Making Sense of NFTs Beyond All the Hype

Here is what I know.

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Making Sense of NFTs Beyond All the Hype

Unless you have been living on the Moon, you surely have seen the rapid rise of non-fungible tokens (NFTs) over the past couple of weeks.

Rather than being the n-th person reiterating the obvious (blockchain, uniqueness, a lucrative opportunity), I would rather ask and answer some of the same questions you’ve probably been asking yourselves.

Google searches for the term NFT went hyperbolic over the past couple of weeks. Source: Google Trends

What are you actually buying?

Let’s use the time machine and go back a couple of decades. You walk along the street and ask a person to sign an autograph for you. The autograph is neither the person nor the work of the person. It is a token whose value is based on two factors:

  • how easy it is to obtain another copy of the same token.
  • who or what is the entity behind the token
    Hand-written autographs are of limited supply (unless you put the person in a room and forced them to sign papers all day long). They are also quasi-unique since no signatures are ever 100% identical, plus the dedication differs each time. This makes the autograph a perfect example of a non-fungible token.

Back in NFT-land, each token is basically a digital autograph that uniquely ties me, the “issuer” with you, the “buyer.”

Whether that “signature” costs a fortunate or is pure vapor is a matter of factor #2 - who am I, and why should people trust me. See, there are really two possible reasons why people collect autographs in the physical world. They were signed by a famous person or by someone whom people believe can become famous one day. The same applies to NFT tokens.

The real value of an NFT is neither that of the digital object that it represents nor of its content. It is the trust and belief that others would want to have it someday. Thus, NFTs are mostly bought for investment and speculative reasons.

Is the item backed by the NFT really unique?

Not necessarily. Many are, but not all. In the case of a genuine artist who backs their works with an NFT, this might be the case. However, issuing (or minting) one does not require the exist nice of a physical or digital asset backing it. This is the point to emphasize that as an NFT collector, you are not buying the digital object backed by the NFT. You are simply buying a signature that I created because you think others will want that same signature and be ready to pay for it one day. The fact that I’m backing the signature with an artwork of mine is a gesture of boosting my future value as a creator (and consequently, that of my “signatures”).

Where is the digital asset hosted?

An excellent question. Everywhere possible, but not on the blockchain. Records on the blockchain have limited space; otherwise, the entire concept would become unfeasible. Most NFT records only have a link to a digital asset hosted somewhere else (on a Cloud-hosting or file sharing service, IPFS, etc.). This naturally leads to the paradox that while an NFT is supposed to live on the blockchain forever, the asset that it represents might be taken off tomorrow. Again, recall that you're not really buying an asset, but only a "signature," that it was made by someone you trust. The asset itself is a nice-to-have.

It’s an NFT Boom. Do You Know Where Your Digital Art Lives? - CoinDesk
What happens to non-fungible tokens (NFTs) when the company or artist that created them closes up shop?

Why pay gas and why is it getting more expensive?

Gas is an important concept in the Ethereum ecosystem. It serves both as a way to prevent people from gaming the system (requires skin-in-the-game to perform a transaction) and as a way to reward the executors of the transaction (miners). Without getting too much into details, in a large queue of transactions, the higher amount of gas one is willing to spend, the faster and more likely it is to get it done.

That's all fine and seems fair until everybody rushes out to hoping to make some quick buck. The surge of transactions causes miners to higher up the demand for gas to extremes. In concrete terms, a few days ago, while researching for this post and trying to get my OpenSea account initialized, the average amount of gas "recommended" for getting a transaction in a reasonable amount of time was close to the Ethereum equivalent of $100.

$100 for putting through a "free" transaction is simply outrageous. Of course, if you're willing to wait or try your luck multiple times (I've had around 5 unsuccessful attempts by now), you can lower the amount of gas you're willing to pay and end up spending way less (sometimes, even below $1). The problem is that most people rushing to the NFT markets these days are barely educated on all that and are willing to pay any price to get in. Don't believe me? OpenSea is currently one of the biggest "Gas Guzzlers" out there, with nearly $0.5 Million paid out in daily transaction fees alone.

NTF market OpenSea is one of the largest producers of transaction fees at the moment. Source: Etherscan

What about the environment?

Let's be honest. If you cared about the environment, you wouldn't be reading this post right now. But OK, let me give you my take on it. Put simply, it's bad. Very bad. According to this source, a single ETH transaction these days is the equivalent to the electricity consumption of an EU resident for 4 days. That's freaking nuts! And yet, it's just a drop in the bucket compared to all the other pollution we cause every day, which is why you won't see any government taking down blockchain activity anytime soon.

The Unreasonable Ecological Cost of #CryptoArt
In Part 1 (this article), I present my motivations, findings, and my conclusions as a result of these findings. In Part 2, I present the underlying data and methodology that gave rise to these…

To be fair, there are attempts to reduce the computational requirements of the blockchain. Like, the Proof-of-Stake switch in Ethereum that is yet to be seen (if ever). Or moving as much activity off the chain as possible, which is like what most big NFT marketplaces started doing. Some will only execute a transaction when there is actual payment involved. The rest will happen on the market's own servers.

Whatever the solution, it does not change the fact that we need a radical switch of thinking towards clean energy sources with maximum efficiency. And I am unfortunately not talking about solar and wind …

I leave the rest of this part to your judgment.

Who will be the big winner of all this?

As I tried to point out a few times already, the value of a single NFT (and on the entire concept, for that matter) is people's trust in the person or entity behind it. If you and work are trusted in the real world, chances are, you can make it into the NFT one too. However, while there are examples of people becoming millionaires from selling just about anything right now (including someone else's copyrighted property), most people will waste their money trying to get in.

The big winners of all this are obviously all this holding Ethereum now, the miners, the backers, and owners of NFT marketplaces, as well as celebrities capitalizing on the hype.

I am not trying to discourage anyone from trying. I am also interested in trying NFTs out as an additional source of income. However, with anything that goes through hype and disillusionment all the time, one needs to tone down their expectations and take the whole thing with a grain of salt.