NFTs are a new financial frontier in cyberspace

There are video clips of basketball highlights, thousands of digital art pieces, GIF files of cats, and original tweets. And they are now selling for millions of dollars through a digital currency called NFTs, short for non-fungible tokens.

While this novel form of cryptocurrency is an outgrowth of Bitcoin, which is only about 12 years old, it is quite different, University of Miami technology experts say.

In a series of questions and answers, Burt Rosenberg, associate professor of computer science who specializes in cryptography (or the mathematics behind securing information on computers), and Tarek Sayed, lecturer of business technology in the Miami Herbert Business School as well as the School of Law, demystify NFTs, describe the technology behind them, and explain why they are so alluring to consumers now.

What are NFTs?

Sayed: NFTs, or non-fungible tokens, are being used to represent original, unique items that cannot be divided and still retain their individual properties. These are things like art, or a house, or a one-of-a-kind baseball card. NFTs cannot be interchanged, like money or Bitcoin (which are fungible because they can be evenly exchanged), because each has a distinctive value. Let’s say I have a home, or a painting like the Mona Lisa, that is one-of-a-kind. I can take a photo of the painting, or buy a duplication, but there’s only one original.

Rosenberg: NFTs were created to provide a structure for contracts of ownership of individual works. Each NFT contains a number that is calculated from the digital artwork in a manner that is practically impossible to forge or predict. Only that specific digital artwork will calculate to that number. When someone buys the NFT, that number belongs to the buyer, and its ownership and resale is governed by what is called a smart contract. The NFTs that have become famous are contracts that exist on the Ethereum blockchain, which is a public ledger housed in cyberspace.

An NFT is similar to a title of a car. A car’s VIN is like the number written into an NFT, and this number is listed on a car’s title that is placed in a real-world “blockchain” of the motor vehicle registry. The difference is the motor vehicle registry is a trusted authority with power coming from the state, whereas blockchains spread trust among the digital miners, who are the only entities allowed to fill the blockchain.

And what is this blockchain technology that stores the NFTs?

Rosenberg: A blockchain is a public log of items or transactions that is arranged in chronological order.

The blockchain model was developed around 2008 by the mysterious Satoshi Nakamoto (this is an alias). Originally, blockchain was created to support a digital currency called Bitcoin. The blockchain was created as a public ledger to record transactions of this digital currency so that anyone could see them. It relies on various cryptographic methods, including “proof of work” to establish a consensus among miners on the contents of this ledger—primarily, that every transaction is correct and ordered absolutely in time. To complete a transaction or create a new block, a consensus must be reached among the miners. This is done without a centralized or trusted authority, which is part of what makes the technology unique.

In January 2009, Nakamoto mined the genesis block in the chain, and the age of blockchain technology was born. To this day, no one knows who Satoshi Nakamoto is, and he seems to have disappeared.

Since 2009, many variations of the original blockchain have evolved, including Bitcash and Ethereum blockchain, which is used to sell NFTs.  

Why do blockchain transactions take so long and need so much computing power that people are saying this technology is not sustainable?

Rosenberg: Transactions often take a while because most blockchains follow a “proof of work” algorithm, which forces the miners to come to a consensus on each decision. This utilizes a great deal of computing power.

Other, newer consensus algorithms that are now under development, called “proof of stake,” promise to be more efficient.

Why are NFTs an attractive investment these days?

Sayed: In general, we put a lot of value on pieces of art because they are unique and have certain markings on them. If I want to represent ownership of that property, I need something to show that I own that particular one. So now, a painting can be represented by a non-fungible token to create a digital certificate of who owns it. And since that ownership can be bought or sold, the information is stored in what’s called a blockchain ledger.

In addition, a smart contract is also attached to the NFT so that if I sell it to someone else, I can also do things like give a royalty fee to the artist who created it. That is one way to utilize these NFTs in novel ways. 

You’re buying something and it’s like you got an autograph from the person who created it. It’s not a copy, but the original, and the NFT gives it a certificate of authenticity, which is why people are paying millions for them.

Do all cryptocurrencies use blockchain technology?

Sayed: Most of them do.

How are Bitcoin and other forms of cryptocurrency different from NFTs?

Sayed: Bitcoin is not tied to an asset, it’s an asset itself. This is different from NFTs, which are attached to an asset, like a digital file, so they are not interchangeable (or fungible). There’s only one NFT that exists to represent the original file. If you use the example of CryptoKitties, a game started in 2017 where people can buy digital cats and breed them, each digital cat is represented by a unique NFT.

Also, NFTs hold value in Ethereum, which is a different type of cryptocurrency. Ethereum is a type of blockchain token, but unlike Bitcoin, it has a smart contract. This allows NFTs to also have a self-executing contract created on the blockchain. Therefore, the seller can put conditions into the smart contract and can rely on the blockchain to guarantee the adherence of the parties to the contract—and in many cases, eliminate the intermediaries. Smart contracts are new and will grow as they gain more adoption and acceptance by courts and legal systems. They are not necessarily a replacement of traditional contract instruments but a supplement that can help facilitate the execution of the contractual terms.

How many types of cryptocurrency exist today?

Sayed: Thousands. It’s an area that’s growing rapidly.

The largest cryptocurrency is Bitcoin, then Ethereum, Bitcoin cash, XRP and now, Polkadot. Some cryptocurrency exchanges are based in the U.S., like Coinbase and Binance, and some are not. But this is a separate market open 24-7, where people can buy and sell cryptocurrencies like other currencies or stocks, and they can even send them to each other, like money.

However, one must be careful in comparing cryptocurrencies to stocks. People who trade them may think they are similar to stocks. And in a simple form, they may seem like a stock you buy and sell. Yet, they are not classified as securities, and so far, they have escaped much of the U.S. regulatory framework for securities, which requires registration and disclosures.

Both Bitcoin and Ethereum have been classified by some U.S. Security and Exchange Commission (SEC) officials as currencies and not securities but the SEC is currently suing Ripple and arguing XRP is a security—because Ripple as a company is behind the cryptocurrency and owns much of it.

How do you think this blockchain technology could evolve to be more useful?

Sayed: Blockchain is getting more efficient and it’s growing. Corporate interest in Bitcoin started in 2020, and now major companies like Tesla and Grayscale have shares in it. Recent headlines have shown that large investment firms like Fidelity are starting to apply for Exchange Traded Funds (ETFs), to track the performance of Bitcoin. These ETFs are investment funds that are traded on the stock exchange, and give consumers an indirect way to invest in Bitcoin. If these are accepted by the SEC, it could prompt a growth in investments in Bitcoin and other cryptocurrencies and make such investments even more mainstream—likely reducing their price volatility too.

But aside from cryptocurrencies, innovations by businesses and industries are taking place to use blockchain for many applications. Decentralized Finance enables consumers to conduct blockchain-based business transactions without intermediaries like banks or financial institutions. This is one rapidly growing segment that is expected to reshape many aspects of the financial industry.

Rosenberg: To the cryptographic community in general, blockchain is very significant. One well-respected researcher, Silvio Macali, makes the analogy that blockchain is to cyberspace what aqueducts are to cities. Until the invention of aqueducts, city growth was constrained by the local availability of clean water.  

Blockchains will help cyberspace to grow because cyberspace participants can have confidence that their transactions will be honored now and in the future. Transactions on a blockchain are agreed-upon facts that anyone can verify for themselves.  

There are many potential applications of blockchain technology. For example, shipping containers can report their location on a blockchain once they arrive at a port, with confidence in the integrity of the report, because it could be accessible and verifiable by all participants of the blockchain. This could be a way for materials moving across the earth to establish a public record of where they have been.

In the future, your doctor could put your prescription on the blockchain, and your pharmacy and insurance company could respond to it directly on a blockchain, rather than all the phone calls needed today. And this information would be encrypted, so that only the authorized parties could read it. This way, your prescription history would be more accessible and more secure on the blockchain.

Companies today are starting to use private permission blockchains for documents. And countries like Estonia have been using blockchain technology since 2012 to power many things, like tax declarations, digital identification, and health information, so there’s a lot more exploration that could be done for other e-governance applications.