35

Non-Fungible Tokens Revealed – Part 1

If you’re into all things crypto, then you’ve surely heard about non-fungible tokens or NFT.  However, few people really understand the importance of such tokens for the blockchain industry. Due to the fact that the blockchain itself is primarily associated with cryptocurrencies, information about new technologies from adjacent areas is not always widespread. If it is assumed that the main potential of the blockchain has yet to be realized, then it is impossible to pass by the NFT. The most important feature of the blockchain is the possibility to tokenize assets of value, representing both virtual or real world objects.

The subject of this article – non-fungible tokens – are the main means of such tokenization.

Understanding what NFTs are and how they function can help specialists to see new potential opportunities for the use of blockchains, as well as objectively evaluate projects that propose various tokenization solutions.

We will explore the latest developments in the field, the most popular technologies and protocols, as well as their current stage of adoption and prospects for the future.

In order to get a clearer idea of the topic, let us examine the notion of a blockchain-based token.

Token – a definition

Blockchain technology owes its popularity to cryptocurrencies; thus, it is not surprising that when we say “tokens” we often mean coins, which is not entirely accurate.

When blockchain technology was first emerging, newly created protocols described a “token” as a means of representing and transferring a certain asset, value, or resource. This is exactly the function performed by the most popular of the existing token standards – ERC-20 – the currency of the Ethereum network.

ERC-20 as an example of a token protocol

But how do tokens differ – except for in their names? And what are token protocols? Let’s take ERC-20 as an example. In the Ethereum network, the token standard is described in its smart contact, which provides a full set of rules governing the interactions with a token of this type. The smart contract defines which information a token can contain and provide and what actions it can perform. These rules apply to all tokens issued under the same name. The phrase “ERC-20-compatible” means that a given type of token has its own name, defined emission, and initial owner – and all the tokens in question can carry out the actions described in the ERC-20 smart contract.

ERC-20

The smart contract of an ERC-20 token is extremely simple. Without going into the technical details, we can put it this way: ERC-20 can only transfer funds between wallets and check their balance. On its own, an ERC-20 token can do nothing more – its smart contract does not even verify that the recipient address really exists. This has already led to over 12,000 ETH (by some estimates) basically disappearing into nowhere.

Thanks to its simplicity and reliability, ERC-20 remains the most widely used protocol not only on the Ethereum network but also in the crypto industry as a whole. It has become particularly popular as a token standard for ICOs. According to our recent report for Q3 2018, ERC-20 is used by over 90% of new ICO projects. It is crucial that developers can extend the protocol’s basic smart contract, adding more complex functionality. For instance, it is possible to add automatic token distribution or transfer functionality based on certain conditions or a previous agreement between parties.

So what information does ERC-20 store on the Ethereum blockchain? Essentially, just records of transactions that include the sender, recipient, and number of tokens transferred. This data is sufficient to determine how many tokens are stored in a certain wallet.

The ERC-20 protocol is a standard for recording account and wallet balances. It records not the tokens themselves but rather their number. The Ethereum ERC-20 blockchain is a list of transactions – just like an accounting ledger.

Fungible tokens

Of course, Ethereum is far from the only blockchain out there. Bitcoin, NEO, Stellar, EOS – these are just the most popular known ones. Each has its own token standard that functions as an internal currency. A token of this type is necessary for any blockchain since internal assets always have to be allocated and accounted for.

Tokens of this type – that is, those used to represent and record completely interchangeable asset units – are called fungible. One dollar is one dollar – it doesn’t matter which exact dollar note you have in your hands. Fungible tokens are just like that: We care only about their number and who their owner is.

Non-fungible tokens

The applications of blockchain range far wider than just accounting (no matter how complex it can be). The use of this technology primarily means data veracity and integrity. There is a wide range of data that requires such a solution.

Blockchain application solutions can include certification, notary records, land and property deeds, supply chains, authentication, prevention of counterfeiting, and so on. But how can all these be implemented using protocols created for other purposes?

By definition, a token can digitally represent anything, including unique objects. What would a tokenized plane ticket look like, for instance? What information should such a token contain?

Clearly, it has to include a range of unique data, including the passenger’s name, route, departure time and date, and airline. It is a typical plane ticket – and at the same time, it is unique. You cannot replace it with another ticket.

If we tokenize all this information, we end up with a token that differs from all others. That’s what non-fungible tokens (or NFT) are: tokens of the same type that contain unique data.

Moreover, such a token can not only contain digital information but also represent a real-world object. There are numerous examples of non-fungible objects that belong to the same type.

Tokenized digital itemTokenized real-world item
Ticket

Diploma/Certificate

Digital piece of art

Crypto-Collectibles

(digital baseball cards, CryptoKitties, etc.)

Works of art (paintings, sculptures, etc.)

Plots of land

Real estate

Brand items (luxury goods, watches, etc.)

Token contentsToken contents
Current owner

Item in digital form (picture, sound, code, CryptoKittie genome, digital image, ticket information, etc.)

Current owner

Unique properties of the item (serial number, technical data, dates, etc.)

As you can see from the table, tokens of the same type are not identical and contain different data. For instance, one student’s diploma differs from that of another student. The use of blockchain, in this case, ensures that sensitive information remains intact and cannot be tampered with.

Comparing fungible and non-fungible tokens

The difference between the two types of tokens in explained in the following table.

Fungible tokenNon-fungible token
ExampleBitcoin
Ether (ERC-20)
NEO (NEP-5)
CryptoKitties (ERC-721)
Decentraland Land (ERC-721)
Enjin (ERC-1155)
UseMeans of payment, currencyUnique assets and information
Measure of valueToken type and numberSingle token (tokenized value)
Blockchain recordsTransfers between wallets:

sender, recipient, amount

Unique data contained in each token

Records of transfer and ownership of individual tokens:

sender, recipient, item

Resulting informationWho owns tokens and how manyWho owns an individual token (tokenized item)

As previously mentioned, fungible tokens are standardized in all blockchains. As for non-fungible tokens, the situation is more complicated: There is still no single accepted standard. This explains the number of projects attempting to tokenize various assets and develop their own NFT protocols. Each wants to become a trendsetter and achieve mass adoption, setting the standard for the whole industry.

Understandably, such fragmented effort leads to the emergence of a multitude of proprietary protocols, which is a serious issue for the projects themselves and for the blockchain space in general. History shows that fast development in any industry begins only after a standard is established. In other words, the battle for the ultimate ERC-20-like protocol among non-fungible tokens is far from over.

What has been done already – and how? Below we introduce a short history of NFTs.

How NFTs were created

The idea of creating unique tokens, which now seems so obvious, was completely neglected by the community until spring 2017, when it was finally taken up by Witek Radomski, founder and CTO of Enjin. Various articles on the Internet harold him as the “the inventor of the first NFT”, but this is not necessarily true. Besides, most of those articles were written by Radomski himself, which understandably reduces the reliability of their claims.

Witek Radomski Creator of ERC-1155, CEO Enjin

In reality, several teams were working on the project simultaneously, but Radomski was the first (in June 2017) to finish writing the code for a token with non-fungibility features – the Enjin Coin.

It was still an ERC-20 token, but its expanded smart contract made each token unique. Enjin Coin did not gain much traction and, for a long time, remained an internal solution used solely by the Enjin project. Only on August 23, 2017, when it became obvious that he was not the only one engaged in this idea and the laurels of the “inventor of NFT” could be challenged, Radomsky published his code.

On September 20, 2017, the first draft of the so-called Etherium Request for Comments no. 721 – ERC-721 – was published. It was introduced by the developers William Entriken, Jacob Evans and Nastassia Sachs led by Dieter Shirley. It should be noted that until the end of 2017, the draft was being developed and the standard was eventually finalized and approved only on July 21, 2018.

This suggests that even ready-made solutions cannot be standardized quickly, and the coordination of all the subtleties of the protocol is usually stretched over a sufficiently long time.

Who knows – perhaps ERC-271 would have eventually been shelved just like the dozens of other protocols that never gained adoption if it hadn’t been for its creator Dieter Shirley implementing his brilliant plan named “CryptoKitties”.

CryptoKitties

The story of CryptoKitties is indicative of both the emergence of NFT and the demonstration of where the technologies and ways of their promotion will go.

The topic is so fascinating that we will devote a separate article to it that goes into much more detail in terms of the technology, marketing, and finance, as well as follows the rise and eventual decline of the project. Moreover, we explain how the emergence of CryptoKitties NFTs affected the Ethereum network and the issues it created. Amazingly, the game has not disappeared from the public radar: It continues to attract new investments and user interest, making CryptoKitties a unique event in blockchain history.

Here we will cite only a few conclusions that can be applied to the subject of NFTs in general.

First, CryptoKitties has demonstrated what a real hype is and what benefits it can cause. And this is not only the financial benefits for the creators of the project. In fact, we see a new way of promoting the technology underlying it. NFTs have attracted widespread attention precisely because of CryptoKitties. The current rapid development of such protocols is also a result of the game’s popularity.

Second, the project brought real value to the blockchain industry as a whole. Vitalik Buterin expressed this very well, saying, “I actually like the digital cat games. They illustrate very well that the value of a blockchain extends far beyond applications that would literally get shut down by banks or governments if they did not use one.”

Third, it is important to understand that non-fungible tokens can be carriers of value – sometimes real, sometimes purely virtual. CryptoKitties have shown that the line between real and virtual assets is becoming ever thinner and people are prepared to pay money for such assets regardless of their “reality.”

Marketing battles among protocols

The less-informed among us might think that the simultaneous creation of ERC-721 and the appearance of CryptoKitties was nothing more than a fortunate coincidence. So fortunate, in fact, that they simultaneously achieved global popularity. CryptoKitties brought its developers massive profit and investments, while ERC-721 became – and remains – the main NFT standard.

However, one and the same person is responsible for both events – a person with a fantastic marketing plan.

Dieter Shirley creator of ERC-721 and CTO CryptoKitties

The fact is that the creator of the ERC-721, Dieter Shirley, worked for many years worked for a Vancouver-based company called Axiom Zen, before the release of CryptoKitties. It is this company that released the game to the market. Not publicizing his involvement at the beginning, he became one of the chief developers of the game, then becoming the technical director (CTO) of CryptoKitties.

We should point out that CryptoKitties is a commercial project with a clear monetization scheme. AxiomZen earns a 3.75% commission on each transaction on the platform except for those executed directly via smart contracts. Moreover, the company earns money by selling 0-gen (zero-generation) kitties.

It is not clear if Shirley’s original intention was to develop the protocol or launch the game. What is clear is that ERC-721 and CryptoKitties became an explosive duo that led to both huge commercial success for the project and mass adoption of the protocol.

Here is how Dieter Shirley explained why he created CryptoKitties: “We need reasons for people who aren’t technophiles, who aren’t financial speculators, to come out and understand the meaning and value of blockchain. … People just don’t care about features. They care about the experience.”

We can take an even wider view: An ever-growing number of blockchain startups are fighting for investors’ money, but they all have the same problem – the success of a project or ICO depends on eventual mass adoption.

Achieving mass adoption is hard even for great solutions. What’s the main issue with projects working on NFT tokens? Usually, it’s the proprietary character of their solutions: Each startup develops its own “unique” token and tries to convince everybody that it’s bound to take over the world. There are dozens of such projects, and their sheer number is the main barrier on the path to the true interoperability of blockchain technologies.

Dieter Shirley turned out to be not just a good developer, but, most importantly, a talented marketer. He was the first to realize that a technical solution does not hold any value on its own. To be noticed and adopted it has to demonstrate its efficiency in a way that everyone can understand. With his project, Dieter Shirley showed everyone what it means to market a technology and how successful such marketing can be. From that moment on, it became clear that the route to people’s minds lies in tangible and simple examples, even for blockchain tech. Promoting a technology in its pure form is simply not effective.

Inspired by Shirley’s success, many developers realized that it’s useless to try and market a project hoping for eventual mass adoption. They recognized that it is more efficient to offer their own version of a standard or protocol on a non-commercial basis, and under successful circumstances, implement own project based on this standard.

Thus, it’s far more lucrative to author a standard and fight to get it adopted by everyone in the space. Marketing competition among protocol developers is still not as fierce as it is among commercial projects. In the near future, we will witness first and foremost marketing battles among protocol and standards, more so than among the apps based on them.

In the next part of the article, we will take a look at the most popular alternatives to ERC-20 within the Ethereum network, as well as at its counterparts in other blockchains. We will also present the key use cases for NFT tokens.