NFT (an abbreviation for the English “non-fungible token”) are non-fungible tokens that are titles of ownership of various digital objects: texts, images, audio recordings, digital works of art, game items or characters, domain names, financial instruments, club cards, etc.
If cryptocurrencies are conditionally interchangeable – for example, one bitcoin in one user’s wallet is equal to and identical to one bitcoin in another user’s wallet (if you do not take into account the traceability of origin through blockchain analytics tools) – then one NFT token representing a picture is not equal to one NFT token of another user, since it can be different paintings by different artists with different values.
Each of the NFT tokens is unique and exists in the singular. Non-fungitable tokens are unique—they cannot be copied. Each of them contains identifying information recorded in smart contracts. This information makes each NFT different from the other.
With the help of NFT, the developers solved the problem of ensuring ownership of digital objects. Information about the owner and his tokens is fixed in the blockchain. It is not possible to replace or delete information.
How did NFT come about?
Experiments with NFT began with the emergence of solutions such as Colored Coins (in 2013) and Counterparty (in 2014), which made it possible to tokenize assets on the Bitcoin blockchain.
In 2017, the NFT project Rare Pepe Directory became famous – memes with Pepe the frog. The first NFT on the Ethereum blockchain in June 2017 was the project of the Larva Labs team – CryptoPunks pixel portraits. Initially, cryptopunks, of which there are only 10,000, were distributed for free, but at the time of writing, they are already perceived as valuable blockchain antiques.
The first hype in the history of NFT was CryptoKitties. Launched in November 2017, the project makes it possible to “breed” cats. The user takes two NFT cats and produces NFT offspring of varying degrees of rarity from them, which he keeps or sells.
Many projects have begun to experiment with the NFT breeding mechanics, adding other game elements. For example, there were L2 games built by third-party developers on top of CryptoKitties. The idea of such games is that not NFT are created for the game, but games are created for already existing tokens. This idea is being developed by the Enjin project, which collected 75,000 ETH during an ICO at the end of 2017, and Eminence from André Cronier.
The Wrapped Kitties L2 application allows you to wrap NFT cats into ERC-20 tokens. If the user cannot afford an expensive token, he can buy part of it. As of March 11, 2021, the market capitalization of wrapped NFT was $ 5.098 million.
Another project with a game element is Aavegotchi, which connects the mechanisms of the landing deFi service Aave and the popular Tamagotchi toy.
There were also so-called bubble games in the style of “Hot Potatoes”. Their rules are simple: each next NFT buyer pays more than the previous one. After someone bought NFT from developers, with each subsequent resale, the price of the asset automatically increases according to a given algorithm.
Tokenization of non-fungible digital objects has quickly spread to card games (Gods Unchained), RPGs (MyCryptoHeroes, Neon District), sports games (F1 Delta Time, Sorare), virtual worlds (Decentraland, Cryptovoxels), domain names on Ethereum (ENS), traditional financial instruments (yinsure).
The tokenization of digital art has received a new impetus: it has become even easier to create NFT, trade them and receive royalties from them.
All classes of digital objects are actively traded on marketplaces. The ecosystem of production and turnover of NFT includes dozens of projects.
What token standards are used to issue NFT?
Most non-fungibility tokens are issued on an Ethereum basis in several major standards. Standardization of NFT issuance guarantees a higher degree of interoperability (the ability of blockchains to communicate with each other), which allows the transfer of such non-interchangeable tokens between various decentralized applications.
ERC-721 is the first and most popular implementation of NFT on Ethereum, extending the capabilities of the underlying ERC-20standard. In it, each type of token requires a separate smart contract.
Later, other versions of the standards appeared:
- ERC-998 is an evolving standard that allows you to create a composite token – a digital asset that “owns” another digital asset. For example, the rights to own a game character in a computer game are represented by one non-replaceable token, and the rights to its equipment are represented by another. ERC-998 allows you to combine them into one token.
- With the ERC-875, you can send multiple collectibles in a single transaction.
- ERC-1155 is an advanced standard that allows you to work with several types of tokens at once through one smart contract. On such a contract, both NFT and ordinary tokens can be simultaneously located. It allows you to store a wide range of items, from armor and weapons to magical potions and scrolls, where each of these items can be interchangeable if there are several copies of the same type. If the game contains tens of thousands of elements, then in the case of ERC-721 it is necessary to create the same number of separate smart contracts. ERC-1155 allows you to combine ERC-721 tokens in one contract, each of which is stored with its own set of data. As a result, the game character consists of all the underlying FTTs: weapons, armor, special characteristics, and even other ERC-20 tokens.
Another NFT standard that is being actively worked on is Blockchain Bean Asset or BBA. The authors of the standard for Ethereum are the Blockchain Game Alliance, which includes prominent companies of the gaming market, such as Ubisoft. Within the framework of this standard, the developers intend to integrate the possibility of decentralized storage of content.
FTFs aren’t limited to Ethereum – they also exist on the NEO, EOS, Tron, Flow, Cosmos, and other platforms networks.
The Mythical Games team, in collaboration with game developers and the EOS ecosystem (Greymass, Cypherglass, Meet.One, Scatter, and Blocks.io), plans to launch its own NFT standard for EOS: dGoods.
Tron also attracts game app developers. For example, the company Biscuit and the creator of the EOS game Knights intend to switch to the Tron blockchain. It is planned to combine game projects, where the possibility of acquiring and selling NFT for both cryptocurrencies will be implemented.
What does the NFT ecosystem consist of?
NFT projects are developed mainly in the Ethereum, Flow and WAX networks, as well as on the basis of second-level solutions and sidechains.
Release platforms and marketplaces can be divided into the following categories:
- Aggregators that provide the purchase and sale of NFT.
- Universal release protocols that enable the creation of NFT.
- Niche Marketplaces: Marketplaces or art issuers predominate, but NFT blogs such as Mirrorand music marketplaces such as EulerBeatsare also gradually emerging.
Where is NFT used?
|Imagery||Paintings, illustrations, designs, photographs, stock images.|
|Audio||Music, podcasts, radio programs.|
|Written content||Blog posts, tweets, how-to.|
|Metaverse||3D models, internal game assets, maps, augmented reality assets.|
|Video||Movies, TV series, streams, shows, videos.|
|Address space||IP addresses, domains.|
What NFT marketplaces are there?
NFT marketplaces/protocols for the release of art objects
Universal Marketplaces/Release Protocols
Niche Content Release Protocols
Art marketplaces are a kind of combination of auction houses, galleries, and release protocols.
Nifty Gateway and SuperRare themselves invite creators with high reputations to the platforms.
Other marketplaces, OpenSea and Rarible, are more versatile and similar to Etsy or eBay – on these sites, creators can exhibit their own works of art.
OpenSea is the largest NFT market by trading volume, it supports the trading of ERC-721 and ERC-1155 tokens, which were used to create more than 4 million unique digital items.
Collectible NFT can be traded on the Auctionityplatform, which allows you to sell and buy game assets in the auction mode.
The KnownOrigintrading platform, launched in February 2018, may be of interest to designers and artists. With the help of the internal token KnownOriginDigitalAsset (KODA) of the ERC-721 standard, users can purchase art objects, as well as confirm the authenticity and authorship of their creation. KnownOrigin offers more than 19,000 works of art for sale.
The Pixura project offers templates for NFT marketplaces that allow you to launch trading platforms with any ERC-721 tokens.
How do they make money on NFT?
1. Purchase of individual FT and subsequent resale.
NFT can be bought on marketplaces like OpenSea and Rarible. OpenSea allows you to buy and sell NFT for different assets, but the default currency is ETH.
2. Purchase of native tokens of NFT-projects.
Users buy RARI management tokens from Rarible. Owners of RARI tokens can vote for project updates and participate in moderation.
Interest is also shown in AXS tokens from the game Axie Infinity, as well as in MEME from the protocol of the same name, the NFT farming project. MeME token staking allows you to unlock limited works by different artists or collectible cards.
Another control token is SAND, an in-game currency in the Sandbox platform universe.
Another category of assets with a bias in NFT is tokens, which are rights to partial ownership. For example, the sharded coins of the NIFTEXproject, which allows you to break the NFT into small parts, expressed in more liquid ERC-20 tokens. A share of one non-fungible token can have several owners at once.
The B20 token of the Metapurse project works on a similar principle, allowing you to share ownership of the works of The Beeple 20 Collection.
3. Lending to NFT collectors.
Many collectors are interested in borrowing against NFT. This allows you to make a marketplace NFTfi. In the event of default by the borrower, ownership of the NFT passes to the lenders.
4. Purchase of tokenized index funds.
The main idea of the NFTX project is to bring liquidity to NPTs like CryptoPunks by creating tokenized index funds $PUNK. The management token is used by the community to manage the protocol.
5. Purchase of tokenized insurance policies.
In the DeFi and NFT sectors, Yearn.finance and its project on income insurance yInsure are popular. Tokenized insurance policies from Yearn.finance can be sold on openSea and Rarible marketplaces.
There is no one right way to collect NFT and make money on them. It should be borne in mind that such tokens are low-liquid, and the value of each item is subjective. To analyze the situation and prices in the segment, you can use analytical resources like NonFungible.
What is PFP?
PFP (Picture for Proof, literally “Image for Confirmation”) is a type of non-interchangeable tokens used as profile images or “avatars”. Many market participants, displaced from it as a result of the rapid rise in prices for CryptoPunks, were looking for more affordable variations of NFT.
This led to the launch of numerous projects in the new sub-segment and the emergence of “PFP mania”. Users of Twitter, Discord, Telegram and even LinkedIn began to change their profile pictures on NFT.
Bored Apes Yacht Club (BAYC). Data: Finematics.
One of the first NFT/PFP projects was the Bored Apes Yacht Club(BAYC).
Yuga Labs launched the NFT Bored Ape Yacht Club series in April 2021. This is a collection of 10,000 high-quality images of “bored monkeys” with an arbitrary combination of accessories – smoking pipes, necklaces, glasses, hats. Among the characters there are both ordinary primates and exotic ones – with gold skin, in crowns, etc.
“Yacht Club” in the name of the collection implies that each NFT is a club card, giving its member privileges: access to exclusive products and an online graffiti board, as well as bonuses from the creator of the Yuga Labs series in the form of NFT dogs.
Yuga Labs originally sold Bored Apes for 0.08 ETH. In September 2021, the cheapest monkey was already worth about 40 ETH. In the same month, auction house Sotheby’s sold a set of 107 Bored Ape Yacht Club for $ 24.4 million A set of 101 tokens of another collection from Yuga Labs – Bored Ape Kennel Club – sold for $ 1.8 million.
The avadarcs mania has led to the emergence of many other PFP/NFT. Most of them are primitive clones of popular projects, but there are exceptions.
The Pudgy Penguins collection includes 8888 penguins with different features and accessories – scarves, T-shirts, glasses, iroquois, etc.
The World of Women collection, which contains images of women, is designed to bring more diversity to the world of NFT and to represent the maximum number of human types.
Along with brand new FTFs, project teams already achieving success are launching collections inspired by their original creations. The most famous examples of this kind are the Meebitscollection, released by the creators of CryptoPunks, and Mutant Apes from the authors of Bored Apes. This approach allows you to expand existing user communities to include people for whom the original collections were not available.
While PFP remains the focus of NFT users, new and exciting niches are emerging in the sector. One of them is generative art. It is at the intersection of art and programming: an artist-programmer writes an algorithm with which AI creates an image.
The art object is created at the time of the release of a new NFT and uses the transaction hash always associated with this token. This model allows market participants to feel involved in the creation of a work of art: two users release an art object from the same collection, but get different results.
Autoglyphs. Data: Finematics.
An example of generative art is Autoglyphs, a collection of 512 items created on-chain based on an ASCII table. They are displayed thanks to the execution of the Autoglyphs smart contract. For each object, the probability of creating certain patterns is individual, so individual fragments are more rare. The average price of Autoglyphs NFT sold over the past week was $1.15 million.
Many popular works of generative art are created on the Art Blocksplatform, launched in November 2020. According to CryptoSlam, the trading volume on the platform for August 2021 exceeded $ 469 million.
Art objects are created in Art Blocks using a script written in the 5p.js programming language. Each collection has its own script stored on the Ethereum blockchain. Written in 5p.js the program can create different geometric shapes with different structures, textures and colors depending on the goals of the creator.
The most prestigious collection of Art Blocks Curated includes NFT Ringers by artist Dmitry Chernyak. In August 2021, cryptocurrency venture capital fund Three Arrows Capital acquired Ringers #879 for 1800 ETH (about $5.8 million at the time of the transaction). 1800 ETH is the maximum amount spent on art blocks. The previous record was 1,000 ETH ($3.3 million) for Artist Tyler Hobbs’ Fidenza #313.
The most expensive works of generative art sold on the Art Blocks platform. Data: Finematics.
What other areas of development of NFT exist?
The non-fungibility and indivisibility of NFT makes them illiquid. The rapid growth of interest in a short time led to a jump in the average price of collections and made them inaccessible to retail investors. This problem is designed to solve the protocols of fractionalization of non-fungiplatable tokens.
The process of fractionalization includes two stages: the division of the token into parts and redemption. In the first step, the token owner creates the vault. The NFT is then sent to the smart contract and the holder receives interchangeable tokens (factions or shards) representing 100% of the ownership rights. Usually, most of the shards are put up for sale at the assigned price on popular decentralized exchanges – Uniswap or SushiSwap.
After the initial placement of the NFT shards, which they are provided with can be obtained in their entirety in two ways. The first is to collect 100% of the shards. This can be problematic for a variety of reasons. For example, when a liquidity pool is created on Uniswap or its clones, part of the LP token is burned so that a non-zero amount of liquidity is always present on the decentralized exchange. Therefore, after listing on a decentralized exchange, no one can get a token in full. This means there is a risk that the NFT will remain frozen forever.
To avoid this situation, NIFTEX, a protocol for creating ERC-20 index tokens secured by NFT, and a platform for fractionalizing Fractional.Art use a buyback model.
If the user has NFT shards and wants to get the token in its entirety, you can make a ransom offer to the rest of the shard holders. The user sets the redemption price of the missing shards in ETH and deposits this amount and his shards in a smart contract. At NIFTEX, the rest of the NFT’s shard holders have two weeks to reject or accept its offer.
To reject the offer, they need to fully redeem the shards at the price offered. If this does not happen within two weeks, the offer is considered accepted: the user receives the coveted NFT, the shards he has placed are burned, and his ETH is used to repay the rest of the shards.
At the Fractional.Art, each NFT has a minimum negotiated price determined by the weighted average of the shard holder’s votes. This model avoids ransom spam. If less than 50% of shard holders voted, the minimum price is not set.
Any external party can deposit funds equal to or greater than the minimum price, which allows you to start an auction. At the end of the auction, the buyer who offered the highest bid can withdraw the NFT, and the shard holders can redeem the proceeds from the sale.
NIFTEX uses a more sophisticated buyback model. Only the holder of a certain number of shards can start the redemption mechanism. If he owns x% stake, he can run a ransom at $N value, depositing $N* (1-x%) in a smart contract.
Although a bidder may bid a price, other shard holders may collectively reject the ransom within a set period of time at the same value. They can do this by pooling funds and buying out the share of the user making the offer. Since the offerer cannot avoid redemption, he is not interested in making offers with a low cost.
If there is no redemption, the offer is accepted. The proposing party can withdraw the NFT and the profits are distributed among the remaining shard holders.
Rejecting ransom requires social coordination. NFT of the upper price segment is not available for listing on NIFTEX, since it is difficult to coordinate the actions of thousands of holders. Currently, the market capitalization of most sharded non-fungite tokens on NIFTEX does not exceed $ 1 million.
Homogenization and redemption
Fractionalization is not suitable for non-fungible tokens of the lower price segment, since their low capitalization makes it difficult to promote the liquid market. To attract more affordable FTFs, you need a vault that accepts deposits of various non-fungibility tokens with the same market value. These can be tokens from the same collection without unique characteristics.
Users who deposit eligible FTFs receive a certain number of interchangeable storage tokens. By burning some of these tokens, the user can withdraw a random token from the vault.
The homogenization of NFT from the lower price segment allows you to accelerate pricing for conventional collections, since it provides buyers and sellers with liquidity. Although the homogenization model contradicts the fundamental idea of non-fungibility of tokens, it is convenient for speculators who want to have access to conventional FTFs without owning them.
Storage tokens play the role of financial derivatives in relation to the market dynamics of the underlying FTTs. An example is the PUNK storage on NFTX. By depositing CryptoPunk, the user can issue 1 vault token (vault token) PUNK. A deposit fee of 5% is prorated among PUNK/ETH market liquidity providers on SushiSwap.
This model encourages passive marketmaking and provides liquidity. In exchange for the deposit, the user receives only 0.95 PUNK tokens. It may not pay a commission if, immediately after issuance, it uses PUNK tokens to provide PUNK/ETH liquidity for at least 48 hours.
For 1 PUNK you can redeem a random CryptoPunk from the vault. Recently, the site added the option of targeted redemption. It allows you to choose from the vault any NFT for redemption with a premium of 5% (1.05 PUNK in this case). As of September 17, 2021, the total amount of funds from commission fees on NFTX exceeded 742 ETH ($ 2.48 million). NFTX was running 8146 NFT.
At the NFT20 site, the vaults operate according to a similar scheme, but the deposit fee goes to the protocol treasury and is distributed among the holders of the MUSE token.
What challenges does the NFT sector face?
NFT storage is done in different ways. Non-fungibility tokens are distinguished by characteristics such as provable ownership, verifiability and availability of the history of origin and ownership. These parameters are achievable due to the fact that NFT is created on Ethereum and other blockchains.
However, image files cannot be stored on the blockchain itself, so most FTFs simply include a reference to the art object and its metadata, which is stored off-the-back.
NFT storage. Data: Finematics.
To store off-the-check data, some projects use centralized servers, others upload metadata and art to IPFS. Another solution is the Arweave(AR)data storage protocol. Exceptions are works of generative art and individual low-resolution NDTs that can be stored exclusively on-screen.
Intellectual Property Rights
Some NPTs allow owners to freely dispose of them, other projects limit the potential use of their tokens, but also give creators intellectual property rights.
Commissions for gas in Ethereum
Most FT Are issued under the “who did not have time, he was late” scheme. As a result, ordinary users are either not allowed to sell or overpay for the issue of tokens. The problem of rising gas prices can be solved by integrating NFT with second-tier solutions.
Infrastructure for buying, selling and displaying NFT
Currently, the lion’s share of NFT trading volume falls on the largest marketplace OpenSea,where centralized supervision of projects is carried out. The solution to the problem may be the decentralization of OpenSea and the emergence of other decentralized solutions.
NFT as a potential tool for money laundering and tax evasion
In assessing the sector, traditional artists are divided into two camps: some, such as Damien Hirst,see the NFT as a new promising direction, others, such as David Hockney, call the segment “the abode of crooks and scammers.”
The huge turnover and traditional way of the art trade industry make it attractive to criminals who want to legalize illegal income. Regulation in this area is becoming tougher, so washers are looking for new tools to implement their schemes. One of these tools can be NFT. There are no problems with the transportation of tokens, they do not need to be stored in a physical place, and most platforms focused on this segment of the industry work with minimal KYC requirements or without them at all.
Potential money launderers can really pay attention to NFT marketplaces. The largest of them – OpenSea – identifies customers by Ethereum wallet and allows for “private sales” of digital assets. The latter are auctions that are available only to addresses specified in advance.
The founder of the consulting company Post Oak Labs and the former director of market research of the R3 blockchain consortium Tim Swanson believes that non-fungibility tokens are already used not only for laundering criminal proceeds, but also for tax evasion.
According to him, the mechanism of money laundering with the help of NFT is as follows: a known account with large tax liabilities buys it [token] from an unknown account, and then resells it to a third account at a significantly lower price, receiving a loss that compensates for the above-mentioned tax liabilities. This is repeated over and over again.
According to Andrey Tugarin, Managing Partner of GMT Legal, there is no legal regulation in the NFT market in the field of combating money laundering – the segment remains a gray area in which it is very easy to “clean” funds. Therefore, we should expect a surge in “washing” transactions with non-fungible tokens, especially against the background of tightening regulation of the material art market.
However, cryptocurrencies are also associated with the legalization of illegal funds, which did not prevent them from turning into a multibillion-dollar industry.
The fact that NFT, like other digital assets, are issued on the blockchain, which means that the history of their transactions can be traced with due desire, also does not speak in favor of money laundering. The seller and buyer of the token can be identified in the “bottleneck” of the proposed scheme – during the conversion of cryptocurrency into fiat.
Regulation of the NFT market
Lawyers at the New York-based firm Kobre & Kim see the lack of regulation as one of the major challenges of the new market. They noted that the US regulatory authorities have already paid attention to this segment of the industry and probably intend to introduce it into the legal field. In particular, marketplace operators can be equated to art dealers.
In case of recognition of NFT cryptocurrencies, the operators of the relevant platforms will also be required to comply with the requirements of AML / KYC, since they are implemented by local bitcoin exchanges.
There is a third option – non-fungibility tokens, at least some of their varieties, can be recognized as securities. Earlier, this was stated by SEC Commissioner Hester Pierce. In this case, the Commission will directly regulate the market.
According to former USA Today journalist Isaiah McCall, the NFT is “doomed to regulate.” If you look at how government agencies systematically restored order in the cryptocurrency industry, you can see that none of its segments – from ICO to DeFi and stablecoins – managed to avoid this.
A similar fate awaits non-fungitable tokens, which will make money laundering with their help difficult. The NFT has already attracted the attention of some financial regulators and intergovernmental organizations such as the FATF.
How is the NFT industry evolving?
From February 4 to March 4, 2021, the trading volume of non-fungible tokens (NFT) on the 12 largest platforms amounted to a record $ 480 million.
Interest in the sector, in addition to representatives of the cryptocurrency industry, was shown by entrepreneurs, politicians and the creative elite.
Among those who paid attention to the NFT were actress Lindsay Lohan, Vermont State Senator Bernie Sanders, author of the meme animation Nyan Cat and Russian artist.
Tokenized tweets, GIFs, portraits of presidents and music albums in the shortest possible time collect millions of dollars at auction. Only during February 22, 2021, users spent more than $ 64 million on NFT, excluding expensive lots. Some copies, such as CryptoPunks, were sold for 90-400 ETH, and the most rare – for a record 4200 ETH.
On March 11, 2021, the British auction house Christie’s sold NFT artist Mike Winkelman, known under the pseudonym Beeple, for $ 69.3 million – this is a record price in the history of NFT.
In the second half of February 2021, the user base of the NFT marketplace NBA TopShot with basketball-themed cards increased significantly – on February 16 and 22, the platform was visited by over 45,000 users.
OpenSea surpassed the 1,000-day user mark in February. On the busiest days, the third largest marketplace CryptoPunks recorded 350 users.
The number of transactions is closely correlated with the number of users. On February 22, the NBA TopShot platform recorded over half a million transfers, OpenSea – over 4000, and CryptoPunks – 1400.
Along with Ethereum, new, high-performance blockchains like Solana, Tezos and Polygon are increasingly being used to issue NFT.
Another direction of development of the NFT segment is the creation of DAOs designed mainly for the purchase of non-fungiplatable tokens. Users with limited means can team up with others within the DAO. Jointly purchased FTFs can be tokenized and distributed among the participants. Under this scheme, PleasrDAO acquired Dogecoin NFT for $ 4 million.
One of the innovations in the market was the Lootproject. Loot NFT only contains metadata that describes a set of items in a hypothetical computer role-playing game. Members of the Loot community have the right to decide how to use and even how to visualize these items.
Loot NFT. Data: Finematics.
For the first half of 2021, the figure for the entire NFT market amounted to $ 2.5 billion.
From May to August 2021, the share of DeFi protocols in the traffic of decentralized applications (dapps) monitored by DappRadar decreased from 45% to 18%, yielding to projects in the NFT and GameFi segments (41% and 55%, respectively). Analysts explained the increase in the share of the NFT segment by a new wave of interest in non-fungible tokens.