By Sharon Fisher | May 17, 2022
It’s been difficult lately to avoid hearing about NFTs, or non-fungible tokens. It sounds like science fiction. Two people, without even knowing each other or their identities, could sell things to each other, including intangible items such as music or computer-generated art, safely and reliably, without having to worry about proving authenticity, currency conversion, or having any banks or governments involved with it at all.
So what’s the problem?
What does NFT mean?
First, what is an NFT? Let’s break it down.
“Fungible,” in the context of finance, means there isn’t any difference between two units of a particular commodity.
“Let’s say you have two quarters,” said Erick Herring, chief technical officer of Vynyl. “The quarters are physical objects. But they’re ultimately tokens of value. You can give them to somebody and the person receiving them will treat them as if they’re worth one quarter of a U.S. dollar. That’s so normal that nobody really thinks about it. Quarters are interchangeable. People don’t care if it’s a Bicentennial quarter, or new, or old. They only might care if you gave them a seriously collectible quarter, and they knew it, but then they would be valuing it as a collectible item. So those quarters are fungible.”
The same is true for other commodities, such as oil of the same quality, Herring said. “Any barrel is as good as any other barrel,” he said. “Within grades of crude, any two barrels are as good as each other, as long as they contain the same amount of oil.”
So how do you make something non-fungible? “You’d have to be able to uniquely identify them,” Herring said. “In practice, lots of things that are fungible are made non-fungible by the addition of something like a serial number.”
For example, take a network router for your house, Herring said. “Yours and mine, we’re buying the same thing,” he said. “The components, the functionality, the software is the same. But if you open it, the components have different serial numbers. You can look us up in the database. Your router is the same as mine for all intents and purposes, but it has a different serial number. If you tried to get service on my router, they would say, ‘that’s not your router.’ In that sense, the router becomes non-fungible.”
How about the token part?
“The token itself is a cryptographic signature,” Herring said. “What that means is that people are using math to make it so that you can tell the difference between one thing and another thing that are otherwise exactly the same. There’s nothing special about any particular token, except the fact that it has a unique signature. When you go through that signature, it can be connected to other unique things. The token itself is simply the signature.” The signature is generated through computer technology known as a blockchain.
How can NFTs be used?
Now, put them together.
“We know what a quarter is, and what a router is,” Herring said. “The promise of NFT is you have this thing that proves you own another thing, like a title to your house. It’s your house, but if you don’t have the title, you’re in trouble — they’re going to come kick you out. Title insurance is the biggest scam of the 20th century, except it’s absolutely necessary.”
Theoretically, technology such as NFTs could solve that problem, Herring said. “You wouldn’t have to dig through paper at the town hall to find the piece of paper to put a stamp on it and record it,” he said. “We would just execute a computer transaction, and the NFT would transfer from me to you when I sell it to you.”
The downside of NFTs
Unfortunately, it’s not that simple, Herring said.
“The defining characteristics of blockchain is that they are pseudonymous,” and don’t require people to prove, or even reveal, their identity, Herring said. “Actually, there’s much less privacy than people want to believe,” he said. “You have to have an identity, at least identified by the cryptographic signature and your location on the blockchain. Turns out these transactions — as the Russian oligarchs have been finding out, are traceable.”
In other words, if your goal in using NFTs is not to reveal your identity, that might not work.
Beyond that, some people have been looking to NFTs to allow them to circumvent the nation- and state-based legal and banking systems. “Pseudonymous is trustless, which means you and I can transact business on the blockchain without having any sort of trust relationship and without involving an official system, meaning the government,” Herring said. “We don’t need lawyers, cops, or the courthouse. If you’ve got your wallet and I’ve got my wallet, I can give you a thing, it’s provably yours, and I can’t take it back. All we have to do is agree that math is math and the thing we’re getting is on the blockchain. If we need that decentralization, there could be a lot of value to solving that problem.”
Unfortunately, many instances where NFTs could be useful need that centralization when problems arise, Herring said. “There’s actually no benefit in the house title scenario to using blockchain, at least in the way it’s intended to be used,” he said. “We need the centralization. We need somebody to say that the transaction means what the transaction means. The reason title insurance and property titles work at all is because the people with guns say it means what it means. We need them because, otherwise, if you and I have a disagreement over the transfer of the house I’m selling you, I guess it’s pistols at dawn. I’m not sure how else we resolve that. But as soon as you resort to courts, you’re back in the land of centralization.”
NFTs in art
An increasing use of NFTs is in the art world, where visual and audio artists are selling original bits of their work, each identified with an NFT to prove originality and authenticity.
Certainly, it’s great that there’s a new way for artists to make money using the digital world. Recall that many musicians find it much more difficult to make money these days – even aside from COVID-19 limiting public performances – because of the ease of copying and distributing digital copies of music. Music platforms such as Spotify and organizations such as Universal Music Group are already looking at ways to add NFT support. And it’s always been difficult to be a successful visual artist; they call it “starving artist” for a reason. Now, some artists are making literally millions of dollars on a single NFT.
But because there’s not a universal NFT platform, that originality distinction loses meaning, Herring said. “If I have a terrible picture of an ape smoking a cigarette, I could have four or five or seven or 20 originals, put them on all sorts of NFT platforms, and it would be an original on each of those,” he said.
“Further, where is the picture?” Herring continued. “The picture you’re buying is not in the NFT. At best, in the current implementations, the NFT points to a place on another mathematical artifact where the thing is stored. It’s not even locked in a museum like a physical picture would be. You have a thing that says you own this terrible picture of an ape smoking a cigarette, but we have to agree on what it means, which brings us back to centralization. Ultimately, to own that thing, you have to have a dispute with someone else who says they own that thing, and you resort to the central authority, so we’re back to pistols at dawn or lawsuits. All these transactions exist in a social context.”
The problem with NFTs
Ultimately, that’s the problem with NFTs, Herring said.
“I want to be a fan because I like math,” Herring said. But while many blockchain aficionados appreciate NFTs’ decentralization, that doesn’t really work in our society, he said. “Decentralization is saying it’s a benefit to get away from government,” he said. “The truth is, we love our government, even if we hate it, because it allows us to transact with each other, and Americans love nothing more than transacting.”
That’s not to say there aren’t advantages to NFTs. “You’ve got this really cool system of math, with incredibly low transaction costs, which are instantly transferrable and instantly verifiable,” Herring said. “You add the math in to reduce transaction costs, increase speed, and get rid of things that are annoying about having piles of paper. That could get rid of all sorts of fees. That could get rid of doubts in transaction. You could get rid of the financial industry and escrow. But all the good uses, the things that make the world a better place, perforce have to exist in the current centralized system, where laws pertain, and we know who we’re dealing with. I don’t think you can replace human trust with math.”
Fisher is a digital nomad who writes about entrepreneurship.