular NFT collections may start to become highly prized assets in the metaverse and there might be demand for engaging NFTs for advertising purposes. In the physical world, brands approach celebrities to leverage on their branding and influence to promote their products. Specific NFTs might become the influencers of the metaverse and brands rent the NFT for such cases. 

Successful projects themselves can grow into large brands over time. Once a project has cemented itself in pop culture, has gained enough mindshare and cultural significance, they might rival traditional firms such as LVMH. Owning an NFT from the project becomes a strong social signal of wealth and it becomes highly desirable akin to that of owning a Rolex watch.

Conclusion

NFTs provide us with a way to leverage on the benefits of both the physical and digital world to create new distribution channels and monetization models for creators. It gives us new ways to engage and galvanize a community of like-minded people and has the potential to change the way we coordinate social groups. They allow us to better ascribe and ascertain the value of digital assets and for the creators involved to get a larger share of the value that they create. “Right-click and save” will always be a feature of the internet but NFTs give creators and users the option to have ownership and a greater degree of distribution control over their assets. Right-click and saving also accrues value back to the original copy instead of diminishing it’s value. 

Current implementation of the technology is limited and isn’t perfect. However, that does not take away from the long term potential and future use cases that will arise in time to come. We’re only at the first innings of the rise of virtual economies and it’s up to us to find new and exciting ways to utilize the benefits of NFTs.  

If you want to track smart money activity in the NFT space, sign up for our 7 day trial here!

FAQs

Why are NFTs so expensive/valuable?

NFTs, like luxury goods, are veblen goods. The demand for them increases as the prices increase. No one wanted to buy Bored Apes when they were at 1 ETH but now everyone wants them at 90 ETH and their desirability continues to increase as their price goes up. Their value today largely depends on two factors - strength of community and expected future utility.

Strength of community: Who are the people buying the NFTs and why are they buying it? Projects that have a strong community backing the project and holders that are in it for the long haul tend to do well over time. A strong community is the best form of marketing as holders display their NFTs as their profile pictures and constantly promote the project on social media.

Expected future utility: What’s the roadmap for the project? Does the team have a proven history of executing well? NFT projects have the potential to become full fledged brands and companies. However, the biggest risk is execution risk and a good roadmap without the ability to execute is something that buyers have to be aware of.

Are NFTs in a bubble?

The broader NFT markets have experienced boom and bust cycles during 2021. Prices of NFTs can be extremely volatile and unpredictable. There are also many projects that offer little innovation or are derivatives of existing collections. These usually are signs of a frothy market and having a cautiously optimistic stance towards NFTs is likely the right approach. If we get a bearish period for the NFT market, good projects will continue to deliver and become easier to spot. In the long term, the NFT market will continue to grow and new use cases will sprout from the constant innovation that’s happening in the space.

Are NFTs a good investment?

NFTs are a relatively nascent technology and are still finding their footing in terms of widespread adoption and utility. While we think that the NFT space will continue to grow over time, it’s likely that NFTs in 5 years time will look very different from the NFTs of today and no one can predict what that future looks like. It’s recommended that users apply proper risk management and not invest more than what they can afford to lose. Tools such as Nansen are valuable when doing research on a particular project or to get an overview of the market. Being able to track what smart money is doing helps a ton when it comes to picking collections to take a deeper look at.

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