How NFTs Work
Roger Lopez
Chief Marketing Officer & Chief Product Officer, Advisory Board Member , AI, Blockchain, Web3 junkie
Non-fungible Tokens (NFTs) are created and stored on a blockchain, where their ownership and authenticity can be verified. When an NFT is minted (created), it is recorded on the blockchain as a smart contract. The contract is managed through a unique address/ID, which displays the current owner. When you buy the NFT, the unique ID changes to reflect you as the owner on the blockchain. This means that you have traceable and public ownership of the asset through the blockchain.
To understand the concept of non-fungible tokens, think of wrapping an object in a digital package and stamping it with a unique signature to certify its authenticity and rarity. This means that you can certify that the object (image or piece of art) is unique and authentic. You can also verify that the unique object was transferred from the seller to a buyer.
The Concept of Fungibility
To get a clear understanding of how NFTs work, you must first know what fungibility is. While the term may sound complicated, it is a simple idea relatable to everyday life.
Fungibility means identical and interchangeable. A fungible item is anything that can be exchanged with another item of the same description of classification. For instance, a currency is fungible in that every unit of a dollar can be interchanged with another unit of a dollar. If you have a dollar in your pocket and exchange it with a dollar that your friend has, you will be left with just one dollar.
Fungible items are also divisible, which means they can be divided or added without changing their fundamental nature. If you have a dollar, you can divide it into any combination of coins to total 100 cents and represent the same value.
Another quality that makes an item fungible is slight differences in physical appearance, but no change in the agreed-to perceived value. For instance, a serial number on a dollar note does not change the face value of that currency. Similarly, withdrawing a crisp new $20 bill from the ATM does not add any face value, and you will end up purchasing the same amount of items as when you have a tattered and crumpled bill. Therefore, fungible items are identical and interchangeable.
?How is Non-fungibility Different?
Non-fungible items are not directly replaceable or interchangeable. Unlike fungible tokens like the US dollar, non-fungible items are characterized by:
1.? ? ? Provable scarcity
2.? ? ? Unique and verifiable identity
3.? ? ? Indivisibility
Usually, non-fungibility as quality is tied to the unique identity of an asset and its owner. When items are non-fungible, every unit is different from the other. This means that the value of each item is different from the next. Factors such as rarity, utility, and differences in appearance have a direct effect on the identity and value of a unit. For instance, a pair of Adidas Predators that Lionel Messi wore at a final match at FC Barcelona is more valued than a similar pair worn by a local teenager. Other classic examples of non-fungible items outside the crypto space include land, diamonds, and baseball cards.
The same concept applies to NFTs. They are non-fungible items, only this time they are shared/traded digitally. Each NFT is a unique digital asset, which cannot be interchanged for another. Therefore, each has its value, with factors such as rarity and linkage to celebrities or brands increasing the value significantly.
NFTs BlockChain
NFTs are part of the Ethereum blockchain, where they are minted (created) from digital objects to represent tangible or intangible assets like art, videos and sports highlights, GIFs, Collectibles, music, designer sneakers, and virtual avatars. These digital tokens are like physical collector’s items, but virtual. So, instead of getting an actual oil painting that you can hang on your wall, you will get a digital file when you buy an NFT. You will also get exclusive ownership rights to that digital file, meaning you will be the only owner at that time.
Initially, blockchain was associated with cryptocurrency until builders of the technology realized the potential to create and store unique digital items. The items could be used to represent real-world objects like marriage certificates and diplomas. The NFTs were then born when Witek Radomski, Enjin CTO created the code for a non-fungible token in 2017.
In the years that followed, the ERC-721 standard was developed for the creation and storage of NFTs. A more efficient toke standard, ERC-1155 was also developed to streamline the process of creating and distributing NFTs. The standard specific important technological practices used with NFTs, such as the use of metadata to describe the identifying characteristics of an NFT. Metadata can also be used in fetching images from an off-chain source to lessen the process strain on the blockchain.
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Creation and Storage of NFTs
An NFT is created and stored on a blockchain like Ethereum, or others like Tezos and Flow. The blockchain is a distributed public ledger on which every transaction is recorded. Since everyone can review the blockchain, the ownership of the NFT is easily traced and verifiable. However, the person or entity that owns the NFT can remain a pseudonym. The unique data comprising an NFT makes it easy to verify ownership and transfer tokens from one owner to the next. As an owner or creator, you can also store specific information inside your NFT. For instance, you can sign a piece of artwork to include your signature as part of the NFT’s metadata.
NFTs are not limited to any specific types of assets as different kinds of digital goods can be tokenized. They include artwork, photos, items in a game, videos from a live broadcast, digital paintings, and more. In fact, NBA Top Shots has one of the largest NFT marketplaces at the moment. The NFT conveying the ownership is added to the blockchain, but the file size of that digital item usually does not matter. This is because it remains separate from the blockchain.
What about Smart Contracts?
NFTs are smart contracts in that they are embedded with metadata that allows relevant information to be stored and visible on the blockchain in an immutable but transparent way. The metadata is used to verify the ownership of an NFT, transferability, license fees, links to other digital assets, royalties, and other payment obligations. When an NFT is transferred to another person, the metadata assures that payment has been accepted and confirmed. It also assures that the correct payment has been transferred, the royalty amount and license fees deducted, and the intellectual property has been passed to the new owner.
Transaction Fees Involved
Every time you transact with a blockchain, energy is used to complete the transaction. When you are creating (minting), selling, and buying NFTs in Ethereum, the nodes of the blockchain compete in solving the PoW algorithm. The competition allows the node to gain the right to process the transaction. The process is thus a financial reward where the nodes (Ethereum miners) receive 2ETH for every complete block at the time of writing.
Transaction fees in the NFTs operations are important to prevent the misuse of the blockchain. Making the process free to use would cause the system to jam because of an infinite number of requests. With a jammed system or network, no one would be able to sell or buy NFTs. Therefore, transaction fees help in solving this problem. The blockchain charges for gas on every transaction that involves writing to a smart contract, including the minting and trading of NFTs. However, reading data from a blockchain, such as viewing all NFTs owned by someone on a marketplace costs no gas.
How NFT Gas Fees are Charged
Every time you create or list an NFT on a marketplace, you will be required to pay a gas fee. In other words, you cannot list an NFT if you have not paid gas fees. For instance, if you purchased an NFT for ETH, you will need to pay an additional 0.1 ETH to cover gas. A similar approach is taken when you are listing or delisting NFTs on a marketplace.
For newbies on NFT, gas is probably the hardest concept to grasp. Some people tend to relate it with normal gas prices, but it is important to understand the additional costs involved before investing. Essentially, gas is measured in Gwei, which is a term used to describe a small about ETH. If your gas fee is 1 Gwei, it means that you have been charged 0.000000001 ETH.
It is important to understand that the exact amount of gas that you pay for a transaction usually fluctuates. The amount will depend on the actions of the smart contract that you would like to perform and the network traffic at that particular time. Unfortunately, you cannot know beforehand the amount of gas you are going to pay. This amount is determined once the transaction has been completed.
Using wallets, such as MetaMask will give you a maximum potential gas before progressing to complete the transaction. This means you will have an estimate to help you plan accordingly for the transaction. Also notice that you will still be charged gas even if a transaction does not go through. A point in case is when you try to mint an NFT, but the supply of that tokens has run out.
Why NFT Gas Prices Fluctuate
NFT transaction fees fluctuate because they are determined based on several factors. One of the factors is the most willing to pay, where individuals who want their transactions to go through fast pay higher transaction fees. The high gas fees usually depend on the network traffic and function being called for at the time.
Due to the factors under consideration in pricing NFT transactions, a phenomenon known as gas wars tends to occur. For instance, when many projects can be launched at a given time or a highly popular one is dropped, the gas prices can easily go through the roof. During such periods, the number of failed transactions also increases due to the excitement of minting. With transaction cost gas also being charged, it can lead to a lot of disappointments.
You may also find instances when many transactions are submitted, but they have no chance of going through before the project sells out. Since the gas levels are also attached, it can lead to unnecessary losses to creators. In other cases, poorly optimized smart contracts can make hopeful minters pay more gas than the actual rating.