NFTs: What they are, what’s their value (AI Academy club deep dive summary).

This article is a summary of a deep dive session on NFTs from the AI Academy club, written by club member Helin Yontar. You’ll find explanations on what NFTs are, how they create value, and some of the considerations we made during our brainstorming session.

Getting started: Using the Monopoly game to explain what NFTs are.

We all know that NFTs stand for non-fungible tokens. But what is ‘fungible’? Basically fungible things are individual units that are indistinguishable. Like exchanging money while playing Monopoly. On the other hand, non-fungible tokens are like exchanging properties while playing Monopoly. Ownership of two property cards is not fungible, if we exchange them with the other player we have a difference since they act as unique tokens. So tokens can be used to represent ownership of an asset. Owning a card that acts as a token means you own a property in Monopoly and it gives you the immense power to collect money when people pass by your property.

Notice that the monopoly card is not the property: it’s something that represents ownership, and we all agree that whoever owns the card owns the property. This concept works for all sorts of assets: if someone steals your car keys, you can show your certificate of ownership to the police and that piece of paper will prove you own the car, even if someone else is sitting in it with your keys. This is the same role NFTs have in the digital world. It defines the ownership.

After understanding what NFTs are, the question that directly comes to mind is, what does crypto have to do with all this? The relationship between crypto and NFTs is about trust. Crypto is used for tracking ownership of assets. The idea here is that you don’t want to trust a single guy but you want to trust technology instead. Crypto is useful for NFTs because it can solve the problem of centralized trust and the biggest argument of NFTs is that it is decentralized, but is this really the case? We will come back to that. This raised many interesting conversation points during our discussion after the deep-dive.

What value can you create with NFTs?

First of all, it creates digital scarcity which enables the creation of a market of digital goods. The creation of digital scarcity also helps explain the close relationship between NFTs and the Metaverse. As Mark Zuckerberg explained in his now-famous video “The metaverse and how we’ll build it together”, in the metaverse businesses will be able to exchange goods, enabled by NFT technology.

NFTs also create a new generation of collectibles. For example, NBA top shots is an NFT platform made by the US National Basketball Association that allows you to own a video clip of Kevin Durant throwing the ball in the basket and create a collection out of similar moments. If you’re confused by the idea of “owning an NBA moment”, think that this is not very different from collecting basketball player cards in the real world. So it is safe to say that NFTs help us position real-world activities in the virtual world.

Collecting scarce digital goods isn’t the only value that you can get out of NFTs. What kind of value do NFTs create for the owner? ‘’Owning an NFT makes you an investor, member of a club, a brand shareholder, and participant of a loyalty program all at once.’’ (HBR) We can have a closer look into the successful NFT project called Bored Ape Yacht Club (BAYC), a collection of drawings of bored monkeys that raised more than $1B dollars.

Examples of bored ape yacht club NFTs. Some of these were sold for 6 figures.

Is it really for art? Is the money going in for art or the hustle behind the art? Are the people who own them, art collectors? Well, there actually is a clear value proposition in their offering for the owner. In many successful NFT projects, it is possible to see a common thread: owning an NFT can give you access to exclusive clubs or physical products. A good example of this is the Apefest of the BAYC: a party exclusive to Bored Ape owners (which include world-famous stars like Eminem). Merging exclusivity or physical products to offer with the NFTs creates an instant tangible value for the investors.

Another important value that NFTs enable is signaling. You can read the time with a $20 Casio or a $20.000 Rolex: the main difference is that the Rolex is signaling your wealth. NFTs play a big role in validating items in the metaverse that can confirm your virtual Rolex is real so that it can create the same effect.

What are the Challenges and Opportunities?

Technically, the main problem with the use of the blockchain that NFTs do is that it is not possible to store much data “on-chain”. Therefore, most tokens store the actual art pieces outside of the blockchain, on some URL. This means that when you buy most tokens, you’re buying ownership of a URL that redirects you to the piece of art, but the piece of art is not really saved in the blockchain.

Moxie Marlinspike, the co-founder of Signal, conducted a little trick that points out this problem by making an NFT that shows a different image depending on who is looking at it. It would look different on different platforms even if it belongs to the same token. Some companies store the images using a technology called IPFS, which ensures that the content of a link cannot be changed, even though it’s not necessarily persistent: It is technically possible that the image goes out of the internet, so your NFT would point at an empty link. Some companies also point directly at their own server, so they have absolute control over what your NFT represents.

The second biggest problem is related to the decentralization of trust. As mentioned before, a strong argument for using blockchain in NFTs is decentralization. Yet, 98.3% of NFTs transactions go through a company named Opensea. There are cases in which the NFT owners have been hacked or lost their NFTs. Opensea was the one that helped their customers get their NFTs back, or halt transactions. This means that they acted as a centralized organization that could in theory choose whom to help and who not to help. Even if centralization of trust is seen as a problem, sure thing the customer who got the NFTs back was very happy to have Opensea intervene in the situation.

Not everyone is technically equipped to play an active role in situations like this. The topic of centralization can be linked to Socrates’s analogy on who should guide a sinking ship. Do you prefer someone who has the necessary skills to intervene and guide or do you choose to give everyone equal responsibility to have the power decentralized? Opensea acted as a centralized organization in the given example. Maybe decentralization is not necessarily a good thing in situations like this. Another important challenge to mention is that the world of NFTs has heavily adopted the practice of whitelisting. An NFT holder has the priority to buy the next one before everyone else does. So ownership is very concentrated, just like with Bitcoin. 98% of Bitcoin is owned by 2% of the accounts and 80% of NFT’s are owned by 9% of all accounts. These numbers lead to a serious question of equality.

Deep dive open questions

At the end of this deep-dive session, we asked each other two questions:

1. What is the real value NFT’s are bringing?
2. How can we leverage it for more than pure speculation?

In terms of value, it seems like NFTs main feature is to create new markets that attract crypto. Today the main two cryptocurrencies (Bitcoin and Ethereum) have a joint market cap of roughly $1T, and the holders of these cryptocurrencies are happy to get more leverage in crypto assets pouring their crypto into NFTs. Want to sell a physical painting? You’ll get access to a market made by people who hold FIAT currency. Want to sell an NFT? You’ll access a market of people holding cryptocurrency, who are more risk-prone and happy to fund more daring projects.

Other than speculation and access to markets, we concluded that the most interesting feature of NFTs is the opportunities opened by smart contracts. You can code different reward mechanisms in NFTs, enabling artists to profit from their work overtime. An interesting field we explored is music. NFTs could allow a model in which fans can buy “stock” in upcoming artists through NFTs and get a share of revenues in the future. It would be possible to create an interesting model to get rewarded financially for supporting your favorite musician early in his/her career.

Want to watch the recording of the deep dive (1.5hrs)? Subscribe to the AI Academy club here. The first 14 days are free, giving you access to all the other deep dives on topics like self-driving cars, the Metaverse, and more.

Thank you for the participation to all the deep dive attendants: Armando Inserra, Niels Schmidt, Adrian Alvarez, Nicolò Valigi, Patrick Mayne, Francesco Bellanca, Helin Yontar, Francesco Marzotto, Stefano Frigerio, Marc Beare, Helgi Finsson.