NFTs Can Bring the Real World On-Chain
This article was first published on Coindesk in March 2021. Ajit Tripathi: NFTs Can Bring the Real World On-Chain.
NFTs or “non-fungible tokens” have generated an unprecedented level of mainstream interest in cryptocurrency technology. Believers claim that NFTs represent a “paradigm shift” whereas detractors compare NFTs to the “Tulip Mania” and the “ICO era.”
We have seen similar polarization of public opinion before with blockchain technology and dot-com stocks that resulted in several breakthrough innovations and some epic commercial failures.
In this article, I will explain why I believe that NFTs in the form of digital art, music and collectibles represent only the beginning of a much larger wave of real-economy “e-commerce” transactions on public blockchains.
What are NFTs
While for a purist, “NFT” stands for any non-fungible token, in popular parlance today, NFT is used in the sense of a “digital collectible.” The New York Times recently described NFTs in somewhat irreverent terms as “blockchain-certified computer files.” In a previous article, the NYT wrote, “Most importantly, NFTs make digital artworks unique, and therefore sellable.”
Influencers such as Gary Vaynerchuk, Marc Cuban and Chamath Palihapitya have expressed their enthusiasm for NFTs triggering a large amount of investment in NFT issuance and trading platforms such as NBA Top Shot and Sorare that are being followed by a sudden burst of of products coming to market in a bit of a gold rush.
For the purposes of this article, we will stick to NFTs as digital collectibles that people love to own, pay for and brag to their friends and strangers about.
NFTs are valuable objects
If I am part of a community that assigns a value to a digital object, that value is the value of the object. This is why Pokemon cards and baseball cards are valuable, why bitcoin and eth are valuable and why NFTs such as Aavegotchis, NBA Top Shot, Non Fungible Pepes and NFTs minted by Beeple are valuable. There is a community of humans that finds the objects valuable and largely agrees on their value.
In my last CoinDesk article, I wrote about the challenges involved in bringing off-chain assets to DeFi. As it turns out, most NFTs, even though digital, are representations of off-chain assets. It’s not surprising then that many of the challenges associated with off-chain assets are directly or indirectly relevant to NFTs as well.
Essentially, an NFT “binds” or maps a unique object, the blockchain native non fungible token to a digital object e.g. a document, image, audio or video file or a physical object such as a house or a bicycle or your own private Island.
That is the crux of the issue. Most NFTs are not crypto-native assets. Unlike bitcoin, a non-fungible asset that lives its entire lifecycle on the Bitcoin blockchain, a digital work of art such as Beeple’s $69 million painting, “The First 5000 Days” is not blockchain-native. This painting was created as a collage made of 5000 different digital works of art in desktop software and then bound to a non-fungible token created by Beeple on the Ethereum blockchain. That means while the token, i.e. the bytes on Ethereum, are blockchain-native, the underlying work of art is not.
More valuable than a copy
The distinction between the token and the digital object to which it binds is quite crucial. In the crypto-native world, property rights and ownership are defined by “not your keys, not your crypto” – meaning that (absent certain circumstances) you control the private key that can send (assign) the token to someone else, you own the token (and all associated rights).
However, in case of a digital collectible, the ownership of a token may or may not mean that you own the underlying computer file to which the token maps. Blockchains use a hash function to establish uniqueness but a JPEG file and its copy both produce the same hash.
Content addressable systems (systems that allow information to be retrieved based on its content rather than location) such as IPFS (a decentralized network) can solve this problem by allowing an NFT to bind with an IPFS URL such that you own the resource but the copy of the JPEG is a different resource.
In this scenario, the URL bound to the token becomes worth 69 million whereas the URL corresponding to the copy is basically worth 0. Essentially it’s the token minted by Beeple that “makes” the artwork worth $69 million more than a copy of the digital artwork.
However, purely from a technical point of view, an artist or another actor can double-spend a digital object on (a) the same blockchain (b) on a different NFT platform (c) on a different blockchain.
Further, multiple non-fungible tokens can be mapped to the same underlying digital file or IPFS URL or to different copies of the same digital file. Indeed, on-chain ownership is not sufficient for off-chain objects unless the legal framework governing the rights of an NFT owner respects and enforces these rights in the off-chain world. I might own a Beeple artwork on Ethereum but Justin Sun might mint the Beeple artwork on Tron blockchain and thus claim ownership of the artwork anyway. A court in the U.S. might enforce Metakovan’s rights, whereas a court in Macau might decide in favor of Sun.
NFTs and contracts
Which means in any of the above double-spend scenarios, what I own could depend on what an NFT marketplace will do to honor and enforce my rights.
NFTs as Ricardian contracts
The long-term value of NFTs
NFT platforms are doing three critical things.
First, by creating a large, digitally native market for off-chain assets using on-chain tokens, these platforms are providing a proof of value for bringing other off-chain assets such as land titles, cars, houses and bonds – basically everything of any value on to Web 3.
Second, by building robust, scalable infrastructure for minting, trading and settling NFTs on-chain, NFT platforms are bringing ordinary, nontechnical people to crypto platforms in the way nothing else has so far. I’d not be surprised if 100 million new people become comfortable with using wallets like Metamask and DeFI products this year and next year because they want to trade digital collectibles.
Third, by sparking debates such as the one contained in this article, NFTs will force common and civil law frameworks to align off-chain rights with onchain rights. Before NFTs, this has not been the case. If degens lose their bitcoin or USDC, they lose it and courts and legislators aren’t particularly called upon.
On the other hand, if investors, asset managers, grandma and grandpa lose their Beeples or Top Shots to a double-spend, they will vote and these votes will force legislators to create laws that enforce their rights.
Essentially with NFTs we are looking at technical consensus evolving into a market which in turn forces the social consensus. While I may personally prefer to own Flow and eth than Beeples and Top Shot moments, it’s the Beeples and Top Shot moments that have suddenly accelerated Web 3 like nothing that came before.
This is why I am so excited about NFTs.
Ajit Tripathi is Head of Institutional Business at Aave and the crypto co-host of the Breaking Banks Europe podcast. He is also a CoinDesk columnist and previously served as a fintech partner at ConsenSys and was a co-founder of PwC’s U.K. Blockchain Practice.