Non-Fungible Token (NFT): Definition and Explanation
Non-fungible tokens – NFTs for short – are currently very popular in the crypto world. But they are also subject to criticism. Are you wondering what exactly a non-fungible token is? What is the difference between it and a fungible token? What are NFTs used for and what are the risks of non-fungible tokens?
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Our lawyers at the Herfurtner law firm will answer all your questions on the subject of NFT, tokens and crypto transactions.
Table of contents
- Non-Fungible Token: What is it?
- Tokens – 2 types and their function
- NFT and their uses
- NFT and their history
- Non-Fungible Token in Criticism
What is an NFT? A brief explanation
A Non-Fungible Token (NFT) is a digitally encrypted item that can never be replaced. It is based on a string of characters that, unlike a fungible token, cannot be changed or copied. The method can be used, for example, to separate different digital files such as memes or computer-generated artwork.
The comparison of the NFT in non-digital life is, for example, Leonardo da Vinci’s Salvator Mundi, which cannot be replaced because it exists only once. Non-fungible tokens are referred to as NFT for short.
Tokens – 2 types and their function
There are 2 types of tokens:
- fungible (exchangeable)
- Non-fungible (not redeemable for cash) tokens.
Non-fungible in this context simply means that it is a one-off digital asset that cannot be exchanged for another.
The scenario with bitcoins, on the other hand, is somewhat different: since their value is constant, bitcoins can be traded at will. A ten-euro note has the same value as another ten-euro note.
A token is the digitised version of an asset. Consequently, the token has some kind of meaning. Real assets, such as real estate or music rights, can also be tokenised by transferring the associated rights and obligations to the token. This allows the property to be traded, as it has been digitally mapped.
Non-fungible tokens, on the other hand, can be compared to art objects such as paintings.
Each of these things has a monetary value. When you exchange things for each other, you generally don’t get back exactly what you gave up.
What does a Non-Fungible Token (NFT) look like?
Drawings, digital artworks, video clips or even actual goods can in principle be converted into NFTs. The crucial thing is that the NFTs carry information that proves their individuality. This way, the rightful owner can always be identified and his or her claim is recognised.
Now, of course, the question arises as to how a digital asset can be protected. Right-clicking your mouse saves a copy of any digital artwork you find online on your computer.
How can you prove who owns what?
The scenario outlined above is true. NFT opponents also cite it more often. But the situation is much more differentiated than first assumed. The reason is that NFTs, like digital currencies, are built on a distributed database, the so-called blockchain.
Put simply, this consists of blocks of information. These are connected to each other like links in a chain.
There are many blocks in the blockchain. Each with its own data record and the hash value of the previous block. For example, the transaction data of cryptocurrencies such as Cardano ADA and NFTs can be stored in one block. Including the names of the sellers and buyers as well as the transaction amount.
The hash value serves as an electronic fingerprint. The hash code of a block is always different, and that is why it is so important. A chain (blockchain) is created because each block carries the hash value of its predecessor.
This is built on a peer-to-peer network. That is, a network of peer computers with a complete copy of the blockchain. When a new record is added to the network, all computers receive it, compare it and then confirm its inclusion.
If someone wanted to add an untruth to the blockchain, they would have to add it to every copy of the system. This is difficult to do, but not impossible.
Blockchain, data storage and NFTs
The traceability of data in a blockchain makes it possible to prove the ownership of a person. Consequently, an NFT stored in the blockchain cannot be duplicated – at least not within the network.
Digital artworks can, of course, be infinitely duplicated using any terminal technology. The question is whether this makes them less valuable than physical artworks (such as forgeries, art prints, etc.).
Compared to Klimt or Monet paintings that can be displayed in your home, NFTs exist only in cyberspace. They cannot really be touched.
Non-fungible tokens and their uses
NFTs are used everywhere where they directly give virtual goods a label. This happens especially in DApps. Digital art, music or certain objects in computer games can be collected and exchanged like unique items.
Token and object are often assigned by the trading platform on which the artwork is presented. This private register is not permanently stored in the public blockchain like coins. Instead, it can be lost or destroyed along with the server.
Many blockchain applications now also offer NFTs as an option (commonly referred to as cryptocurrencies). Ethereum is the most widely used blockchain for NFTs and smart contracts (as of August 2021).
The copyrighted material is not automatically transferred to the NFT recipient. The respective legal meaning of an NFT transfer is determined individually and under private law by the contracting parties, depending on the contract design. It can only cover certain forms of use (cf. for Germany Section 31 UrhG).
NFTs and their origins
NFTs are often compared to Colored Coins, which are considered their predecessors. NFTs went live in 2017 with CryptoPunks. In the same year, NFTs became as popular as CryptoKitties. Most of the Ethereum transfer consists of trading Non-Fungible Tokens and Cryptokitties.
The hype around the topic took on such proportions that in 2018 the Centre for Art and Media Karlsruhe held an exhibition on CryptoKitties. In 2019, there were NFTs worth around 210 million dollars in market capitalisation.
Interesting to know: 16 facts about non-fungible tokens
1. well-known examples are the CryptoKitties cats, each of which is unique. These can be moved to the independent game coinsandsteel.com or Decentraland to play with them. Another example is user-created objects in the game The Sandbox.
2. Sotheby’s sold an NFT of Tim Berners-Lee’s World Wide Web source code for the equivalent of $5.4 million.
3. OpenSea is the largest NFT market in the world.
4. F1 Delta Time sold a virtual Formula 1 NFT race car for 415.9 ETH (about US$113,000).
5. NFTs accounted for 10% of global art industry revenue in Q1 2021. Global NFT trade was worth $2.5 billion in the first six months of 2021.
6. The total value of all NFTs exchanged was $100 million by July 2020. In the first quarter of 2021, NFTs were sold for $2 billion. The NBA Top Shot platform sold approximately $500 million worth of NFTs in the first quarter of 2021, and the website reached one million users in May of the same year.
7. Over $5.4 million was paid for an Edward Snowden Non-Fungible Token (NFT) in April 2021. The money was donated to the Freedom of the Press Foundation, which works to protect press freedom worldwide.
FC Bayern Munich, Nike and eBay
8. the NFT sneaker “CryptoKicks” was patented by Nike.
9. NFTs are also growing in popularity due to the recent boom in the sale of virtual properties in the digital universe Metaverse.
10. licensed FC Bayern NFT player cards were auctioned for 240 ETH (approx. US$ 31,100).
11. in February 2021, the well-known auction house Christies became the first auctioneer to allow crypto payments in Ether to auction the artwork EVERYDAYS: THE FIRST 5000 DAYS. The auction of the collage of 5000 tiny images by US digital artist Beeple raised the equivalent of 69.3 million US dollars. This is equivalent to 42,329,453 Ether. This makes it the third most expensive art sale by a living artist.
The buyer of this collage appears on the internet under the pseudonym MetaKovan. Behind the pseudonym is a crypto-based fund called Metapurse, which buys NFTs and other virtual items. He claims to be the world’s largest NFT fund. 12.
12 Goati from 22Racing are also regularly up for auction. The special feature is that a single racing car consists of a total of 22 different components (Multi Layer NFT).
13. the Azure Heroes NFT project was launched on Microsoft’s Azure cloud platform to give back to the developer community. The ERC-1155 protocol underlies Azure Heroes. The Enjin team developed the protocol and it has been officially approved.
14. eBay also wants to start selling NFTs in May 2021, according to a message on its website.
15. GameStop announced an NFT marketplace based on the Ethereum blockchain in May 2021.
16. gaming and earning from it with non-fungible tokens has become an attractive profession in low-wage countries like the Philippines.
NFT – all the rage?
Many people may find NFTs confusing or pointless. Ultimately, they are nothing more than a fragment of data in a computer system. The fact that digital assets are so popular at the moment has a lot to do with the excitement around digital currencies like Bitcoin and Ether.
In addition, the Corona epidemic may have had an impact. On the one hand, there are artists and musicians whose sales have plummeted dramatically overnight. Through NFTs, they have discovered new revenue streams. (See Grimes and Kings of Leon). On the other hand, buyers have retreated more and more into digital realms due to the numerous locks and quarantines.
On top of that, people are worried about demonetization due to rising debt from the pandemic. As a result, cryptocurrencies and NFTs could be seen as a way to protect savings from such a scenario. Another group are investors who assume that the value of their NFTs will increase in the future.
It remains to be seen whether the sometimes astronomical prices paid for some NFTs have paid off.
Non-fungible tokens under criticism
The technological processes of a blockchain are known to consume an enormous amount of energy. According to researchers at Cambridge University, Bitcoin alone, for example, consumes more electricity each year than the Netherlands as a whole.
This is due to the extensive hardware requirements of the peer-to-peer network. If the electricity is generated in a certain way, the C02 emissions are high. But that doesn’t mean NFTs are free of them either.
Memo Akten, a British artist and engineer, spent several months investigating the electricity used in the manufacture and sale of NFTs. About 18000 NFT artworks were studied, with an average electricity consumption of 3.4 megawatt hours (340 kWh).
This corresponds to about 10 per cent of the annual electricity consumption of an average German household. According to the documents, one NFT with 211 kilograms has the same CO2 footprint as a two-hour car journey.
Although the Ethereum blockchain, on which most NFTs are built, has energy-saving goals, every transaction so far has been a massive power guzzler. However, the question of whether a few colourful pixels are worth all that work is a valid one.
Other risks and questions associated with non-fungible tokens arise in the legal areas of copyright and property rights. In many cases, it is not completely clear what rights the NFT user acquires with his purchase. The unlawful tokenisation of other people’s property (e.g. other people’s works of art) also poses a danger.
We, Herfurtner Rechtsanwaltsgesellschaft mbH, advise you nationwide on all legal questions and concerns in the areas of blockchain, tokens, smart contracts, cryptocurrencies (Ether, Bitcoin, Cardano) but also internet fraud, investment fraud or cybercrime.
If you have invested in or made payments to one of the companies on this list, our lawyers will be at your disposal at short notice.