All about NFTs #2 The Mechanism
How do NFTs work?
NFTs are different from ERC-20 tokens, such as DAI or LINK, in that each individual token is completely unique and is not divisible. NFTs give the ability to assign or claim ownership of any unique piece of digital data, trackable by using Ethereum’s blockchain as a public ledger. An NFT is minted from digital objects as a representation of digital or non-digital assets. For example, an NFT could represent:
Real World Items:
- Deeds to a car
- Tickets to a real world event
- Tokenized invoices
- Legal documents
Lots and lots more options to get creative with!
An NFT can only have one owner at a time. Ownership is managed through the uniqueID and metadata that no other token can replicate. NFTs are minted through smart contracts that assign ownership and manage the transferability of the NFTs. When someone creates or mints an NFT, they execute code stored in smart contracts that conform to different standards, such as ERC-721. This information is added to the blockchain where the NFT is being managed. The minting process, from a high level, has the following steps that it goes through:
- Creating a new block
- Validating information
- Recording information into the blockchain
NFT’s have some special properties:
- Each token minted has a unique identifier that is directly linked to one Ethereum address.
- They’re not directly interchangeable with other tokens 1:1. For example 1 ETH is exactly the same as another ETH. This isn’t the case with NFTs.
- Each token has an owner and this information is easily verifiable.
- They live on Ethereum and can be bought and sold on any Ethereum-based NFT market.
In other words, if you own an NFT:
- You can easily prove you own it.
Proving you own an NFT is very similar to proving you have ETH in your account. For example, let’s say you purchase an NFT, and the ownership of the unique token is transferred to your wallet via your public address. The token proves that your copy of the digital file is the original. Your private key is proof-of-ownership of the original.
The content creator’s public key serves as a certificate of authenticity for that particular digital artefact. The creators public key is essentially a permanent part of the token’s history. The creator’s public key can demonstrate that the token you hold was created by a particular individual, thus contributing to its market value (vs a counterfeit).
Another way to think about proving you own the NFT is by signing messages to prove you own the private key behind the address.
As mentioned above, your private key is proof-of-ownership of the original. This tells us that the private keys behind that address control the NFT.
A signed message can be used as proof that you own your private keys without revealing them to anybody and thus proving you own the NFT as well!
- No one can manipulate it in any way.
- You can sell it, and in some cases this will earn the original creator resale royalties.
- Or, you can hold it forever, resting comfortably knowing your asset is secured by your wallet on Ethereum.
And if you create an NFT:
- You can easily prove you’re the creator.
- You determine the scarcity.
- You can earn royalties every time it’s sold.
- You can sell it on any NFT market or peer-to-peer. You’re not locked in to any platform and you don’t need anyone to intermediate.
The creator of an NFT gets to decide the scarcity of their asset.
For example, consider a ticket to a sporting event. Just as an organizer of an event can choose how many tickets to sell, the creator of an NFT can decide how many replicas exist. Sometimes these are exact replicas, such as 5000 General Admission tickets. Sometimes several are minted that are very similar, but each slightly different, such as a ticket with an assigned seat. In another case, the creator may want to create an NFT where only one is minted as a special rare collectible.
In these cases, each NFT would still have a unique identifier (like a bar code on a traditional “ticket”), with only one owner. The intended scarcity of the NFT matters, and is up to the creator. A creator may intend to make each NFT completely unique to create scarcity, or have reasons to produce several thousand replicas. Remember, this information is all public.
Some NFTs will automatically pay out royalties to their creators when they’re sold. This is still a developing concept but it’s one of the most powerful. For example, the original owners of EulerBeats Originals earn an 8% royalty every time their NFT is sold. And some platforms, like Foundation and Zora support royalties for their artists.
This is completely automatic so creators can just sit back and earn royalties as their work is sold from person to person. At the moment, figuring out royalties is very manual and lacks accuracy — a lot of creators don’t get paid what they deserve. If your NFT has a royalty programmed into it, you’ll never miss out.