What are non-fungible tokens and why are they popular?

In Take 5, Sheridan's thought leaders share their expert insight on a timely and topical issue. Learn from some of our innovative leaders and change agents as they reflect on questions that are top-of-mind for the Sheridan community.

1. What are non-fungible tokens and how are they similar or different to cryptocurrencies?

It is useful to first define the term “fungible.” If some object is fungible it means that individual units can be mutually substituted. Coins and paper bills are excellent examples of something fungible. For example, a $10 bill can be converted into two five-dollar bills or 10 loonies. Consider paying off $100 off your credit card – it does not matter if you use a $100 bill or transfer money from your chequing or savings account. The credit card company is not expecting you to pay with a particular $100 bill with a certain serial number. Another example would be common stocks selling on different exchanges – they both are identical and represent the same share of ownership in the company. The bottom line is that there is nothing unique about any individual quantity of something that is fungible.

Non-fungible tokens (NFT), as the name suggests, represents something unique and not mutually interchangeable. To achieve this feature NFTs make use of blockchain technology. Thus, before we go further it is important to understand the basics of this innovative technology. 

In essence, a blockchain is an evolving sequence of time-stamped and unalterable ownership records called blocks. The blocks are linked together using cryptography which make it impossible to alter a record without affecting all other records. The entire blockchain is not centrally managed but rather is distributed across multiple computers and is completely transparent. 

NFTs make use of the blockchain technology. In a nutshell, a NFT is a virtual record that you create to prove authenticity and ownership of a digital asset. This security is assured since they make use of blockchain technology and its cryptography characteristics. For example, suppose you create a digital piece of artwork. You then can create a NFT which proves you are the owner. It is non-interchangeable and is stored on the blockchain as property that belongs to you. Once this record is created it cannot be manipulated in anyway. It is then easy to verify that any copies of the digital artwork are not the original. Analogous to physical artwork, there could be many prints of the Mona Lisa painting, but only one person owns the original work. 

NFTs and crypto currencies both use the blockchain technology, but the key difference is that the former is fungible. For example, while every Bitcoin created can be exchanged for one another, this is not possible with NFTs as each one is unique. Bitcoins are also divisible but NFTs are also not. At this point in time the Bitcoin market dominates the market for NFTs.

2. Why are non-fungible tokens popular at this moment?

I believe it is at least partly due to the usefulness of this technology. Specifically, NFTs provide creators a fail-proof way of proving the authenticity and ownership of their work and an efficient market in which they can be traded. Also, there is a huge variety of digital content that can benefit from this technology, from digital music and art, to document identification and much more. They also create revenue opportunities for all kinds of digital artists including musicians and game designers. As well, there are potential uses in terms of recording ownership of real assets such as real estate or even proof of certification credential completion. 

3. Who is investing in non-fungible tokens?

Certainly, a significant portion of the market is collectors and firms who want the right to digital works as they are useful in their business. There is likely also a great deal of speculators who may think the values will skyrocket like the value of Bitcoin. Some information on the size of the NFT market can be found here.

4. How do non-fungible tokens differ from traditional alternative assets (e.g. owning art or gold)?

A key difference is mainly that in the digital world works can easily be copied but physical assets like gold cannot. Also, the blockchain technology would provide much more security in terms of ownership and authenticity. Someone could steal a physical piece of artwork but not your NFT.

5. Do you think in five years time we will be talking about non-fungible tokens or is this a short-term trend? 

I believe this technology creates a great deal of utility for creators of digital works, in terms of security and proof of ownership, and the potential for revenue generation. There also seems to be numerous uses of this technology, such as contract verification and for proving ownership of physical assets. 

In my opinion it has more long-term prospects than crypto currencies. For any object (either physical or virtual) to have value it must be relatively scarce and have utility. For example, a four-leaf clover is scarce, but it is not valuable because it has no utility. Bitcoin is scarce, but crypto currencies overall are not, and the utility of cryptocurrency is debatable. They provide little advantages over our regular currency and its use as a store of value is poor given its extreme volatility. Even if crypto currencies provided a substantially high level of utility, they are not scarce overall. One can imagine people shifting their preferences away from Bitcoin and favoring another one - there is nothing stopping the value then from going to zero. In terms of NFTs, the scarcity and utility are very clear and provided there are no unforeseen issues with the technology I think these have a great deal of promise in the future.

Jason Dean joined Sheridan’s Pilon School of Business in 2013. Prior to Sheridan, he worked as a health economist at Analysis Group in Montréal. He is an applied econometrician with interests in labour, health and housing market economics. He received a Bachelor of Business Administration from Wilfrid Laurier University, a master’s degree in economics from the University of Guelph, and a PhD in economics from McGill University. At Sheridan, Jason teaches microeconomics and macroeconomics.