What are NFTs, and how do they work?
If you’ve been keeping an eye on the tech news lately, you’ve probably heard of terms such as Bitcoin, blockchain, and more recently, NFTs. Stories of multi-million dollar auctions for digital assets have attracted the attention of artists and collectors alike. But what are NFTs? And how do they work?
Here, we explore the basics of non-fungible tokens, the technology behind them, and their uses in everyday life. We also look at some of the skills and knowledge you’ll need to get involved with them.
What are NFTs? Key terms explained
First things first, let’s take a look at some of the key terms and definitions we’ll be using. To understand what NFTs are and how they work, we need to have some broader context:
NFT
NFT stands for non-fungible token. That probably doesn’t mean a whole lot at this stage; the word ‘fungible’ isn’t a particularly common one. However, it essentially means that something is interchangeable.
For example, in economics, money is a fungible asset. It has units and can be easily interchanged (such as swapping a £20 for two £10s) without losing or gaining value. Fungible assets also include things such as gold, cryptocurrency, and shares.
As we explore in our cryptocurrency open step, a fungible asset is something that can be divvied up in a bunch of different ways, and there can be an unending supply of it. They can be used in a myriad of ways, such as for payments or to store value.
A non-fungible asset, on the other hand, is a one-off; a painting, a house, or a trading card, for example. Although a painting, for example, can be copied or photographed, the original is still the original, and the replicas don’t have the same value.
NFTs are units of data stored on a blockchain digital ledger. Each non-fungible token acts as a kind of certificate of authenticity, showing that a digital asset is unique and not interchangeable. An NFT can never be changed, never be adjusted, and never be stolen, thanks to the principles of cryptography that make the blockchain unique.
Digital asset
Put simply, a digital asset is anything that exists in a digital format and has a right to use (a right to copy, duplicate, reproduce, modify and otherwise use). So, for example, things such as documents, audio or visual content, images, and other similar digital data are all considered digital assets.
Blockchain
We’ve got a full article on understanding blockchain, cryptocurrency and bitcoin. In that post, we highlighted that a blockchain is a type of database — a collection of electronically stored information or data.
Unlike a regular database, a blockchain is a series of data ‘blocks’ that are linked together. This chain of blocks creates a shared digital ledger (collection of data) that records the activity and information within the chain.
Each blockchain ledger is stored globally across thousands of different servers. This means that anyone on the network can see (and verify) everyone else’s entries. This peer-to-peer and distributed ledger technology, as it’s known, means that it’s nearly impossible to falsify or tamper with data within a block.
So, to use IBM’s definition, blockchain is a shared, immutable (permanent and unalterable) ledger that facilitates the process of recording transactions and tracking assets.
When we think about NFTs, they are created on a blockchain and can never be taken into a separate blockchain ecosystem. It will exist on that blockchain and prove the authenticity of the good that you’ve purchased.
Non-fungible tokens vs cryptocurrency
It’s important to outline the distinction between cryptocurrency and non-fungible tokens. Although both are based on blockchain technology, the fundamental differences can help us to understand how NFTs work.
The key difference goes back to cryptocurrency being fungible. You can exchange a Bitcoin for another Bitcoin, for example. However, you cannot do so for an NFT. A non-fungible token is tied to one particular digital asset and cannot be replaced.