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What are non-fungible tokens (NFTs) and how do they work?

Updated 07 June 2022

5min read

Kate Morgan
Staff Writer

NFTs have become a hot ticket, with celebrities buying into them, and millions apparently being made at a stroke.

But we need to look beyond the hype and headlines to find some real-world answers.     

The technology behind NFTs is complex, so there’s plenty of potential for confusion.

Most NFTs are perfectly legitimate, but in such new and technology-led terrain there are bound to be pitfalls to negotiate. 

What are NFTs and how do they work?

What does NFT stand for?

NFT stands for a ‘non-fungible token’. Something that is ‘non-fungible’ is unique. The ‘token’ part refers to the fact that an NFT is a digital asset representing a real-world object, protected using blockchain technology. An NFT cannot be replicated. 

Most of the famous NFTs are works of digital art, but they can be a whole host of different things, including videos, songs or tweets, and when you buy an NFT, you are recorded as the sole owner in the blockchain. 

How do NFTs work?

An NFT needs two current technologies to work: blockchain and cryptocurrencies.

A blockchain is a kind of shared electronic database, a bit like Dropbox for example, except that while you can add to it, you can’t remove or edit content. There are numerous different blockchains out there. 

You can only buy NFTs using a cryptocurrency – a digital currency that works through computer networks but is not reliant on banks or any central authority.

When you spend your cryptocurrency on an NFT, your purchase is added to the blockchain, and no one can alter this: it’s clear proof that you now own the NFT. This is called a smart contract, which is data showing all the key information about your transaction. 

A short NFT history

The NFT story begins around 2012-13 – here are some of the main milestones in the NFT timeline:  

  • On 3 May 2014. Digital artist Kevin McCoy minted the first NFT, ‘Quantum’ on the Namecoin blockchain. ‘Quantum’ is a digital image of an octagon that changes colour and pulsates. When this artwork was first revealed, the audience apparently laughed, but in 2021, Quantum sold at Sotheby’s Native Digital auction for $1.4 million. 

  • In 2016, when memes – ideas that spread through imitation - were becoming hugely popular, they also appeared on the blockchain, in the guise of the ‘Rare Pepes’. These are cartoon depictions of frogs created by Matt Furie. The frogs were sold via the Rare Pepe Wallet website.  

  • 2017 saw the arrival of CryptoPunks, which featured 10,000 algorithmically generated unique characters. At first they sparked little reaction, then suddenly sold out within 24 hours. Initially selling for a few dollars, today they’re worth thousands and occasionally millions. 

  • A classic recent NFT success was the Bored Ape Yacht Club. A collection of randomly generated ape images released in May 2021, it became an overnight sell out. Beginning from a small group chat, the Club has now expanded into the biggest NFT collection, valued in the billions, with real-life events, a game and merchandise 

How to buy and sell NFTs

Once you have some suitable cryptocurrency, you need to find a legitimate NFT trading platform. Because the world of NFTs and crypto exchanges can attract fraudsters and scammers, consider seeking expert financial advice before you take the plunge. 

One trusted platform is called OpenSea, where many of the headline-grabbing NFTs have been uploaded and bought. Reassuringly, it has plenty of backing and regulation.

When deciding whether you should invest in NFTs, it’s worth remembering that just as with physical art, an NFT is only worth what the market decides, and this can quickly go up and down.  

The key is to understand the technology involved and do plenty of research – ideally with expert guidance. This is a highly speculative environment with undoubted potential, and knowledge is power. 

How to make money from NFTs

The combination of new technology and currency, plus the big stories about epic profits can make the NFT market look intimidating. So how do you actually earn money from a digital asset? 

The most straightforward way to generate money from NFTs is to sell them on a credible NFT specialist marketplace.

There are quite a few now, where you can create, list, sell and exchange NFTs, such as these: 

OpenSea 

Mintable 

SuperRare 

CryptoPunks 

There are other approaches to making money from NFTs, such as renting them out, charging royalties if you are the creator, trading, and investing in NFT startups, but if you’re a beginner, a regulated platform is probably the best place to start. 

How do you create NFTs?

You can develop and sell almost anything as an NFT, provided it’s digital and has unique attributes. Original art, music, memes and films are just a few examples. It’s up to you. 

The process of creating your NFT is called minting. Before this is done, you need to follow some key steps: 

  • Make sure you know exactly what you’re getting in to 

  • Do your research – pick the platform or marketplace that suits what you want to create and sell 

  • Connect your crypto wallet, where you can store NFTs and cryptocurrencies   

  • Now build your NFT and list it on your chosen platform 

What is the most expensive NFT so far?

It’s hard to pinpoint exactly which NFT is currently the most expensive, but there are a couple of recent high-profile examples. 

‘The first 5000 days’ by Beeple, an intricate digital collage combining work from the artist’s career to date sold through Sotheby’s for $69 million in March 2021. 

However, this has been eclipsed by the sale of ‘The Merge’, which went for $91.8 million in December 2021.

There has been some debate over this record however, because some regard ‘The Merge’ as more than one artwork, because it sold to multiple buyers.  

The pros and cons of NFTs

So what are the advantages and disadvantages of NFTs?

Firstly, NFTs provide you with a clear record of authenticity and ownership that’s verifiable on the blockchain. They’ve sparked a whole new market that has great potential for growth too.  

The processes involved in buying and selling NFTs are really streamlined and efficient. Smart contracts eliminate the need for physical intermediaries and experts.

NFTs also allow artists to sell directly to collectors, and receive royalties when their art is resold. 

On the negative side, NFTs are very speculative investments in a young marketplace, so there isn’t much historical data to use as research.

Also, value is based on what someone is willing to pay – it’s entirely relative, so can rise and fall just as rapidly. 

Importantly, NFTs are not good for the environment. The blockchain has a bigger carbon footprint than Singapore! In the future, NFTs should become less CO2 heavy, through the use of sustainable energy such as solar and wind power. 

Always bear in mind that fraud and scammers are present in this space too. NFTs can be hacked and stolen. 

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About the author
Kate has written for leading publications and blue chip companies over the last 20 years.