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NFT – Digital Asset Representation on a blockchain
In the digital world, the cyberspace, "infinite copying" is an expected and well-known feature that we are familiar with, and there is no limitation to it except for the hardware or file format limitation. From a computer science perspective, data is technically not even really sent when sending data but copied and the original file is subsequently deleted at the source. In 2009, blockchain technology brought something we were used to in the physical world to the digital world: the concept of digital scarcity. Scarcity occurs when a finite amount of something meets a corresponding demand. Digital scarcity is the fundamental property on which a new generation of digital certificates is built. NFTs.
The attention momentum for non fungible tokens
Depending on whom you ask, the term “NFT” evokes ambivalent feelings among listeners. A sensational pricing phase of NFTs that began in 2021 resulted in many noteworthy transactions such as:
- Jack Dorsey selling his first Twitter tweet for $2.9 million, which was sold as a memorable news certificate
- NBA’s LeBron James sold a slam dunk moment for $200k, which was sold as a certificate of ownership for a special moment
- the established Nyan Cat GIF sold for $600k and is being sold as a retro-activated artwork certificate
- the first Vodafone SMS for around 150k$, which is sold as a milestone certificate
According to these transactions, a smaller group of buyers with relatively high purchasing power competed for these scarce digital certificates. Traditionally, this behavior is known from classical works of art, antiques, luxury real estate or access to certain positions of power such as box seats at a concert, resulting in similar market transactions. It is important to emphasize that these transactions are still exceptional among the many other transactions that take place daily. These art and snapshot transactions are uncertain in their future trading value, as there is no history to support estimates of future performance.
NFTs hype in 2021
The nature of NFT's explained and defined
Aside from the first wave of use cases, digital collectibles, NFTs can represent any ownership of a digital or real-world asset in an immutable, always-on database that is visible and tradable worldwide at any point in the future. B2B processes and structures need to be explored in their potential relationship to NFTs to understand the spectrum of impact this young technology will have on the corporate world.
Intuitively, the question might arise: "Can't I just use "right-click>Save As...?" to get the digital art NFT instead of buying it?".
Non-fungible token definition - What are nfts?
Before getting into the actual argument, it is important to understand that most NFTs are certificates of ownership and do not represent an asset itself on the blockchain. That's why those images, videos, or similar artifacts mentioned above are not themselves NFTs, but NFTs are typically unique digital certificates meant to represent the original claim on a blockchain environment. Blockchain space is limited and very expensive and typically not used to store those data. Typically, fingerprint-like hashes of the digital assets are stored in the blockchain instead and are representing property rights.
To copy or not to copy
Copyrighted images on the Internet can be right-clicked at will; Picasso's Guernica can be photographed at will in its location. But their respective certificates of ownership cannot be duplicated on blockchain-based assets.
You can make unchecked copies or screenshots on your own local file system, but the basic feature, scarcity, will be missing. They will remain just effortless copies. Scarcity is important for people to develop status symbols and identity concepts. We assume that it will be difficult to find a buyer's market for these effortless copies due to basic economic assumptions. Obviously, these assumptions will lack the afore mentioned blockchain inherited scarcity and the blockchain transaction publicity that creates transaction visibility.
Transferred to the physical world: even if a talented painter could produce many perfect-looking copies of Picasso's Guernica in a short time, buyers would pay far less for the duplicates because they would measure the price only according to the material used and the amount of work, not according to the rarity of the original. A wall poster of the same motive is even worth less, proportional to its inflationary character.
The above example highlights another important feature of NFTs: authentication. While well-made copies of traditional physical artworks are difficult to identify and require rare, specialized experts to be flown in from all around the world at great cost, NFTs can be verified with a smartphone in a few seconds by anyone with no prior knowledge. Verification of ownership can be given by simply sending a signature of the asset holding crypto wallet. This wallet, like Metamask, manages and stores the digital certificates in an user-friendly interaction.
Basic concepts - NFTs on blockchain
The origins: Where Non-fungible Tokens come from
We now explore how, over a decade after the launch of Bitcoin, the Blockchain-based concept called "NFT" (Non-fungible Tokens) has gained traction and examine the facts behind the recent hype and what essence really lies behind it.
Blockchain Technology and NFT
Blockchain technology is being used to embed certificate-like programmable structures in this new digital scarcity to combine its benefits with certification methods. These special digital certificates, called NFTs, are a special form of smart contract. While Bitcoin has successfully solved the basic task of having a fungible digital hard money, the idea of a digital asset certification that is uniquely assigned and a clear proof-of-ownership concept with blockchain qualities has remained unsolved. In essence what can be implemented with NFTs is the concept that two digital items are guaranteed to be unique, not the same and cannot be duplicated or counterfeited.
The origins of NFT on Blockchain
Looking back to the origins of NFT blockchain technology, which was originally created as "Colored Coins" on the Bitcoin blockchain to address these challenges, the idea emerged of giving certain bitcoins an "identity" by adding additional information such as a unique fingerprint-like hash to their specific unspent transaction outputs (UTXOs) via the Bitcoin scripting language. UTXOs can be "marked" in this way and become distinguishable from other UTXOs. This allows individual bitcoins to be made unique by also carrying a non-counterfeitable digital identifier that can be used for example to represent vouchers, digital collectibles, credentials, or an issuer's promise to redeem these certificates for goods or services. Colored coins have not caught on. Potential erroneous transactions, bugs, the need to run their own specific clients, the lack of a common standard, backward compatibility with existing node structures, scalability issues, and other factors held back the concept of NFTs for many years.
NFT and Ethereum
Today’s NFTs has been given a re-run on the Ethereum blockchain with its enhanced smart contract capabilities. In doing so, this new iteration of digital certificate inherits the natural strengths of blockchain technology, such as selected immutability, forgery resistance, excellent verifiability, time durability, and public transparency. As a result, NFTs succeeded recently and possess an unprecedented set of properties that enable these digital certificates to create new approaches to solving previously unresolved problems.
The trade-off of using the technology
NFTs, the new generation digital certificates, have specific superior properties compared to other types like signed PDF files, paper-issued certificates, or traditional database records that cannot be replaced by centralized approaches. However, it is important to emphasize that these new properties come in exchange to considerable costs, which we will discuss in more detail later. You don't just add "NFT" technology to existing structures or processes and they magically improve and become better versions of themselves. Rather, there is a major challenge at this early stage of these emerging technologies, which is to determine when the cost-benefit ratio is justifiable and when it is not. For example, whether a classic .mp3 file becomes an NFT version of itself in the future or remains as a local file depends precisely on this cost-benefit ratio and the advantages and disadvantages for providers and buyers.
Non-fungible tokens and the current challenges
However, NFT structures are not yet fully built out and developed as of today. Examples of current challenges for emerging NFT markets include lack of regulations, law enforcement, and copyright issues. For example, regulations for European GDPR standards have not yet been clarified. Any resulting law enforcement is also not clarified. Copyright issues mirror those in the real world: the specific certificate may exist, but the original authorization of the issuer may remain unclear.
E.g., the lawsuit filed by production company Miramax against film director Quentin Tarantino, who wanted to sell NFTs based on "Pulp Fiction."
But technical questions about which blockchain to take now, for example, and if there are several, how they will be connected, are also current challenges without clear answers. Clearly, NFT technologies are still an exploration area, much like the Internet in the 1980s.
The term, the properties - NFT stands for...
A non-fungible token (NFT) is a technical term to describe unique and non-exchangeable smart contracts with their own specific properties on a blockchain.
In contrast, fungible items are by definition interchangeable with each other, e.g., a €50 bill issued by the central bank is accepted by all market participants as equally fungible. The interchangeability of 1 kilo of apples in the supermarket of equivalent quality to another 1 kilo of apples, since they are by their nature similar items, also illustrates this property. From the point of view of fungibility, fungible items are interchangeable, uniform and divisible. This is precisely not the case with NFTs.
Non fungible meaning:
The opposite is true for non-fungible objects, since they are not interchangeable, unique in their nature, and not divisible. You can't just substitute one thing for another, like giving someone a valuable painting in exchange for their unfortunate destroyed vintage Porsche collector's car. The equation would only work by exchanging a reasonable amount of money without replacing it.
Ownership of an NFT is always assigned to exactly one particular unique ID represented by one entity and never to multiple entities.
The ownership history of the NFT itself and the ownership assignment is preserved in the NFT Smart Contract and cannot be subsequently changed without authenticated consent.
Blockchain and nft - digital certificate
A paradigm shift towards digital certificates
Paper, digital, …blockchain?
Certificates come in various forms and are basically documents that prove the authenticity of a service, a valuable transaction, an important event, the existence of ownership or a specific fact. They range widely, from birth certificates to death certificates, from degree certificates to professional certificates, from credentials to property deeds, or from physical to digital certificates. They are usually issued by a trusted third party and are binding on the recipient, such as an individual or an organization.
Characteristics of digital certificates
According to their characteristics, certificates are valuable because they can confirm the identity and/or status of the owner of an asset. The added value generated for users is that the proof of ownership or certified circumstance can be communicated to other parties without the need to trust each other but can safely verify possible ownership claims and facts.
Issuers of traditional certificates vs. counterfeiters
Historically, certificates have been issued on paper for centuries. Paper certificates are inherently a popular target for counterfeiting because they are relatively easy to create. Counterfeits reflect performance or ownership status that is not true in order to gain an advantage in each case. Among the certificates in circulation, there are a questionable and damaging number of certificate forgeries that cause significant economic damage. To combat these fraudulent attacks on authenticity, security mechanisms such as watermarks, embossed paper or special ink have been developed. The success of these defense mechanisms is often only a partial success in a constantly ongoing battle between counterfeiters and issuers.
Digital evolution of certificates
The digital evolution of certificates brought advantages such as typical non-physical exchange over the Internet, triggering the exchange process by machines, and instantaneous delivery at near-zero cost.
Digital certificates are not as static as their paper-based counterparts. Copies can typically be made digitally out of thin air and at will. At first glance, this might give the impression that authenticity and stability principles are relaxed, when in fact, if used correctly, this fact is a key advantage that saves time and money and enables new workflows. When certificates are digital, they can be updated instead of being reprinted and sent out, and if there is a legitimate interest, they can even be revoked completely, immediately or after a certain period of time. Cryptography is one of their essential building blocks. Its digital nature enables automated machine use and verification, for example in the form of an API exchange. Indeed, even our most basic Internet structures are built this way.
Problems of digital certificates
Certificates in digital form still face potential problems such as identity theft, compromise of authority, the oracle problem (is the claim even true?), long-term storage, and most importantly, guaranteed accessibility.
The positive side
One of their key positive attributes is their exceptional verifiability, which is supported by cryptography.
NFTs can be considered as a possible next evolutionary step of specific branch of digital attestation of authenticity, as they are:
- Always accessible, as they are public, robust against time.
- Non-duplicable, relying on the digital scarcity of the blockchain
- Intelligent, as they offer new mechanisms such as royalties, fractionalization, or combustion
- Reliable and tamper-proof timestamps are another strong argument for using NFTs.
For a deep dive into the technology behind NFTs:
Core features of a Non-Fungible-Token
Potential NFT use cases and examples for businesses
Evolution beyond digital art, the following use cases, and the underlying NFT-specific mechanisms should be explored by experienced industry experts to identify potential synergies and symbioses and build appropriate architectures:
- Strategic Customer Analysis
- Pre-Sales Offers
- Brand Relevance in Cyberspace & Metaverse
- Strengthening Customer Relationships
- Loyalty Programs
- Monetization of Time & Data
- Data Usage Rights
For more details about these use cases, see: Blog Post will follow soon.
NFT dictionary and defintions
What is the Minting process?
First, a new smart contract is created through hard coding solidity in the case of Ethereum or with no code/low code software such as an NFT marketplace. Once the compiled ByteCode is transferred to the blockchain network as a transaction and added to the blockchain according to the consensus mechanism, the smart contract itself representing the NFT can be considered published and robust.
The majority of the NFT market could arguably be assessed as speculative due to its foundations based on aesthetics and sentiment. A market, brand, and community are essential foundations for valuable NFT certificates in current digital art use cases to create and continue to build a broad market. Similar challenges can be observed in traditional art, where valuations are also difficult to create in advance of quantifiable observations.
What is a NFT identifier?
Each NFT has a unique unforgeable identifier associated with a specific blockchain address that cannot be falsified.
The current owner of the NFT can be easily and securely verified by looking it up in the blockchain, and the identity can be quickly proven with cryptographic signatures from the current holder.
What is the NFT chain of trust?
The new unregulated and pseudonymous crypto space is also attracting a lot of illegal activity. In the digital arts space, NFTs were sold on marketplaces, created, and offered by criminals who used identity fraud such as misleading names in order to mislead their buyers into believing that the particular seller was the original creator. Such authenticity issues have long existed in the digital space, which is why mechanisms such as Twitter's "verified badge" have emerged. These verification mechanisms are currently being adopted by popular NFT marketplaces. However, these facts should not obscure equivalent problems in existing markets. Traditional art forgeries are even more difficult for buyers to detect and remain unsolved to this day despite occasional forgery detection.
Since there is no direct concept of person identity in the blockchain environment itself, but rather account numbers and their corresponding secrets to authorize spending and transactions, the question is where to begin the search for verified identity when it comes to asserting who minted a particular NFT. Chain of Trust.
Since one can create a nearly infinite number of accounts in the blockchain environment, the chain of trust must start somewhere else. If it is to be asserted that a particular NFT originated from a particular entity, that bridge can be established by a third party such as Twitter, acting as an intermediary. If a verified account makes the claim to be the issuer behind a particular NFT, then Twitter's "verified brand" would be the actual root of that chain of trust. One of the major NFT marketplaces “Open Sea”, serves as the root of many chains of trust that make up much of the current NFT space. Comparable known issues exist with Internet URLs and their associated IPs, for example. How do users know and verify that they are really visiting sap.com and not being connected to a fraudulent third party? This question is resolved by DNS servers, i.e. third parties that serve as the trusted root of this chain of trust.
What is NFT proof of ownership?
NFTs are not necessarily the same as copyrights, this needs to be legally clarified in the future and it one of the big current issues in the NFT field. The open blockchain data structure is always available for public verification. Cryptographic signatures of the private key (PrivKey) of the actual digital asset owner can provide proof of ownership for any NFT, since the NFT itself carries the public key (PubKey) as the public address of the actual owner. The PrivKey owner basically just proves that he is the owner without revealing it. The signature proves his authenticity. To simplify this PubKey identification, public keys can be represented by blockchain name services, comparable to Internet domains we are used to.
The respective owner can sign each message with a cryptographic signature to prove ownership of their account.
The history of this ownership, represented by the owner's PubKey, is a permanent part of the history of the NFT.
The creator of the NFT can also be uniquely identified by his or her PubKey and publicly proven if desired.
NFTs reside in the associated blockchain, which is basically a simple infinite state machine and a distributed ledger (DLT). Wherever this ledger is copied, the NFT is also present. On the Ethereum network, this is equivalent to 6400 copies of the contract in January 2021.
Destruction of an NFT or state changes such as change of ownership or other intended functions can be triggered by the rightful owners of the respective private keys.
Since NFTs inherit blockchain properties, the information itself cannot be modified externally, which protects the NFT from third-party attacks.
Nevertheless, poorly designed smart contract code can lead to losses and collapse of functionality such as the infamous Ethereum DAO hack.
Since NFTs are smart contracts on a blockchain, the same high costs of a blockchain apply here as well. Secure and public robust transactions come at a prize and can take time. The use of NFTs must be carefully considered for the cost-benefit of the transaction in question.
New scaling technologies are expected to expand the range of security and cost combinations and further open the NFT transaction space to smaller and smaller transactions. Second layer technologies such as Lightning RGB will provide scalable alternatives in the future.
NFTs can be transferred from one user to another in exchange for any amount of money the recipient is willing to pay. Transfers from other smart contracts initiated transactions are also possible. On open blockchains, these digital assets, represented as NFTs, can move without permission and are not tied to a specific provider and its platform. NFT transfers occur without intermediaries, while multi-signature (MultiSig) configurations can again involve certain third parties if desired. Thus, groups of decision makers can be formed in n:m constellations. For example, the future of at least 3 decision makers out of a group of 7 in total is needed to sign and authenticate a transaction.
The NFT creator minting the digital assets decides how many replicas of the same asset exist. An example of this would be a limited number of tickets to a concert. However, manually or algorithmically created digital assets such as crypto punks with unique characteristics can also be created. These can be identified as a unique, verifiable asset that can be purchased with a smartphone without any specialized knowledge.
Smaller groups with high purchasing power compete for specific digital assets they deem valuable, which can lead to very high market prices.
The creator of an NFT may introduce a mechanism for non-deductible royalties when minting the digital asset. Therefore, whenever the same NFT is resold, royalties may flow back to the original creator. Conquering the aftermarket, creators can participate unrivaled. From a business perspective, this is new, compared to local owned assets such as MP3 files or PDF files and provides additional functionality.
Original content creators gain access to a new monetization tool for secondary market sales. Benefiting groups currently include artists, musicians, celebrities and influencers. Likewise, producers of goods can benefit from these mechanisms.
NFT tokenization of physical assets.
While many challenges exist with fully digital inherent assets, connecting physical assets with NFTs remains an even greater challenge. To put things in perspective, one has the same challenge when it comes to connecting physical assets to paper-based or PDF-based certificates, known as the "oracle problem." A digital twin is only as good as its ability to accurately and currently represent the real asset. NFTs also cannot resolve this problem of linkage between physical asset and certificate. The link between certificate and physical good is so difficult because, on the one hand it is difficult to verify that the physical good has really changed hands, e.g., from sender to recipient, and, on the other hand that the certificate clarifies the new ownership status. Conversely, the digital certificate also has no guarantee that it will also become the property of the new owner of the physical good. There is always the possibility of desynchronization between these two states.
NFTs should be used as a tool to solve other problems, not the oracle problem.
NFT Fractional Ownership
In contrast to the first design approach of NFTs, new fractional NFT data structure concepts have been developed to establish a "one to many" relationship. An NFT can be owned by many entities. The NFT itself is divided into smaller fractions by associating a fungible token smart contract with an NFT contract. These fractionalized NFTs can be traded as equal pieces in DEXs, for example. In the real world, one-to-many ownership concepts can be mapped in this way such as owning a skyscraper together with other investors.
When creating limited but similar and numerous NFTs, such as 40,000 tokenized tickets for a concert, a lot of minting needs to be happen on the costly blockchain. Imagine if each ticket had to be represented by its own smart contract on a blockchain, resources would quickly fall short of reasonable values in terms of cost, so similar use cases would be considered inefficient and therefore impractical.
New smart contract structures have been developed to represent these many similar cases with a minimal amount of data without code replication. For example, batch processing of digital objects can be represented by new standards such as ERC-1155 that hide the differences between fungible tokens while integrating their potential functionality. In this way, the exemplary concert tickets can be mapped into a single NFT contract while preserving their individual seat numbers. Smart contract minting costs are thus reduced by a factor of 40000 in the case of tickets. These standards are still under active development and are expected to be replaced and improved by future successors.
NFT contracts can communicate events such as change of ownership to listening servers and provide alerting and monitoring capabilities.
What are NFT marketplaces?
Most NFTs are traded and sold early in dedicated NFT marketplaces. These marketplaces provide the beginning of the "chain of trust" with verification processes such as authentication of Twitter accounts and the like. OpenSea or Rarible, for example, are worth mentioning here. Crypto wallets such as Metamask provide access to authenticate, purchase, and store traded NFTs. Thousands of hosts, creators, and collectors are already trading every day. Counterfeiters are certainly still a problem, especially for inexperienced buyers, and therefore require a cautious attitude.