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Lesson No. 4: Introduction to NFTs
An introduction to ERC Standards; types of "tokens"; NFTs; and applied blockchain technology.
Welcome back, readers! Last week, we covered the Merge, Ethereum’s transition from Proof of Work to Proof of Stake, which took place successfully on September 15th. Ethereum’s network of developers must be given immense credit for pulling off an unprecedentedly complicated technological feat. Today’s edition is all about non-fungible tokens (NFTs). Specifically, we’ll cover:
Different types of ERC tokens;
An introduction to NFTs
Real-world application of NFTs;
Before diving into NFTs, it’s important to understand the different types of tokens used in the Ethereum network. But wait, isn’t Ethereum’s token Ether (ETH)? Yes, Ethereum’s native token is ETH, but the network also hosts decentralized applications (DApps) that have their tokens. For example, Uniswap is a decentralized finance (DeFi) application that runs on Ethereum and has its token called ‘UNI.’
How is this possible? That’s where ERC, or “Ethereum request for comment” comes in. Essentially, an ERC refers to a set of technical guidelines that must be followed by a developer when creating a token. These guidelines typically refer to token fungibility, transfer of tokens, identifying token supply, and data storage. Having standard guidelines for a type of token simplifies the creation process for developers. More importantly, it allows tokens to interact with other tokens and DApps. ERC-20, ERC-721, and ERC-1155 are different types of token standards on Ethereum. While there are many more, these three are the most pertinent to today’s lesson. Let’s take a quick look at each of them:
These tokens are most commonly used on Ethereum. ERC-20 tokens are fungible, meaning each token has the same value as another. For example, if you and I each have a $1 bill, they may be two different notes but their value will always be the same. Fungible tokens have various use cases including utility, governance, and initial coin offerings (ICO).
An ICO is similar to an initial public offering (IPO) except, what is being sold is a digital token instead of shares. For example, Banco (BNT) is a DeFi protocol that raised over $150 million during its ICO. Furthermore, many DApps use the ERC-20 token standard for their native coins. Uniswap (UNI) and Aave (AAVE) are two such examples.
These tokens have a standard that allows them to be non-fungible i.e. unique. Therefore, while two ERC-721 tokens follow the same guidelines, their values are always different. ERC-721 standard is what empowers NFTs.
This standard is the “middle ground” between ERC-20 and ERC-721 tokens because it allows for the creation of both non-fungible and semi-fungible tokens (SFT). SFTs are fungible until they are redeemed. CoinDesk provides an excellent analogy: think of an SFT as a concert ticket. Before the concert takes place, a general access ticket in one seating area has the same value as another general access ticket in that area. After the concert however, the ticket becomes “memorabilia” and can no longer be traded for another one. They are semi-fungible because they transform from a fungible token to a non-fungible one. Furthermore, ERC-1155 tokens help solve an existing problem with the ERC-721 standard: only a single ERC-721 token can be transferred at any point in time because each token represents an individual smart contract. This leads to a crowded network and higher transaction fees. ERC-1155 allows multiple tokens to be transferred at once, reducing fees and transaction time.
INTRODUCTION TO NFTs
Anyone who’s been on the internet in the last couple of years would’ve come across pictures of apes selling for hundreds of thousands of dollars. If you stopped and wondered why, you’re not alone. These ape pictures are part of the NFT collection known as the Bored Ape Yacht Club (BAYC). People often mistakenly assume the pictures themselves to be the NFTs and struggle to understand why they would be worth so much money. Their question is based on a misunderstanding of what NFTs actually are, and where their value comes from.
An NFT is not a picture but a representative piece of code that is associated with an asset–physical or digital. Think of it like a certificate of authenticity that proves someone is the rightful owner of something. The value of an NFT is not so much in the asset it is associated with; rather, its value lies in establishing provable exclusive ownership. It is similar to owning a limited edition pair of shoes except it’s better; shoes can be counterfeited (often extremely accurately) but an NFT cannot. Why? Well, this is where the ERC-721 guidelines come in. The standard set forth by these NFT guidelines ensures their uniqueness by making them non-fungible. To make things even better, because NFTs are stored on blockchains, their authenticity and ownership history can be verified by anyone at any time.
The use of NFTs is not restricted to the art industry. Below are some current and potential applications of NFTs:
Ever wonder why Facebook changed its name to Meta? Here is the answer: in an effort to improve the plateauing trajectory of the company, Mark Zuckerberg decided to pivot his focus from social media to the metaverse, an emerging technology destined to change how we live. The metaverse can be difficult to define but it is essentially a digital reality where people can interact with each other, play games, and purchase digital goods and experiences. By combining many technologies including virtual reality (VR) and augmented reality (AR), the metaverse allows people to create their virtual avatars and attend work meetings, purchase digital art and much more!
NFTs will play an increasingly pivotal role in the Metaverse. One popular use of NFTs in the metaverse is the selling and buying of virtual land plots. Virtual landowners can rent out their NFTs and earn passive income on various DeFi protocols. Those uninterested in leasing out their digital properties can alternatively earn royalties by buying and reselling NFTs at higher prices. The metaverse has also allowed creators to exhibit their digital art in museums and art gallery spaces.
In a perfect world, buyers and sellers of physical real estate should conduct transactions without intermediaries like agents, banks and notaries. Unfortunately, these third parties continue to oversee transactions, often at the expense of efficiency and convenience. Fortunately, Web3 provides a solution: these intermediaries could theoretically be replaced by NFT smart contracts, making transactions transparent, fast, and immutable. NFTs also enable investors to own and trade fragments of physical real estate via fractional ownership tokenization. The property or deed is divided into tokens or shares with smart contracts being used to enforce off-chain agreements.
The modern gaming industry represents a massive market with 2.7 billion players worldwide. Although NFT gaming has struggled to find success due to its complexities and often poor UX design, a new business model for gaming that works on blockchain technology has nonetheless emerged. Play-to Earn (P2E) games reward players with small amounts of cryptocurrency or other cryptographic assets when they participate in tasks and other activities.
Further Applications of NFTs:
Ticketing: Use of NFTs as tickets for concerts or sports games can prevent counterfeiting and provide additional perks.
Music: Musicians and artists can create NFTs for their work and receive royalties every time their songs are played.
ERC (Ethereum Request for Comment) refers to a set of technical guidelines that developers of tokens on Ethereum must follow
ERC-20 guidelines are for fungible tokens; ERC-721 guidelines are for NFTs; and ERC-1155 guidelines are for semi-fungible tokens
An NFT is a representative piece of code associated with a physical or digital asset
NFTs have the potential to improve various industries including real estate, the metaverse, gaming and plenty more!