As I go through the newspaper on a lazy Sunday morning, something catches my eye. “Indian couple has a blockchain wedding with NFT vows”. Whaaat?? Is this the teaser of a new Christopher Nolan movie? I pinch myself and read the headline again. What in the wide world is that supposed to mean?
Welcome to the world of Nfts – Non Fungible Tokens. A non-fungible token is something unique and one of a kind. This is the opposite of a fungible token, for e.g., the rupee. A 100 rupee note could be exchanged for two 50 rupee notes and the value would still remain the same. That makes the rupee a fungible token. That makes cryptocurrencies fungible tokens too. A person can exchange one bitcoin for another.
A non-fungible token, on the other hand, is unique and irreplaceable. Something like the Mona Lisa, my UG degree certificate or your favourite Bollywood song. NFTs help to represent ownership of these unique items in a digital world. They are secured by the blockchain which makes it almost impossible to modify or delete the record of ownership. This unique digital footprint of NFTs makes it very easy to verify their ownership.
I guess that makes it clear.
Well…almost, but not quite. To start with, how could anyone own the Mona Lisa online?
Well, let’s say you are an artist who creates exquisite art or a designer who comes up with some cool stickers. You can make an NFT of your digital painting, sticker, book, video, music or anything that can be reproduced as a multimedia file and sell it online for money. Doesn’t that sound way more appealing than today’s world where the best reward for a digital painting or video is a bunch of likes and hearts? Amrit Pal Singh, a Delhi-based designer capitalised on this and earned $1 million in nine months by selling 57 NFTs of his artwork. His artwork is 3D cartoons of famous people.
Wait, someone actually paid $1 million for random cartoon characters?
Yes. In fact, there’s more! A digital painting called “Everydays: The first 5,000 days” was recently auctioned by Christie’s for $69 million. I am sure you know that Jack Dorsey sold his first tweet for $2.9 million. Now I am wondering if I should just tweet a little more regularly, I mean you never know what they might be worth in a few years!
My tweeting ambitions apart, who’s buying these things and why?
The buyers of NFTs mostly treat them as speculative assets, hoping to make a tidy profit when their value goes up. That explains the rather unrealistic valuations. It even begs the question if these ‘over valued’ NFTs are simply digital versions of Ponzi or pyramid schemes where the last person holding the NFT is left gaping. Assuming the valuations are not completely bizarre, one can argue that buying NFTs could yield speculative gains. However, it is not merely speculative gains that is driving the market on NFTs. The buyers of the NFTs get digital bragging rights to the asset which make them part of an elite club.
But that’s where it gets messy. How is ownership defined in a digital world? Though the owner of the NFT gets the title of the asset, bragging rights and has the right to sell the NFT online, almost anyone can copy or right-click on the NFT and download it for free. So anyone can have a copy of the NFT, just like anyone can have a copy of the Mona Lisa, but there is only one original and one owner.
Secondly, the buyer does not have the copyright of the NFT. The original artist or creator could continue retaining the copyright while merely transferring ownership. The devil is often in the details. Recently an NFT group committed a multi-million dollar mistake when they bought the rare art book, Jodorowsky’s Dune, mistakenly thinking that they had the copyright to the book.
If NFTs are just about a bunch of artists, writers and bored millionaires buying things for speculative optimism, why did it become the flavour of the season? The answer lies in the potential of NFTs to transform the world and the way business is done in future.
NFTs are likely to be the new disruptors in the world of finance and operations. Logistical nightmares in supply chain management are a common problem and 2021 was an especially disastrous year in this regard. NFTs have the potential to eliminate bottlenecks and increase transparency in supply chain management so that we do not have a repeat of 2021. Since NFTs are stored in blockchains, they have the exact time and date stamps. If a manufacturer in Japan wanted to source a component from China, he can get an accurate and timely view of the location, condition and possession of the component that he has ordered and view its movement in real-time. This not only means that the quantity, quality and other details of the component can be verified, it also means that if the component gets delayed he gets notified in real-time. This can help him make alternate arrangements immediately without interrupting his production. This ensures an uninterrupted supply of components anywhere in the world, facilitates Just-In-Time Inventory control, improves inventory management and prevents fraudulent activities in the supply chain.
It can also ease the process of trade finance by capturing the payment guarantee of the buyer through an NFT which can then be used as collateral to effectively sponsor the supplier’s credit line. This process can effectively eliminate middlemen leading to huge cost savings. Digitized letters of credit are already gaining traction. The resultant reduction of payment time from 10 days to a mere 24 hours has helped save millions of dollars.
NFTs can also revolutionize loan and debt management through real-time verification of payment processes and authorization of signatures. NFT collateralized loans are slowly but surely on the rise. The owner profile, risk score, trading history and other details of the NFT are evaluated. These form the basis for deciding the fair value of the loan. NFTs can also add immense value in most areas that require cumbersome paperwork. It can speed up the processing of insurance applications and help universities authenticate student transcripts with ease. This could make the whole process of admission to foreign universities a whole lot easier and less expensive by eliminating middlemen.
NFTs have also entered the world of real estate. TechCrunch founder Michael Arrington recently executed the world’s first real estate NFT deal by selling his apartment in Kyiv through NFTs. After completing the legal formalities, the documents were tokenized and the NFT was transferred to the buyer.
However, the very fact that NFTs are non-fungible and unique also makes them illiquid high-risk assets. To overcome this NFT liquidity platforms like NFTX have started offering liquidity pools. An NFT liquidity pool is simply a group of people contributing NFTs to create a large pool of NFTs thereby making NFTs more liquid. These liquidity pools help to swap one NFT for another or convert NFTs into fractional tokens which can then be sold in the open market.
For e.g., one NFT could represent 1,000 fractional tokens. The use of fractional tokens divides the ownership of NFTs, enhances their liquidity and facilitates price discovery. The price that a buyer is willing to pay for a fractional token can be used as the basis for determining the value of the respective NFTs. Since these liquidity pools are decentralized they eliminate the need for market makers or middlemen making them potential game-changers in the future.
The recent regulations on taxing cryptocurrencies and NFTs give them the much needed legal backing. If the number of players in the market increase, we might soon have analysts crunching numbers for fundamental and technical analysis, derivatives contracts and valuation models on NFTs. In the years to come, blockchain-based NFTs could be used for everything from fraud prevention to debt management, from collateralized lending to working capital management, from trading to liquidity enhancement and more.
However, the advent of any new technology comes with its challenges and NFTs are no exception. Access to so much private and confidential information online could lead to a proliferation of nefarious activities and scams. With little or no governance to speak of, handling such scams could be a mammoth task. The use of blockchain entails massive environmental costs which make their long-term use a dubious proposition from a sustainability perspective. The long-term ramifications of a technology that could further diminish human interaction and its effect on the mental health of the next generation is a different issue altogether.
