Non-Fungible Tokens (NFTs)

Non-Fungible Tokens are, quite simply, pieces of data found on a blockchain. In most cases, the NFT includes a link to, or an identifier for, something of value. The data on the blockchain (the NFT) is similar to a Bitcoin or other digital currency, in that the NFT can be transferred between accounts using mechanisms built into the blockchain. The mechanisms ensure that only one party (one address) can be considered the owner of that NFT. Other than being owned and transferred on the blockchain, an NFT can do nothing of value, and has (in and of itself) no artistic or utilitarian value. Nonetheless, billions of dollars have been spent in the last few years on the ownership of NFTs.

This page discusses NFTs, and is divided into these parts:

What is an NFT?

A non-fungible token, or “NFT,” is a piece of data (a token) on a blockchain that is linked to a unique digital asset. An NFT is frequently thought of as a device to prove ownership of a particular copy of an asset. In most cases, however, a change in ownership of an NFT does not legally change the ownership of the underlying asset. If the NFT relates to a digital artwork, a transfer of ownership in an NFT that links to that artwork will not typically affect an assignment of the copyright to that artwork. Similarly, changing ownership of an NFT that uniquely identifies some real property will not legally change the owner of that property.

Since NFTs exist as data on the blockchain, and since NFTs can be sold to other parties anonymously, NFTs are similar to crypto currencies like Bitcoin or Ether. Unlike crypto currencies, however, NFTs are not fungible. Fungible tokens like a Bitcoin can be interchanged with other Bitcoins as there is no technical or financial difference between two different Bitcoins. In contrast, each NFT represents a different digital asset, and therefore is unique and has its own unique value—it is non-fungible.

Digital Works and NFTs

NFTs are frequently associated with digital art works. For example, the digital work “Everydays: The First 5000 Days” by the digital artist Beeple was auctioned off as an NFT by Christies for over $69 million (actually, 42,329.453 Ether) in March 2021. The artwork is a composite (below) of 5000 images created by the artist over thirteen years, with the second image showing one of the works that depicted former Vice President Mike Pence, which was created after a fly landed on Mr. Pence’s head during a televised debate.

Beeple First 5000 Days
Beeple Example Image

At the conclusion of this auction, an NFT with a Token ID of 40913 on the Ethereum blockchain was associated with a new owner. The token with this ID contains a contract number that links to a smart contract. Technically, the NFT was a token governed by the MakersTokenV2 smart contract on the Ethereum blockchain.

The token on the blockchain does not contain the digital work itself, as the work itself is 300 megabytes in size. It would have cost about $5 million in gas costs (see Bitlaw's discussion on gas) to insert the entire artwork into the blockchain. Rather, the digital artwork is sent through a hashing algorithm to create the following string: “QmXkxpwAHCtDXbbZHUwqtFucG1RMS6T87vi1CdvadfL7qA”. Because of the way hashing algorithms work, no other digital file can create that string, and this digital file will always create that string when sent through the algorithm. This hash string is also not found on the blockchain. Rather, a link to a file containing metadata on the InterPlanetary File System (IPFS) is included in the blockchain. The IPFS is itself a distributed file/storage system that uses multiple, peer servers to maintain a world-wide (not quite yet interplanetary) file system. This system uses hash values in place of file names. The metafile itself includes an IPFS link to a copy of the artwork file. Any file stored on the IPFS at this location (this file name/hash) will contain the original Beeple image with no possibility of any changes having been made to the file. If any change were made to the file, this would result in a new hash value, and hence a new "filename" within IPFS. Note that even if the IPFS stops functioning, the content of metafile can be proven based on its hash value as found in the blockchain, and the content of the original file can be proven based on its hash value as found in the metafile.

The Beeple NFT was not auctioned on the blockchain. Rather, Christies auctioned the NFT offline, collected the payment, took its cut, and sent the rest of the payment to the artist. The artist than manually transferred the NFT for zero Ether on the Ethereum blockchain. NFTs can also be auctioned off through smart contracts. To accomplish this, ownership of the NFT would be transferred to the auction smart contract, and the auction smart contract would receive bids, determine the winner of the auction, transfer crypto currency in the amount of the winning bid from the bidder to the original owner (after taking its cut), and finally transfer ownership of the NFT to the winning bidder.

Rights Granted by Ownership of an NFT

The NFTs are also created with smart contracts. Generally, the creation of an NFT starts when a user submits a digital work to an NFT smart contract and pays the necessary fee (in Ethers, for example). The smart contract will then generate a token for that digital work having a token ID. Tokens created by different smart contracts can share the same token ID (such as 40913), but token IDs created by a single smart contract will be unique. A new token will identify a “wallet” address as the original author/owner of the NFT. A typical cost for creating a new NFT token on the Ethereum blockchain is about $70 of gas. The same smart contract will then manage transfers of the ownership of the NFT.

The sale of the NFT may or may not also involve additional rights in the work. While the sale will certainly require that the change of ownership in the NFT be recorded in the blockchain, and will typically include the right to download the copy of the work, one should consider whether the sale in the NFT includes the following elements as well:

  • ownership of any copyright rights;
  • a license to copy the work or make derivative works;
  • a right to exclude others from making copies or derivative works;
  • a right to make commercial use of the work;
  • a right to object to additional NFTs being made from the work; and
  • a physical copy of the work.

Note that these rights are not enforced by the smart contract, but by “non-smart” entities such as lawyers and courts. As for the Beeple auction, it is unclear whether the winning bid received anything other than the right to control and transfer token ID 40913 using the MakersTokenV2 smart contract on the Ethereum blockchain.