The idea that you can claim ownership of a physical or digital item using a blockchain’s immutable ledger is so compelling that it has become the darling of the blockchain world. So let’s dig in to understand what NFT’s are and how the blockchain is supposed to register items so that digital items can be owned in perpetuity and royalties for usage of registered items can be established.
Decrypting NFT
Currency is fungible. It has a fixed denomination and is interchangeable from the perspective that my ten-dollar bill can be interchanged with yours – they have the same value. A non-fungible item is unique, and its value varies, typically based on the perception of its value.
The NFT solutions coming to market are for digital items, but those could also represent something in the physical realm. This means that NFTs are similar to a commodity where the value is established by what someone else will pay for it. Objects considered artistic worth is one example, but almost any digital item can be registered as an NFT.
What Does It Mean When An Item Is Registered as an NFT?
An NFT is a digital asset, perhaps an image, an article, or a recording, deposited into an immutable ledger with details of ownership verified through blockchain technology.
Put, registering ownership of an object with the NFT is nothing more than creating a record in the immutable ledger that contains the digital object or points to it in some other storage medium and documents that ownership.
In most instances, smart contracts are associated with the object that defines transferability, which might include royalties for every resale in perpetuity; however, everything becomes much more complicated when you delve beyond this simple description because there are multiple implementations of this basic concept already on the market.
Value of an NFT
In general, however, you have to dig deep and understand the following issues if you want to understand the value of any particular NFT solution:
Provenance
Without some external effort to identify the object’s provenance, nothing prevents me from registering a duplicate or a flat-out fake. However, assuming the act of recording an object somehow guarantees the object is yours or even real would be a terrible mistake.
Inhibits Duplication
In some instances, as with digital art, it may be possible to tag the original object to identify duplicates, but no technology will prevent duplication in the digital age. For example, anyone can grab a copy when the digital item is included in the immutable ledger.
Prevents Unauthorized Distribution
As identified above, making copies of a digital object is simple. Duplicating that object is also simple, but utilizing that copy might be managed if the actual delivery or presentation requires a particular application.
In theory, a smart contract might encapsulate the digital item in a secured PDF format (or some application that is even more secure) and then send the unlock keys when a purchase or rental is entered into.
Fraud Risk
This is perhaps the weakest link in NFT implementations today. Criminals create duplicates and even fake originals supposedly by famous artists and then falsify the provenance. Unfortunately, no technology, including immutable ledgers and smart contracts, can validate the origin of a digital item.
In essence, the NFT infrastructure enables this criminal activity by expanding that activity into the world of e-commerce. NFTs also allow the identity of the seller and buyer to remain undisclosed, so prosecution in this instance would be impossible!
Regulatory
If you discover that the item purchased was counterfeit, it is unclear how that can be prosecuted under existing laws. First, the identity of the seller may be unavailable. Second, the law assumes the buyer and the seller are in the same jurisdiction.
If this was an international transaction (which may also be unknown), it is improbable existing laws will operate as you hoped they would. However, it has already been reported that there have been many intellectual property infringements in the NFT world.
Governance
The hype around blockchain technology – distributed with no central control – is inaccurate for blockchain and even less valid for NFTs. Therefore, the blockchain needs to be upgraded with new features regularly.
If the blockchain in question isn’t already operating based on quantum-resistant cryptography, a significant upgrade will be required in the next seven to ten years. However, it seems that some of the smaller blockchain implementations, including those running unpopular cryptocurrencies, will fail to be upgraded.
The NFT infrastructure requires even more management and operates more like an exchange. Remember, the exchange is where almost all crypto thefts have taken place. Two primary areas of concern would be maintaining and upgrading smart contracts that manage the asset and external vaults that store digital representations to assure longevity.
Environmental Impact
Lastly, there is the environmental impact created by the essential operation of the blockchain. For example, it has been estimated that a small image stored as an NFT could consume as much power as is used to power a home for two months.
Since that environmental cost is simply additive to all the different use cases implemented on Ethereum, it is unlikely the ecological impact will weigh heavily on most of those considering the utilization of NFTs.
Should You Buy an NFT?
So should you buy a non-fungible token? If you do, you should know precisely what you are buying, what you aren’t buying, and if it protects you under existing laws (for the most part, it doesn’t).
Recognizing that acquiring an NFT doesn’t guarantee the object’s provenance or prevent its duplication and distribution, what does an NFT provide? When everything is operating correctly, and you are not mistakenly interacting with criminals, NFTs provides an automated mechanism for owning, selling, buying, and profiting from digital goods.