NFTs: More Than Just Digital Art

April, 2022

Non-fungible tokens (NFTs) have been a hot topic as art, fashion, video games, and social influencers have embraced the technology to sell one-of-a-kind digital objects. But enterprises, outside of a few specific industries, have largely neglected NFTs. Nevertheless, companies should not ignore the technology, because along with blockchain, NFTs are necessary to show ownership of items within virtual worlds like the metaverse and even have applications in the physical world.

What Are NFTs?

NFTs are digital assets with a unique identity recorded on a blockchain, which securely tracks their ownership or other attributes and can be traded securely from person to person. One of the key benefits is that NFTs allow for free trade without a central authority due to the blockchain technology, which mitigates fraud. As more companies sell products that exist across real and virtual worlds, NFTs are a way for trading partners to know that what they are purchasing is authentic and that its usage is permitted.

NFTs are certainly getting some attention. Figure 1, adopted from data presented on the Nonfungible website, shows that in 2021 NFTs had tremendous momentum, with over 21 million sales transactions compared to less than 1.5 million in 2020. One reason for the significant increase in trading volume may be due to the attention NFTs received, with many of them selling for over $1 million in 2021. The most expensive NFT sold was digital artist Pak’s The Merge at $91.8 million. This NFT was a collective purchase and has multiple owners. The most-expensive NFT sold with one owner was Beeple’s Everydays: The First 5000 Days at $69.3 million. These big-ticket sales swiftly elevated awareness of NFTs in the popular culture.

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These big-dollar sales also bring speculators into the market, because they perceive quick profits. The global economy has been hit with uncertainty due to the ongoing pandemic and other factors. Some investors are looking for opportunities for growth. On the surface, speculating in art and collectables in a potential fad market does not seem like a secure place to invest, with some critics viewing NFTs for digital art as a bubble and equate it to the 1970s craze of the Pet Rock.

But NFTs have use cases beyond digital art and collectibles. They provide a way for trading partners to be sure of the authenticity of an item, whether digital or physical. As Dave Wagner, senior research director at Avasant Research, recently wrote, “In a world that is infinitely repeatable and copyable, NFTs can help establish authenticity and originality.”

Blockchain, NFTs, and Cryptocurrencies

To understand NFTs, one must also understand the workings of blockchain. Blockchain provides a platform to record a time-stamped ledger of transactions where each block of information is transparent, yet immutable, and protected using cryptography. Each transaction is verified through a consensus mechanism, such as proof-of-work or proof of stake, which can detect and prevent fraud.

The transparent and immutable nature of blockchain maintains the security and integrity of transactions, and NFTs thrive on this foundation. Once an NFT is minted through a smart contract, it can be sold, typically with cryptocurrency. However, what is being sold is the blockchain code, which is the identifier for the digital asset, in this case, the NFT. Each NFT has a unique code and metadata which cannot be replicated. The code is executed based on the standard established in the smart contract and stored on a blockchain, which provides assurance of authenticity.

NFTs are similar to cryptocurrencies in that they are tokenized representations of a product of value. However, the difference between NFTs and a cryptocurrency like Bitcoin is non-fungibility. NFTs are considered non-fungible, because two NFTs in the same environment will sell at different price points, compared to Bitcoin where one Bitcoin will always be equal to one Bitcoin. For example, the Bored Ape Yacht Club NFTs, which are digital collectibles of cartooned apes, have varying price points. In March 2022, one was sold for over $1 million, compared to another that sold for less than $80,000. The variance in price is possible due to the embedded smart contacts, which is another unique feature of NFTs. This flexibility allows NFTs to be used for goods of all types regardless of value. Enterprises should be able to use them to solve both real-world and virtual-world business cases.

NFTs and blockchain are about authentication first. Whether you’re tracking the latest pair of Jimmy Choos, verifying the authenticity of an AIDS drug shipped across the planet, or determining who owns a piece of digital real estate, the problem is the same. Is it real? Who owns it? What is it worth? How can I sell it? Who owned it before? NFTs promise to reduce the sale of counterfeit products and make the market safer for consumers.

Beyond Digital Art: NFT Use Cases in the Enterprise

Looking ahead, the concept of the metaverse (or, as we prefer, omniverse) which is the convergence of the real, virtual, and augmented worlds, should make NFTs a prerequisite. The use of wearable technology and the inventiveness of physical-virtual connections are creating scenarios to enable hybrid experiences. The omniverse is not limited to the gaming community. It is expanding and creating opportunities more broadly.

Take, for example, apparel. Companies can now sell clothing that exists in the physical world, but for an additional fee, they could allow the use of the same clothes in the virtual world. They could even sell clothing that produces an effect, such as changing colors or displaying secret messages, that can only be seen in the augmented world.

This is already starting to take shape. Nike, for example, recently acquired a company that makes footwear NFTs. The intention is to use NFTs as the mechanism to verify shoe purchases. The fashion industry has taken the leap into the omniverse, and other brands such as Gucci and Marc Jacobs are thinking about testing the waters.

Other industries, such as manufacturing and wholesale distribution, can benefit from NFTs. Although blockchain is already being applied to track products through the supply chain, it is possible that additional benefits can be realized by extending these blockchain applications with NFTs. This may be especially relevant in supply chains for products that are not interchangeable, for example, such as automobiles, where each car is serialized with a vehicle identification number, or pharmaceuticals, where each batch or lot number must be tracked individually to facilitate recalls. Within the supply chain, each unit being transferred can be represented as an NFT on the blockchain. This provides additional security and legitimacy of the transactions recorded against each NFT.

Another enterprise use case is intellectual property (IP) tokenization. NFTs can be utilized as an alternate digital representation for intellectual property rights. Currently, applying for a patent or a trademark is a time-consuming and costly process. As noted earlier, NFTs are authenticated on the blockchain. Therefore, the potential in this domain is possible because IP tokenization can promote transparency and liquidity in the commercial space. Tracking patent ownership would be easier, because every transaction would be recorded on the blockchain. Revenue generation can be simplified and automatic, as owners can embed royalty-collecting methods to each license. However, there are challenges, because there is no reliable framework for NFT-based IP. But IBM and IPwe may already have one solution. The platform developed aims to tokenize patents for easier licensing, selling, and commercialization of patents, now termed business assets.

“The NFT bubble may already be bursting,” wrote Frank Scavo, president of Avasant Research. “Once we are past the hype cycle, the more realistic use case of documenting ownership of intangible assets, such as patents, or in electronic contracts, will emerge.”

These potential use cases are examples of the digital world merging with the physical world. However, there are limitations. It will not be possible to represent every physical asset as an NFT due to the issues of authenticating physical assets—cost and time. However, land is a use case where NFTs have potential because land has a fixed location. In March 2022, Nemus announced a new initiative to stop deforestation and protect the biodiversity of the Amazon rainforest. The company is using NFTs to be linked to certain tracts of land in the Amazon. Every purchaser of a Nemus NFT will be given a “Guardian” status. As the platform evolves, Guardians will be part of the decision-making process in conserving and protecting the rainforest.

Similarly, vehicles may benefit from NFTs, because they carry unique identifiers such as the VIN number. But there are obstacles with respect to smaller items, like jewelry. These items have a higher risk of being forged, misrepresented, and passed off as the original asset. Therefore, the authenticity component may not be a benefit for smaller physical assets without creating more complicated processes.

Challenges in Widespread Adoption of NFTs

Other limitations and concerns regarding NFTs include the lack of legal clarity and the environmental impact of blockchain.

The legal status of NFTs is currently being tested in the courts, which are expected to soon make decisions on rights, ownership, and contractual types of NFTs. The issue of whether NFTs can be classified as securities and provide consumers with further investment protection will face the rigors of legal principles and interpretation. Legal precedents and jurisprudence will emerge to determine the issues of copyright and intellectual property.

Even though authenticity is a major feature of NFTs, until there are legal decisions, consumers may doubt their legitimacy. NFTs are a new concept and easily misunderstood. While the aim of blockchain technology is to be truly decentralized and rid itself of the red tape of regulations, legal correctness and legitimacy may be required within the space to provide a level of comfort to the general public. The legal status of NFTs will eventually become clear with the resolution of pending litigation. These outcomes will aid regulators and legislators in the direction to accommodate, hopefully not stifle, the digital economy.

NFTs and cryptocurrencies present the same dilemma with respect to environmental impact. Minting one NFT has a high computational cost that results in a high energy cost. Therefore, it is important for enterprises that wish to create NFTs to use blockchain platforms that use proof-of-stake methods, which have a lower energy consumption compared to proof-of-work.

NFTs are still in their infancy, and many challenges remain. NFTs as an application of blockchain can be a difficult concept for the general public to comprehend. Over time, we expect public understanding of NFTs to become clearer. In companies, it will be important for NFTs to be embedded in enterprise systems, hiding the technical complexity. The future is near, and we may see solutions developed to overcome these challenges. NFTs provide a way for digital assets to have real-life applications in the real, augmented, and virtual worlds.

By Tracell Frederick, Research Analyst, Avasant