March 18, 2022
technology
The Latecomer’s Guide to Crypto
Kevin Roose
This is part of “The Latecomer’s Guide to Crypto,” a mega-F.A.Q. about cryptocurrency and its offshoots. Kevin Roose, a Times technology columnist, is answering some of the most frequently asked questions he gets about DAOs, DeFi, web3 and other crypto concepts.
OK, I know NFT stands for nonfungible token. But what does it actually mean?
Let’s start with the words themselves. In economics, “fungible” is a term used for things that can be exchanged for other things of exactly the same kind. The U.S. dollar is fungible, because you and a friend can trade $1 bills, and each of you will still have the exact same spending power. Most cryptocurrencies are fungible, too — a Bitcoin is a Bitcoin, and it doesn’t really matter which Bitcoin you have.
But most objects in the physical world, such as cars and houses, are nonfungible — meaning they have unique qualities, and you can’t just exchange them for others of the same type. (You might be willing to swap your 2020 Honda Civic for another 2020 Honda Civic, but the cars wouldn’t be exactly the same, and you’d want to know what condition the other car was in before you’d agree to the trade.)
Tokens, in crypto speak, are units of value stored on a blockchain. Cryptocurrencies like Bitcoin, Ether and Dogecoin are tokens, but not all tokens are meant to be used as money. Tokens can be attached to tangible goods — Nike, for example, is experimenting with crypto tokens that are linked to the ownership of physical shoes — but they can also represent intangible goods, like access to a private chat room or storage space on a cloud server.
So nonfungible tokens are sort of like cryptocurrencies, except they have unique qualities and they aren’t necessarily used as money. Why is that important?
Well, until pretty recently, nonfungible goods didn’t really exist on the internet.
The internet essentially works like a giant copy machine — any digital file can be duplicated an infinite number of times, and every copy is exactly the same as the original.
The infinite copy-making quality of the internet was great for making digital objects abundant. But it was horrible for making them scarce. If you were an artist who wanted to make only 100 “first editions” of your digital artwork, or a professional athlete who wanted to sell digital trading cards to your fans (and have those cards retain value the same way that physical trading cards would), your options weren’t great.
Several years ago, people realized that blockchains (the shared, decentralized databases that power Bitcoin and other cryptocurrencies) could be used to create unique, uncopyable digital files. And because these files were simply entries on a public database, anyone could verify who owned them, or track them as they changed hands.
That realization prompted the creation of the first NFTs.
But aren’t most NFTs just JPEG files that you can copy by right-clicking them and saving them to your computer? How does that solve the file-copying problem?
Correct. NFTs don’t make it impossible to copy JPEGs. But they make it possible to create an uncopyable digital asset linked to a JPEG, which can be used to mark that particular copy of the JPEG as the “real” one.
If it helps, you can think of NFTs as like the certificate of authenticity you might get if you bought an expensive sculpture. The sculpture could be copied or forged — or someone could break into your house and steal it — but because you have the certificate of authenticity, you can prove that you are the owner of the original.
I’m starting to get it. So NFTs are basically a way to claim ownership of a digital file?
Yes. Which might not sound like a big deal. (And maybe it will turn out not to be!) But people who are into NFTs think that this idea of being able to claim ownership of digital files is a radically important concept.
They argue that scarcity is what gives a lot of objects in the offline world their value. And bringing this quality to the internet through NFTs, they believe, will unlock a whole new market for scarce digital goods.
I can see why NFTs are an interesting technology. But why would someone pay millions of dollars for one? You can at least drive a fancy car or appreciate a Picasso painting hanging on the wall — you can’t drive a JPEG.
It’s true that most NFTs aren’t valuable because they’re useful. And at the high end of the market — like the Bored Ape Yacht Club, or the NFT collections being auctioned off by Sotheby’s for millions of dollars — a lot of the value boils down to speculation and bragging rights.
But a defense of NFTs I’ve heard from people in the industry — or, at least, an explanation for their popularity — is that NFTs aren’t unique in their uselessness. People spend money on objects of no practical value all the time — maybe to feel good, maybe to show off to their friends, maybe to signal membership in a group. Some objects we buy are tangible (designer clothes, expensive jewelry) and some are digital objects (Fortnite skins, short Instagram usernames). Empires have been built selling useless luxuries to rich people, and even if all that NFTs represented was a new class of luxury digital good, they would still be worth taking seriously as an emerging industry.
And what’s with all these cartoon apes and penguins I see crypto people using as their Twitter avatars?
Those are what are known as community or pfp (profile picture) NFTs. Basically, they’re a series of unique but thematically related NFTs, released in limited batches.
Once they’re released or “minted,” these NFTs become a kind of digital collectible, and a membership card to an exclusive club. Many NFT groups have their own chat rooms on the Discord messaging app, where owners hang out and talk among themselves. Some community NFT projects even organize offline events and parties, which you can only get into by proving that you own one of their NFTs.
These community NFTs signal a kind of in-group status, and it’s become customary for owners to display them as their Twitter profile picture, marking themselves as a Bored Ape or a Cool Cat, or whatever. And everyone in crypto world knows that NFTs from the most valuable collections sell for millions of dollars apiece, which is why you see celebrities like Jay-Z and Snoop Dogg showing off theirs on Twitter.
But NFTs are just digital Beanie Babies, right? Aren’t most of them going to end up being worthless?
That is the million-dollar question. (Or, to be more precise, $40 billion, the estimated size of the NFT market.) It’s possible that the people investing in NFTs are right — that we’re on the cusp of a revolution in the way digital goods are bought and sold, and that early NFTs will one day become as valuable as original Picassos and Monets.
But the NFT market appears to be cooling off these days, with falling transaction values and canceled auctions of high-dollar NFTs. Even some zealous NFT supporters are worried that the market has gotten oversaturated. Gary Vaynerchuk, the online marketer and a NFT mogul himself, recently predicted that 98 percent of NFTs would lose money.
98 percent!
Yeah. NFTs are controversial, even inside the crypto community. Some investors won’t go near them, while others treat them as speculative gambles or buy them purely for fun.
And inside the NFT world, there’s now an increasing focus on “utility” — basically, bundling other things with an NFT purchase (like concert tickets, signed memorabilia or early access to future releases) to ensure there’s something of value included, even if the value of the NFT itself goes to zero.
That still sounds kind of shady. Are there lots of scams in NFTs? What about money laundering?
Yes, there are tons of scams in NFTs. “Rug pulls” — when a crypto developer abruptly abandons a project and runs away with buyers’ money — are a common experience. Several hyped projects have turned out to be rug pulls — including Evolved Apes, an NFT scheme whose creator vanished along with $2.7 million.
In addition, many projects are corrupted by a practice called “whitelisting,” in which certain people are invited to buy their NFTs before they’re available to the general public. Whitelisting means that many profits flow to well-connected insiders, who get their NFTs at a discount and can sell them for more once they’re released publicly. A study by Chainalysis found that whitelisted users who resold their NFTs made a profit 75 percent of the time, versus 20 percent of the time for nonwhitelisted users.
Money laundering, wash trading — a scheme that involves selling something to yourself in order to inflate its perceived value — and other shady practices are almost certainly happening in the NFT market, too. It’s not clear how often this happens, but it’s a big enough risk that financial regulators in several countries, including China, have warned about the potential use of NFTs and other crypto assets for money laundering.
Of course, an NFT fan might argue that scams and money laundering happen in the regular economy, too. (The traditional art market, for example, is rife with money laundering, a Senate investigation found.) Crypto might just make it easier.
Let’s back up for a minute, because I still have questions about NFTs and how they work. I saw a thread on Twitter that compared NFTs to those “name a star” gift collectibles, where all you get is an entry in a database saying that a star is named after you — not any official claim to the star itself. Do NFTs actually include ownership or usage rights?
Not necessarily. In many NFT sales, what the buyer gets is simply the unique entry in the blockchain database that identifies them as the owner of the digital good — the token, rather than the thing the token represents.
The person who bought the famous Nyan Cat NFT, for example, doesn’t actually own the copyright to the Nyan Cat image, or the right to turn it into Nyan Cat merchandise. Its creator, Chris Torres, reserved those rights. All the NFT buyer got, in essence, was an “official” copy of the image that was cryptographically signed by Mr. Torres.
NFT creators can choose to include additional rights in an NFT sale. But they don’t have to. And there have already been high-profile copyright disputes over NFTs, such as the lawsuit filed by Miramax against Quentin Tarantino last year, after Mr. Tarantino announced he would be auctioning off unpublished excerpts from the “Pulp Fiction” screenplay as NFTs.
I’ve also heard that NFTs get stolen a lot. Is that true?
Yes, there have been a number of NFT thefts in recent months, as the price of popular NFTs has climbed. Thieves recently targeted several members of the Bored Ape Yacht Club — whose NFT cartoons of ennui-stricken apes often sell for six or seven figures apiece — by tricking them into giving up the passwords to their crypto wallets. And hackers recently stole $1.7 million worth of NFTs from users of OpenSea, the largest NFT trading platform.
Another kind of theft — the kind that involves creating NFTs out of copyrighted or protected material — is also common. Many artists have complained about their work being turned into NFTs and sold as “official” versions without their permission. And while many platforms have tried to clamp down on the sale of stolen NFTs, some theft is probably inevitable given the lack of oversight in the market.
If NFTs are so flawed, why do so many people seem to be obsessed with them? What’s the optimistic take that I’m missing?
I’ve spent a lot of time talking to NFT creators and collectors, and their pro-NFT argument generally boils down to a few main points:
• The existing internet is too centralized, and NFTs could help decentralize it. Right now, most people who make media on the internet (artists, musicians, video game streamers, etc.) put their work on giant platforms like Spotify, YouTube and Facebook. Those platforms are great for building an audience, but they’re not great for making money. NFTs, they say, make it possible for creators to sell unique digital objects directly to their fans, keeping a much bigger chunk of the revenue for themselves. An artist like 3LAU might sell one album NFT to a superfan for $3.6 million, and make more money than they would have from a lifetime’s worth of Spotify streams.
• We’re entering the metaverse era — an age in which more of our daily interactions and experiences will take place inside immersive digital worlds, rather than in offline physical spaces. Just as many kids today spend real dollars on Fortnite skins and Roblox accessories, adults who spend more of their days interacting in virtual spaces will buy all kinds of digital objects to enhance their lives, and many of those objects will take the form of NFTs.
• NFTs are still a brand-new technology, and we can’t yet see all of the ways in which they will be used. Digital scarcity is a genuinely important concept that will open up an entirely new economy of unique digital goods, and we should be patient and open-minded while we wait to see what’s going to be built with them.
Didn’t we hear a lot of this “creator economy” stuff years ago, when people were optimistic about how platforms like YouTube and Twitter would make it possible for all these vloggers, gamers and musicians to make money online? Couldn’t the NFT market end up consolidating under a few big companies, the way social media did?
It’s certainly true that there are large platforms in the NFT world. (The biggest, OpenSea, is valued at $13.3 billion.) And some crypto fans have criticized these platforms for engaging in behavior that undermines their claims of decentralization, such as OpenSea’s decision to delist certain NFTs that it deems stolen or fraudulent.
It’s also true that NFT ownership is relatively centralized, in the sense that a small number of people appear to control the majority of high-value NFTs.
But a market with concentrated ownership is different from a market that runs on centralized technology. And there are some structural forces that could make it harder for big companies to seize control of the NFT market.
For starters, NFTs are personal property, in a way most other digital goods aren’t. When you upload a video to YouTube, YouTube hosts that video on its servers and effectively makes all of the decisions related to that video — whether it violates community guidelines, whether it’s eligible to run ads, whether it gets recommended by the algorithm, and so on. But NFTs live in their owners’ crypto wallets, which aren’t chained to any particular platform, and they can use them any way they choose.
There’s also the idea of interoperability. One feature of NFTs is that they can be made interoperable — that is, unlike buying a skin in Fortnite that can only be used inside Fortnite, you can theoretically take NFTs with you from one virtual environment to another. An NFT sword you purchase in one video game might come in handy in a different game. Or a cartoon animal you’ve bought as an NFT could become your avatar in a V.R. metaverse app. And if you get mad at OpenSea, you can easily take your NFTs (which live in your crypto wallet, not on OpenSea’s servers) and trade them on a different platform.
That kind of thing doesn’t happen in social media. If you have a YouTube channel, you can’t simply port your subscribers over to TikTok when you feel like it.
I’m an artist myself, actually. What if I want to switch from crafting to NFTs? Can I get in on this?
You can indeed go from selling knitwear on Etsy to selling an NFT of your wares on OpenSea, although there’s no guarantee you’ll make more money doing so. (And a substantial chance you won’t.) Any digital file, more or less, can be turned into an NFT.
My experience as a seller is limited, but here’s how it went for me: First, I used a browser extension called MetaMask to set up an empty crypto wallet. I used that wallet to open an account on Foundation, a NFT trading platform. Through Foundation, I “minted,” or created, my NFT, which involved uploading my file to a decentralized hosting service and creating a blockchain-based asset pointing to that file. Then I listed it for sale.
The whole process took a few hours, from start to finish — not counting the many, many hours I spent convincing my bosses it wasn’t a terrible idea — although it did cost me roughly $100 in “gas fees” to mint the NFT.
I get the theoretical benefits of NFTs. But none of this is actually all that deep, right? Like, nobody is using NFTs in video games — they’re just buying them and hoping the price goes up.
I wouldn’t say “nobody.” There are a few big NFT-based-games, like Axie Infinity, that allow players to earn real money by winning in-game battles using their NFT characters.
But it’s reasonable to conclude that most of today’s NFT activity is speculative, and that if another type of digital asset was routinely making people rich (or giving them fun communities of like-minded people to join), some people might stop trading NFTs and go trade those items instead.
Ultimately, the big selling point for NFTs isn’t that they make trading digital goods easy and cheap (they don’t), or that they’re permanent and indestructible (the tokens may be, but the digital files they link to typically aren’t), or even that they represent the future of intellectual property (we’ll still need lawyers to hash out copyright disputes).
It’s that they allow people to create and trade scarce digital objects — for better or worse.
Go deeper:
“What Critics Don’t Understand About NFTs” This article from The Atlantic, by Jonathan Zittrain and Will Marks of Harvard’s Berkman Klein Center for Internet & Society, raises the question of what NFT investors are really buying, and unpacks the age-old philosophical question of why we value things.
“How NFTs Are Building the Internet of the Future” This 2021 TED Talk by Kayvon Tehranian — the founder of the NFT platform Foundation — makes the case that NFTs are the building blocks of “an internet where economic control rests in the hands of creators, not platforms.”
“Why NFTs Are Bad: The Long Version” This 2021 blog post by the pseudonymous programmer Antsstyle is a novella-length takedown of NFTs, based on the claim that “no system can ever prove ownership of anything.”
“Line Goes Up: The Problem With NFTs” If you prefer your NFT takedowns in video form, this YouTube video by Dan Olson is a two-hour exegesis on the flaws with NFTs and crypto more broadly, which went viral and racked up millions of views.
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