4 Critical Facts About NFTs

The manic fervor around non-fungible tokens ("NFTs") is reaching a fever pitch. People are searching for the term "NFT" in droves, more often even than "Ethereum", the network on which NFTs are minted and sold (among many other useful crypto functions). Everyone from Taco Bell to the guy in the "Bad Luck Brian" meme are jumping on the bandwagon and selling NFTs, and the draw of NFTs is bringing people to cryptocurrency who otherwise never would have been interested, which is great. But that's also a lot of people buying NFTs who don't know much about crypto, and people are frequently confused about what they're actually buying and what rights it grants them. That is what inspired me to write this article to edify buyers about NFTs.

What is an NFT?

It might be easiest to conceptualize NFTs by first considering fungible tokens, which are tokens that are equivalent and can be exchanged one-for-one - for example, Bitcoin is a fungible token. One Bitcoin is equivalent to another Bitcoin. In contrast, non-fungible-tokens, as the name implies, are different and not equivalent. The type of NFT this article discusses is a digital item (often a piece of art but sometimes a tweet, a video, a song, a trading card, or an in-game item) that is linked to a token minted on the Ethereum blockchain. (Minting a token just means to issue or create it.) NFTs have many more use cases than just the sale of art and other digital items, but that is the type of NFT that is capturing everyone's interest, so that is the focus of this post.

Four Important Facts About NFTs

Let's turn to some critical facts about NFTs. But first let me clarify one thing because when I state facts about NFTs online, I get called a hater, accused of not wanting artists to get compensated, and even reported, so right up front I would like to dispel the assertion that I don't want creators to get compensated. Hell, I am a creator. My point is not that people shouldn't buy NFTs. My point is only that buyers should be educated about NFTs before buying them, especially if they are buying them for speculative purposes. I believe it is a poor idea to purchase an NFT for purely speculative reasons because the NFT market currently feels very similar to the ICO craze of 2017, and I saw a lot of people severely burned by that mania. Buy an NFT to support an artist you love or collect a piece of art you love (but read this article first!) - but caveat emptor if you buy one only for the purpose of selling it to someone else at a higher price.

Here are four critical facts about NFTs, with further discussion about each point below:

🔸There is nothing about NFTs that inherently prevents creators from minting and selling an infinite number of the exact same piece of digital art.

🔸Most NFTs are simply URLs that host a piece of art or bits of code that give the owner the ability to interact with a digital item while using a specific platform or app. This URL, platform, or app may go down permanently, potentially leaving the buyer with nothing. The right an NFT grants you is only access to that URL, or to interact with that digital item on that particular platform or app.

🔸A creator or seller of an NFT must have the IP rights to the underlying artwork to be able to legally sell it to you.

🔸The process of creating, minting, and selling an NFT typically consumes a massive amount of energy and Ethereum fees.

One: There is nothing about NFTs that inherently prevents creators from minting and selling an infinite number of the exact same piece of digital art.

There seems to be confusion about the concept of non-fungibility - some buyers thing that the fact that these are non-fungible tokens means that there will only be one of each piece of art or other digital item sold as an NFT. But, as discussed further in point #2, the underlying piece of art itself is not on the blockchain - typically just a URL pointing to the art or some bits of code allowing you to interact with your digital item are on the blockchain. This means that it is entirely possible for an artist to take the same piece of art and mint a literal infinite number of them as NFTs. That is not to say that they will do that, but you would have no legal recourse if they did. People other than the creator may also replicate the digital art and sell it as an NFT. (They likely would be violating the artist's IP rights, as further discussed below, but the seller of an NFT is generally only a identifiable as an Ethereum address, so it might be hard to track down the copier.) Buyers should know they might not be the only person owning an NFT of a particular piece of art before they buy it because that fact impacts its objective and subjective value. If they don't know that, they might pay more than they otherwise would.

Walter Benjamin authored a book called The Work of Art in the Age of Mechanical Reproduction (1935) in which he posited that the ability to easily reproduce a work of art devalued its "aura" (its uniqueness and value). Part of what gave art its value was that everyone couldn't easily see it and, once it was possible to reproduce it, its specialness was somewhat reduced. Of course, paintings and other pieces of physical art are still very valuable even though reproductions are made of them, but paintings and other physical art are also limited in quantity. In contrast, digital art can be easily replicated an infinite number of times and can easily be minted as an infinite number of NFTs. The nature of digital art, and digital art in NFT form, in comparison to physical art raises a question about its value. This applies to all digital art, of course, not just NFTs. Further, I am not suggesting that digital art has no value. But many people who are buying NFTs are speculators rather than collectors or lovers of art. Many of these speculators are also crypto newbies, and they should be going into their purchases with their eyes wide open about the fact that the NFT they are investing in may not be unique.

Two: Most NFTs are simply URLs that host the artwork or bits of code that give you the ability to interact with an item while using a specific platform or app.

As I mentioned above, NFTs are art or other digital items linked to the Ethereum blockchain. In other words, the artwork or item itself is not stored on the blockchain. Storing entire works of digital art, even in compressed form, on Ethereum's distributed ledger technology would take a gargantuan amount of energy, especially as NFTs surge in popularity. Most NFTs are simply a few bits of code on the blockchain that either point to a URL where the art is hosted or permit the owner to interact with or view a digital item when the owner is on a certain app or website. This fact leads to a few important considerations:

• The website or app on which your NFT is viewable or usable may go down permanently.

What happens when the URL hosting your art, or the app or platform on which you interact with your digital item, is no longer available? In the current implementation of NFTs, you are shit out of luck. You really only owned a token pointing to that URL or containing a bit of code that let you interact with a digital item on a particular website or platform - you don't have any further rights vis a vis your NFT. You may be fine with that, but you should know that.

• The URL may become public, or the underlying digital art may be otherwise shared, released publicly, and copied, by you, the artist, or a malicious actor.

People purchase art for different reasons, but often one motivation is to view the art and share it with others. In the case of a physical piece of art, you may hang it on your wall or even display it in a museum for a period of time so others can enjoy it, but at any time you can easily put the cat back in the bag (i.e., reclaim your physical art and hide it from the whole world, if you wish). In the case of an NFT hosted on a URL, you could share it with other people by taking a screenshot, but you may also want to share the URL itself. But there are two consequences of sharing it - the first is that you lose more and more control the more you share it. The chance of someone releasing either the URL or the art itself publicly increases. Also, arguably, the specialness of your NFT goes down. Unlike with a piece of physical art, there is not an easy way to put the cat back in the bag. Digital art is far more easy to copy than physical art.

Refer back to what Walter Benjamin's age of mechanical reproduction and its impact on value. Every time you share the digital art you purchased as an NFT is another chance that someone may copy it, and that relatively easy compared to physical art. (I frequently make the comparison to physical art because people often think of NFTs like physical art when they have many important distinctions.) It could also be a malicious actor that does so (say, by hacking you to get access to your NFT) or the artist themselves. These copies may be sold or otherwise distributed. In the case of most physical pieces of art, it is very hard nigh impossible to exactly reproduce it. Any reproductions are worth far less than the original. But, in the case of digital art, it may be possible to exactly copy it or get very close, so a reproduction may be worth relatively more compared to the original than in the case of physical art and reproductions of physical art. The reason for this would be, I believe, that the existence of copies would bring down the value of the original.

You may think, well, I have the original NFT of the art, and the blockchain will prove that, so I don't care about copies online. I will return to the blockchain point below because it's not so simple, but let's first consider whether the concept of an "original" piece of digital art even makes sense - I mean, the artist themselves likely did not delete the art from their computer when they sold it, so really that is the original, and everything else, including the first one purchased as an NFT, is a copy. That raises an interesting question about the value of one copy of a piece of digital art versus another. Is a copy of a piece of digital art minted by the artist and sold as an NFT more valuable than a copy of that same piece of art gifted by the artist to a friend or a copy of that same piece of digital art stolen from the artist by a hacker or a copy of that same piece of digital art recreated by another artist? I think this suggests the value of an NFT is derived from the connection to the artist - the fact that the artist directly minted the token. (This ties into point #3 about how critical it is to ensure that the token was in fact minted by the real artist.)

Now let's address the assertion about proving you have the "original" NFT by checking the blockchain. First of all, all the blockchain will show is which ETH address purchased a certain NFT at a certain time. You have to further prove control over that ETH address to establish that it is your NFT (and, arguably, even that does not prove that its your ETH account because someone could have taken the original buyer's private key to their ETH account and gain control over the original buyer's account and, therefore, not be the true buyer). But even doing that does not prove that you have the original NFT. How do you know that your NFT was in fact the first NFT of that piece of art? There are many NFT platforms and more are being established every day. The artist may have minted and sold an NFT of that same piece before the one you bought on another platform.

Three: A creator or seller of an NFT must have the applicable IP rights to the underlying artwork to be able to legally sell it to you.

On most NFT platforms, buyers and sellers are nothing more than Ethereum addresses. Sellers can choose to add more information like links to their various social media accounts, but they are generally not required to. This means that it can be hard to verify the true identity of a buyer or seller. Someone could impersonate an artist and starting minting and selling NFTs of that artist's work, and it wouldn't necessarily be an easy task for the buyer to confirm whether the seller is the real artist or an impersonator.

In order for someone to sell an NFT, they need to have the IP rights to the underlying IP. If they don't, then the buyer is purchasing an NFT that is in violation of IP laws. Plus, you can't sell something you don't own or have license to reproduce and sell. This effectively means, for the buyer of an NFT sold by someone who has no IP rights to the art, the buyer has a big fat nothing to show for it. This is not necessarily an insurmountable obstacle if buyers take the time to confirm that a seller is who they say they are (an easy way to do this might be to reach out to a verified account on a social media platform and ask if the artist is selling the NFT you are thinking of buying - send the link to it in your message). It could get complicated if the seller licensed the rights from a third party.

Four: The process of creating, minting, and selling an NFT typically consumes a massive amount of energy and Ethereum fees.

Any transaction that is performed on the Ethereum network must be confirmed by miners who are compensated by a fee paid by the wallet making the transaction. Ethereum is moving away from the mining model but for now this still applies. Mining uses a lot of energy, as you have probably seen reported in the news, and Ethereum fees are very high because the network is very congested. (Again, changes are being made to address this but they have not happened yet. It is not just the creation of the NFT and the purchase of the NFT that are Ethereum transactions. Every bid made on each NFT is also an on-chain transaction that must be mined and paid for with fees. Given that some NFTs receive many bids, you can see how both the energy and the fees could add up quite quickly. Some have asserted that the amount of energy used to mint and sell one NFT could heat multiple swimming pools for a year. There is some controversy around this issue. You can check out this piece for more information. It is true that Ethereum will be making change this year that should decrease both energy usage and fees but those changes have been promised for several years - as much as I love Ethereum (and I really ❤️ ETH), I will believe it when I see it. NFT mania is happening right now, and those transactions are happening on the current high-energy, high-fee network, so I believe this point is still relevant to know.

Bonus Point: Check the royalty percentage on any NFT you purchase.

When an NFT is created, the creator will be able to specify a royalty percentage associated with that NFT. What this means is that, if you buy that NFT, and then later you sell it, the original creator will receive that percentage of the proceeds of your sale, and if the person you sell it to later sells it, the original creator will get that percentage of the proceeds of that sale, etc. This is perfectly fine and a good way for creators to receive fair compensation, but in some cases artists have set these percentages super high (like 90%), and buyers naively bought the NFTs, not realizing that if they ever sold it, the original creator would get 90% of the proceeds. Essentially the creators took advantage of buyers' ignorance. The royalty should be specified in the details about the NFT. Typical royalties would be like 5% to 20%.

I'm not an NFT hater. NFTs definitely have their place and I can see many practical uses for them. My concern is that buyers don't really understand what they are buying and don't appreciate all the points outlined above, especially speculative buyers. There are additional things that could be done to protect buyers but that's for another article.

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About the Author: Emily Stork is co-founder of Worth The Fight Boxing & Fitness in Denver (Worth The Fight's website) and is forming DeFi-based crypto hedge fund, QuoinVault. She is passionate about cryptocurrency and DLT, especially DeFi and smart contracts. Follow QuoinVault on Facebook and join QuoinVault's LinkedIn group!