What is an NFT and how do they work?

Type 'what is an...' into Google and an acronym almost no one had heard of at the start of 2021 is in the top five suggestions. The NFT, or non-fungible token, has shot to fame in recent weeks, with some examples selling for thousands or even millions of dollars.

One NFT, attached to a piece of art by Beeple, shown below, was auctioned by Christie's in mid-March and sold for an astonishing $69.3 million after fees. Over 350 bids were placed by 33 bidders, and the auction began without an estimate at just $100 – a demand from the artist for the NFT to plot its own course into wholly uncharted waters. The price leapt by $40 million in the final 15 minutes.

So why are NFTs suddenly so valuable, and what are they? Read on to find out.

First up, it is worth explaining that if something is non-fungible then it is unique and cannot be replaced. Currency is fungible, since you can trade a dollar bill for another and still have the same amount of money. Same goes for bitcoin; it doesn't matter which coins you actually own, just the quantity of them.

A non-fungible item is like a piece of art. The Mona Lisa is very much non-fungible, because despite countless replicas appearing on novelty posters the world over, there is only one original.

But unlike a painting, NFTs are digital, non-tangible items. In simple terms, NFTs live on the blockchain of the Ethereum cryptocurrency. Like bitcoin's blockchain, the Ethereum blockchain is a permanent digital record of all Ethereum transactions; it is also an indisputable record of NFT transactions. NFTs are not unique to the Ethereum blockchain, however, and other blockchains can be used to implement their own NFT transactions.

When an NFT is added to the blockchain it is assigned a unique ID, so that the provenance of the NFT can be traced and it can be told apart from any number of copies. If someone claims to own an NFT, this can be verified by checking the blockchain.

So far, so good. NFTs are unique, identifiable digital assets whose exchange between owners, via the financial transaction of Ethereum cryptocurrency, is logged for all to see.

But because the items represented by NFTs are commonly images and gifs, they can easily be copied by anyone and redistributed. It is all well and good buying a piece of art for $69M, but the Beeple piece was a digital image, not a painting, so can be downloaded by anyone; if you wanted, you could print it out and hang it on the wall. But you wouldn't own the NFT, and therefore can't brag about being its one true owner, and that's where the value is with an NFT.

Where can NFTs be bought?

There are already a handful of online marketplaces selling NFTs. One of the most popular is OpenSea, which sells all manner of digital artwork as NFTs. Many of these are images and gif files seemingly of little value, other than being (sort of) unique.

Some of these are digitized drawings, while others are a little more unusual. For example, a verified seller called SaveTheDate is selling NFTs of famous dates in history, such as January 24, 1984 (debut of the Apple Mac computer) for $815.

However, some of these dates are completely wrong, such as August 10, 1846, which is priced at $325 and claimed to be the date Louis XIV was crowned King of France – a coronation that actually happened on June 7, 1654. Similarly, the guillotine was not first used on August 25, 1972 (yours for $812). Blunders like this certainly don't add to the legitimacy of NFT marketplaces.

NFT Showroom is more interesting, as the tokens it sells are closer to what you might describe as art – even art that you'd hang proudly on your wall. But, in these early days of NFT popularity, the artistic merit of a token seems to have little impact on its worth. This one-off CryptoPunk image last sold for 4,200 Ethereum, which at the time of writing is over $680,000.

All of these NFTs are bought using the Ethereum cryptocurrency, and once the transaction is complete the NFT will appear in your Ethereum wallet, which itself can be stored on your computer. Like protecting bitcoins, you could then take that computer offline to stop anyone from potentially accessing the NFT.

What else can be bought as an NFT?

The market is still very young, but beyond digital artwork there have also been sales of digital trading cards and even video highlights from the National Basketball Association.

The NBA's Top Shot product works like a trading card system, where highlight clips can be sold and traded as NFTs. It has so far raised more than $230M, with a particular highlight being a five-second clip of LeBron James that sold for $200,000. Like trading cards, these clips are first distributed in packs, priced from $9, with buyers queuing up online to buy them despite not knowing their contents.

As a sign of their popularity, 5,000 packs were released in late-February and 90,000 people got in the virtual line to buy them, all in the hope that their pack might contain a valuable clip – the 2021 equivalent of a shiny Pokemon card. The hope is that a clip of LeBron James acquired in 2021 could increase in value over the decades in the way 1950s baseball cards have, with some now fetching millions of dollars.

Other recent NFT sales include Jack Dorsey's first tweet, which he auctioned for charity for $2.9M to someone who described his purchase as the Mona Lisa of tweets. As an example of why owning an NFT doesn't necessarily mean you have control of whatever it represents, here is Dorsey's $2.9M tweet, for free:

How does copyright work?

This is where the lines blur somewhat, because despite an artwork being sold as an NFT, the creator retains the copyright for it and has the right to reproduce it as often as they like. In theory, they could produce a set of identical artworks then sell each of those as an NFT; each would be unique as far as its NFT identification is concerned, but visually they would be identical.

The original creator also takes a cut of every future sale of the NFT, meaning an artist could continue to earn money years after their work was first sold, like a musician picking up royalties for every stream and sale of decades-old albums.

What is the point of an NFT?

It's a fair question, and one we don't fully know the answer to, yet. NFT's could become a new standard in the way digital assets are created and distributed. NFTs could lead to a marketplace where easily copied (and pirated) digital assets like music and images are given a higher value, as they are deemed to be unique or of a limited run.

Fans of a certain band might take pleasure in buying an album as an NFT that they know only a handful of which exist. And while it might sound identical to the same album streamed on Spotify, there could be some kudos attached to owning the unique or limited-run NFT version; it could also increase in value over time.

That is perhaps the crux of the matter – the perceived value of something that is rare. The rarity of a digital artwork NFT might not be as obvious as that of a Monet hung in a gallery, because it can easily be copied. But the owner knowing they own the undisputed original, and for that ownership to be traded for money in a transaction logged on a blockchain, could be a big deal for some deep-pocketed collectors.

What will the future hold?

The future of NFTs is anyone's guess for now – and by using blockchain technology the system relies upon powerful computer servers completing complex calculations, and thus has the same environmental issues as bitcoin, due to the energy consumption of those computers. So while being a new and interesting way to assign value to something, and a means to trade rare digital items, it could be deemed environmentally irresponsible before it can justify its own existence on a large enough scale to survive.

For now, anyone wishing to invest in NFT collectibles should proceed with caution. It isn't clear if the market will survive, let alone flourish. Until that picture becomes clearer, NFTs are something for collectors (millionaires or otherwise) to speculate on.