NFTs what you wanted to know but didn't know where to start

Hey guys, Andy here. I first came across NFTs at the start of 2021 and they appeared on my radar in association with copyright issues, but I refrained from commenting as I hoped it was a fad that would disappear. However, here we are, months later and they’re still with us; indeed recent conversations would suggest that NFTs are growing on the public consciousness however they remain misunderstood.

NFT stands for non- fungible token. The definition of the word fungible is:

(of goods contracted for without an individual specimen being specified) replaceable by another identical item; mutually interchangeable.

Thus non- fungible means an item that is not mutually interchangeable, a one of a kind and unique. An NFT is a unit of data stored on a digital ledger called blockchain. A blockchain is a list of records, or blocks, that are linked together where each block contains details of previous blocks, a timestamp and transaction data. The blocks form a chain with each additional block reinforcing previous ones and are thus resistant to modification as any data recorded can not be altered retroactively without altering every subsequent block.

NFTs act as certificates of authenticity and relate to digital assets such as graphics and audio, even tweets, with recent NFT news and excitement relating to video and digital art. However while the transaction data that an NFT stores includes the purchaser and the price it does not contain information on the work it relates to, such as artist name, description and title of the work, rather the data points to where this information can be found via links. These links come in the form of URLs or IPFS (InterPlanetary File System) both of which have risks. The owner of a domain could either redirect the URL to point elsewhere or could simply forget to pay their hosting bill which would mean the disappearance of the URL altogether resulting in an expensive 404 Page Not Found. Comparatively an IPFS address does not identify a specific file at a specific domain; a piece of content can be found as long as someone, somewhere, on the IPFS network is hosting it. However no host on an IPFS network has direct responsibility for the file an NFT points to. Thus it is possible that, at some point in the future, an NFT will point to a missing file and if so, how do you substantiate your proof of ownership as most NFTs do not include a literal contract, rather rights are normally included in the terms of service of the platform where the NFT was purchased?

And this is where NFTs get awkward. 

While an NFT itself may be unique, the digital asset it may be associated with is not. Digital assets such as digital music, art and photography are easily copied so the purchase of an NFT means the purchase of a unique token associated with an asset of which multiple copies exist. It is not the purchase of a rare or scarce digital asset. It is also worth considering what rights are purchased with an NFT and it is important to realise the distinction between the purchase and ownership of an NFT compared to the ownership of the content an NFT is associated with. Purchase of an NFT does not automatically mean the rights to the work it is related to have also been bought. For example if you buy a painting, you acquire the physical painting which you can then display but you do not buy the rights to reproduce, create derivative works of, or distribute copies of the painting.

Unlike the painting in a gallery, you can not buy NFTs with traditional currency, they are sold in cryptocurrency, the most popular of which, in regards to NFTs, is Ether (ETH) which is stored on the Ethereum blockchain, the world’s second largest cryptocurrency by market valuation after Bitcoin. It is not possible currently to buy anything in a cryptocurrency other than more of the cryptocurrency and as such it resembles an asset more than a ‘currency’. Cryptocurrency is also volatile; Bitcoin for example hit a record high of $64, 829 in mid April but suffered a 30% one day drop falling to $30, 000. Cryptocurrency is part of decentralized finance (DeFi) that does not rely on central financial intermediaries such as brokerages or banks to offer traditional financial instruments. As such there is not a single entity in charge of the system which leads to the question to how agreement is reached on what entries are added to the digital ledger. This is achieved through a consensus algorithm which is used as a method of securing the ledger, of which the main type is Proof of Work (PoW) which uses large amounts of energy to ‘mine’ a new block. The annual power consumption of the computing processing power that goes into Ether mining is comparable to the country of Iraq with each single Ether transaction the equivalent to the power consumption of an average US household for approx 3.3 days with a carbon footprint of 103, 14 Visa transactions. Due to the high energy consumption of crypto, it is common practice for miners to seek out cheap energy with the destination of choice until recently being China. Despite cracking down on cryptocurrencies in 2017 China currently accounts for 65% of the world’s Bitcoin mining however the country has recently again pushed to rein in crypto following a surge in illicit, and deadly, coal extraction. Miners have recently relocated to Kazakhstan and the increased demand for electricity is testing the country’s electricity grid. It is now estimated that a single crypto mining farm equals the consumption of 24,000 Kazakh homes and following a total black out in mid- July that affected the country’s largest city, Almaty, the country has imposed a national limit for energy cryptocurrency mining. It is important to note that the consensus algorithm was designed to be deliberately hard to compute and, in the case of Bitcoin, would become incrementally harder (ie take more computational power) the longer into the crypto currency lifecycle we go. Thus the basic price of crypto reflects the cost of the hardware required (which can not be repurposed at the end of it’s life cycle) and amount of electricity. 

Both artists, when they create or ‘mint’ work into an NFT and also buyers when they purchase an NFT are charged a ‘gas fee’, charged in ETH, for the transaction to appear in the blockchain. The gas fee is paid on submission of a transaction which, due to being based on computation processing, is charged regardless of whether the transaction succeeds or fails. The amount of gas depends on the size of the contract and how fast you want it to be executed; and as the fee is paid to the miners who keep the network running low fees may be overlooked in favour of high ones.

The NFT sale that generated the most buzz was a work by American digital artist Beeple called Everydays: The First 5000 Days which sold at auction house Christie’s for $69.3 million on March 11, 2021. The work was acquired by Vignesh Sundaresan, a programmer based in Singapore and the owner of Metapurse a crypto based investment firm, known by his pseudonym MetaKovan (it is worth noting that Beeple is an investor in Metapurse). Other notable NFT sales include Disaster Girl and Charlie Bit My Finger which sold for $473, 000 and $761, 000 respectively and both bought by the NFT collector @3fmusic. These prices have led to a surge of interest from both artists and buyers alike in NFTs, however diving into sales figures would suggest that the most artists should not expect riches anytime soon. The first time an NFT is sold, the sale is classified as a Primary Sale with subsequent sales classified as Secondary Sales. According to research by Kimberley Parker, 67.6% of sales have not had a Secondary Sale and 19.5% have had one Secondary Sale. Of Primary Sales two largest sectors were for $100 or less at 33.6% and between $100- $200 at 20%. Further investigation showed for artists selling their work at $100 or less, the average gas fee was 100.5% of the sale leaving the artists with a deficit of $0.50 or more. For artists in the $100- $200 range the average fees were 54% leaving the artists with $92 or less (figures taken from 14th- 24th March 2021).

The question of authenticity is also worth asking in regards to NFTs. How does a potential buyer know the work his NFT is associated with is real? Some platforms, such as SuperRare, require artists wishing to sell work to submit an application to ensure the work is genuine. Other platforms, such as AtomicAssets avoid the issue with disclaimers putting the risk of fakes on the shoulders of buyers. If you consider the number of Twitter accounts that offer to mint any work tweeted at them into NFTs, the risk of buying a work that is not genuinely backed by the creator is not negligible.

In addition to authenticity, there is the issue of fraud and money laundering. Most industries and sectors that deal with high value assets and wealth have been known to be targeted by those of lessor moral standing and the art world is no different. The tale of the Knoedler Gallery is a cautionary one; the gallery was forced to close its doors after 165 years of business when it came to light that it had been selling fakes for 15 years to the tune of $80million. The art world has rules and regulations to combat fraud but it is still estimated that 3% (or $6billion) spent on art annually is tainted by illegal activity. Comparatively digital art and NFTs offer a perfect landscape for criminality as buyers and sellers can set the value of work with little historical context to help establish any baselines or guides. Indeed cryptocurrencies have had their own fair share of scams with imposter websites, fake mobile apps, fake social media accounts and scam emails. It is perfectly feasible for an NFT to be sold from account A- B- C- D, with the first three accounts belonging to the same person in order to drive up the price before selling it to person D for an inflated sum. In regards to money laundering the process is as straight forward as this; if you have $1 million in illegal money, you anonymously mint an NFT and purchase it yourself from ‘anonymous’ with your illicit funds and those funds are now recognised as legitimate from the sale of the artwork. There are no physical artworks to transport or store in off-shore tax haven warehouses; it is all completed online. 

And lastly, what happens when the technology progresses to the point where you can not see or view the digital asset your NFT relates to? For example consuming music has changed from the 8-track, the cassette tape, the CD to streaming in 50 years. NFTs are being marketed and advertised as original and unique; how original is your asset if you have to convert it from file format X to Y to be able to view it in the future?

I have struggled with this post as very little of what I have written makes rational and logical sense to me. While each component element may appear reasonable I find the sum to be harebrained. Why anyone would purchase a digital token linking to a URL associated with a digital work of which there exist multiple copies which at some point in the future devices will outgrow is beyond me. I fail to see any benefit in a system that is rife to abuse and risk where scarcity has been created when none exists. Snake-oil salesmen, the Emperor’s new clothes, call it what you will; however reasonable and secure, it certainly is not.

 

 

*amended 24th Oct ’21 with updated information on international crypto mining