What are NFTs?
NFT is an abbreviation of the term non-fungible token, which can be explained as a non-exchangeable token. It is a virtual object usually saved on the blockchain. It differs from other digital goods, such as the Bitcoin cryptocurrency, in that each NFT token is unique, i.e. it is individually coded.
What is this “non-fungibility”? After all, the modern economy is based on exchange.
This term can actually be a bit confusing. Non-fungible simply means that there is no set exchange rate to convert it to other assets. The money we use every day is a good analogy. The Polish zloty is fungible (i.e. it is not an NFT token) because each banknote is equivalent to another banknote with the same denomination. For example, in accordance with the law, when returning goods to the store, the customer has no right to demand a refund of exactly the same banknotes with which he previously paid.
It is different in the case of antique collector coins – they are non-fungible. Of course, they can be exchanged for other coins or for modern zlotys, but the price of each such coin is always a matter of individual valuation, depending on many factors, including even the subjective sentimental value to the owner.
What are the uses of this technology?
The fashion for NFTs started a few years ago. Initially, it took the form of a game, a good example of which are the so-called CryptoKitties – virtual cats that can be bred and reproduced (as NFTs, every cat is unique!). Of course, in practice, each crypto-cat is just a string of bits on the Ethereum blockchain and only becomes a cat in the human imagination. The same is true for virtually every other case of NFT; digital information stored on a blockchain becomes meaningful only when enough people believe it matters. While this sounds like a vicious circle, it’s actually not as absurd as it might seem at first. In his popular book, Sapiens. From Animals to Gods, Yuval Noah Harari argues that the ability to create abstract creations that exist only in the collective imagination is a key characteristic of humans as a species.
How can NFTs and the use of smart contracts change the situation of artists and affect the art trade? (e.g. royalties, resale, certificates of authenticity)?
The use of NFT in art is based on people’s attachment to the concept of “original work”, its “aura”, i.e. the nimbus that accompanies the original work. Art has always faced the problem of the fact that the original cannot be distinguished from its copy. In a sense, this problem appeared even before the digital age, e.g. it occurred in graphic art made with the use of the engraving technique. This technique allowed the artist to make any number of identical copies of the same work, so to ensure the value of individual copies, they began to be numbered and signed (thus creating a kind of “analog” NFT). More recently, this type of art distribution was popularized in the 1970s and 1980s by Andy Warhol’s Factory. Of course, this problem is multiplied in the case of digital art, because here a perfect copy of a digital work can be made not only by its creator, but by any person who has mastered the not very difficult operation of copying files on a computer.
Currently, NFTs are transferring the idea of “numbering and signing” to blockchain. Compared to the above-mentioned analog NFTs, they are much safer because they are secured with cryptographic methods. Since everything that happens on the blockchain is public, we no longer have to take the creator’s word for it that he has not released more copies than he promised. Blockchain NFTs are also easier to use because they can be exchanged over long distances on the Internet in a flash.
How does it look in practice?
The artist creates a work in the form of a digital image and places it on line. Anyone with access to the Internet can copy this picture or, for example, print it and hang it on their wall at home. On the blockchain, only the information who owns the image is recorded. Initially, it is the creator of this work himself, but he can sell it. Moreover, such a “virtual deed of ownership” may also entail obligations, for example, a rule may be embedded in it that in order to maintain it, its creator must regularly pay “royalties”.
This is, at least, the vision of the NFT supporters. Like I said before, it works as long as enough people believe it works. So all of this is a matter of agreement. For example, technically, the creator of the work can sell it again by creating a new contract on this or another blockchain. However, the general public will then consider that this new copy is not the only and original copy of the work. Today we do not know how things will turn out, a scenario is possible in which legal regulations will include new ways of creating and exchanging goods online. But, what is worth emphasizing, today the NFT system is somewhat independent of the legal system, so in the actual circulation there are, for example, “unique” NFT series concerning works to which another person or institution has rights.
Are there any areas where “NFT ownership” is not contractual?
In a way, this is the case with applications in the multiplayer gaming sector or virtual worlds like the Metaverse. Then the NFT system can be a kind of ‘mortgage land registry’ for such environments. Although then an administrative and technical question arises: do you really need blockchain for this, if you usually play via central servers anyway and it works relatively efficiently? Here the answer depends on what we mean by “blockchain”? Probably the use of the Ethereum blockchain for such purposes would be an exaggeration due to the high costs of using this system. But blockchain based on a consortium of game operators – why not?
In 2021, the NFT market was valued at $ 40 billion. How can this increase be explained?
Indeed, NFTs have gained immense popularity recently, with some auctions reaching prices in the tens of millions of dollars (for example, the work of “HUMAN ONE” by an artist using the pseudonym Beeple was sold for 29 million dollars in December 2021). Since I have never been interested in collecting works of art, it is a bit difficult for me to empathize with the motivation of the buyer of this work. Perhaps he was driven by more than financial speculation, but I do not know that for sure.
Critics of NFTs, just like with cryptocurrencies, compare them to pyramid schemes since the onset. Is this a good way of thinking?
Perhaps they are right. As an IT specialist, it is very difficult for me to comment on this. Probably economists will have more to say here, although as you know, economics is a social science, and it usually does not provide answers as unambiguous as mathematical or natural sciences. As is usually the case in this field, the names of well-known economists will probably be found in the camps of both opponents and supporters of NFTs.
In 2021, the first “serious” NFT art auctions were held in Poland. What should people who intend to invest in such an art form know about blockchain? What should they pay special attention to?
I will repeat myself, but as an IT specialist, I can only substantially comment on technical issues. A very important aspect of such transactions is the security and appropriate protection of the private key that gives access to such work. By investing in blockchain goods, a small “collector” can store them on his own, but it is not easy and requires appropriate equipment and some technical knowledge. An alternative is to use exchanges (they can also be called virtual vaults) that store such goods, but then we lose the main advantage of blockchain, which is its decentralization and not having to trust one institution. The reality is that in the event of a hack of the exchange, recovery of digital goods is usually difficult or completely impossible. The graveyard of cryptocurrency exchanges that have collapsed as a result of such attacks is already quite large and may soon begin to expand with exchanges dealing with NFTs.
What are, in your opinion, the biggest challenges for researchers dealing with the practical application of NFTs?
As part of IDEAS NCBR, we deal with technical problems related to this technology. First of all, the challenge is the low throughput of the blockchain, which, e.g. in the case of Ethereum, does not allow the massive and cheap use of NFT on a global scale (the aforementioned CryptoKittes led to the clogging of this system a few years ago). In addition, there are privacy concerns. This raises serious questions, e.g. do we want everyone to know what virtual works of art we have at any moment? And yet blockchains such as Ethereum are publicly available, visible to anyone interested to search it. The security issues of the storage of NFTs (as well as other virtual assets) are also a big challenge, as today they can both be lost and forsaken as a result of a hostile takeover of the data carrier and private key. All these issues are the subject of our research.
Stefan Dziembowski is a researcher and a group leader at IDEAS NCBR and a professor at the University of Warsaw. He is interested in theoretical and applied cryptography. Dziembowski received an MSc degree in computer science in 1996 from the University of Warsaw, and a PhD degree in computer science in 2001 from the University of Aarhus, Denmark. He was a post-doc at the ETH Zurich, CNR Pisa and the University of Rome “La Sapienza”, where he joined the faculty in 2008. In 2010 he moved to the University of Warsaw where he leads the Cryptography and Blockchain Lab.