Understanding NFTs for Babies like Me
By: Andrew-Chen-Wang
Written on 2021-12-03
Imagine owning a house in the U.S. An NFT is like a piece of paper provided by the government, a trusted source, that you own that house. If I want to sell that house and a buyer arrives, the buyer offers a price. If I like it, I take the cash in full amount and transfer the piece of paper to the buyer.
Why some NFTs are worth so much is because people speculate the value of the item to be sold. Trump's mansion is worth a lot and some people are willing to purchase it for millions if Trump puts the house up for sale.
NFTs are just claims to owning something. That something can be anything, from a tweet to even Trump's mansion. But that claim only has value in the virtual world. You don't actually own Trump's mansion after buying an NFT or a claim of Trump's mansion. If we limit "something" to a physical thing like a mansion, we have a split between virtual and physical. Trump still owns Trump's mansion in the physical world, but I own the idea of Trump's mansion in the virtual world. The idea is one of a kind as agreed to by the population in the virtual world. People in the virtual world speculate the value of my claim to ownership of Trump's mansion if I put it up for sale.
To sum it up, NFT is just the board game Monopoly where you claim ownership to a property by the Monopoly cards, and the players can trade properties but the seller can decide whether the price is right and the purchaser can offer whatever price they want.
I am going to explain this concisely, imperfectly, and non-technically. This is like a reference guide for someone like me who is technical but hates reading long technical material. Enjoy :)
To understand NFTs, we need to understand how the cryptocurrency market works. You've heard of Bitcoin, Ethereum, hackers from North Korea, and Elon Musk. The first two are actual cryptocurrencies, Bitcoin and Ethereum.
What you need to know is that they are basically real currency. You cannot go to a gas station in the heart of Texas, fill your tank up for $18 USD, then try to pay in $20 Chinese Yuan and expect change in either USD or Yuan:
- These currencies are not interchangable. You can "exchange" them like any foreign currency exchange. But each currency market is disjoint from others.
- You just tried to give a Texan a Chinese Yuan... they ain't going to accept it, whether that be because they see no value in having the Yuan, by principle, or because the gas station doesn't have Yuan.
Forget everything you know about NFTs. Imagine an NFT is your piece of art. You just drew a dog on a sheet of paper with crayons. In the physical world, that is a sheet of paper. In the virtual world, that is an NFT.
Again, forget everything you know about NFTs. Forget about claim to ownership, copyright, etc. Just stick to the example.
NFTs abide by the aforementioned concepts of cryptocurrency.
- There are many NFT markets, though you may never have heard of them. You now want to sell your drawing of the dog. Where do you sell it? One market is the Ethereum NFT market. Another market is the Bitcoin NFT market. In other words, you can sell your artwork multiple times in parallel universes where these markets are the universes. But you can only seel the piece of art once in a universe.
- Let's say you just sold the piece of art on the Bitcoin NFT market. It is freely exchanged as in it is resold multiple times, maybe in an auction house. But the only people who can purchase them are people with Bitcoin.
There is no Bitcoin NFT market. Most NFTs are traded on Ethereum which made software to support an NFT market which is helpful for traders working with NFTs since everyone just buys artwork with a single currency.
You've heard the high-profile NFT purchases reaching millions of dollars or Jack Dorsey selling his first tweet for a couple million dollars worth using an NFT marketplace. But who owns the physical artwork or the actual thing that is being sold?
What NFTs really are: solely within the Bitcoin universe or solely within the Ethereum universe, only one person can claim that they own it. This claim to ownership doesn't translate whatsoever to the physical world. It has no value in the material world whatsoever.
The value behind it is the drive to own something. Capitalism at its finest. If you're an American or a household owner, you may probably understand the concept of an "increasing house value." For instance, the house I live in right now increased in speculative value by 10%. The keyword there is "speculative" because I still live in the house; I haven't sold it, I'm not interested in selling it, and no one is looking to buy it. There is no value because it's not on the house market.
But when I look on Zillow, it says my house is worth $80k. That's the estimated value. The purpose of claiming ownership to something now is because my house is one of a kind. It has a specific address. It is situated at this exact geographic coordinate point in the world. The mailbox is on right side of the driveway. In the NFT world, there is a verifiable way to say you have claim to "something;" in the case of the house, the government is the verifiable way to say I own my house, my property.
An NFT is just a claim. But that claim is in the virtual world! It is not a claim in the material world. The virtual and the physical world are completely separate. COMPLETELY. Certain NFTs are evaluated and purchased because of their speculative future price. I can sell my house as an NFT but still have ownership of the house in the real world. Whoever purchased my house with that NFT has claim in the virtual universe; but if they come to my house, I'm 1) calling the cops and 2) having them prosecuted for intrusion. They have no right and no ownership to the house in the material world.
The reason NFTs are sold at astronomical prices is because of their speculative value. Because some pieces of art (or tweet or really anything) are thought to have higher value, when someone tries selling it, people speculate and offer a price based on their speculation of the piece of art's current value and future probable value. That is it.
At the moment, most of the market is gambling. If you're still confused, think of NFTs as antics. Some purchases are more strategic such as the person who bought Jack Dorsey's first tweet; I find that highly valuable because in the future, Jack Dorsey is probably going to become a prominent cryptocurrency figure (if not already). It's like selling A-Rod's 3000th baseball. It's special, and people want it. So it could've been sold for millions whereas my little league baseball from my first strike out (shocker :P) would've only been sold for a buck.
This claim is just sold over an over again. My house was built in '69, and there have been multiple home owners. Just like NFTs, there can be multiple sales and transfer of ownership.
I used Ethereum NFT market and Bitcoin NFT market because, to buy an NFT, you have to use the cryptocurrency, not actual USD, to buy the NFT or the claim.
Yea, it's a problem. In the case of Jack Dorsey (the following may be incorrect) and his tweet, everyone knew Jack Dorsey. Jack may have publicized his cryptocurrency wallet. When actually giving money, you have to know someone's cryptocurrency wallet "address." Jack may have publicized it and told everyone from his Verified Twitter account that the address is authentic and his tweets are verified by Twitter which everyone in the world treats as authentic (i.e. we trust that his publicizing of the address is authentic and actually from Jack).
So when Jack sells his first tweet's virtual claim to someone else, people know it's the real deal and not a fraud. A fraud can be caught because, before giving money to the fraud, you can check the address that the fraud gave matches the verified one that Jack publicized.
Ok, but how about finding random images online? Yea, that's a problem, and no solution for this. If you don't understand the problem: in the Jack story, Jack had a verifiable identity. We knew the first tweet came from Jack and his verified Twitter status provides authenticity. In most cases, we don't actually know the original owner in the real world. And so people are just making up claims themselves. I can say "I own this drawing of a dog," when it's actually yours! But you're unaware of this sale. The drawing of the dog is unknown to everyone but you and me. Any purchaser who is interested in purchasing the piece of art can't find you anywhere on the internet or find the image anywhere on the internet since the drawing is on a piece of paper. But because the purchaser finds value and can't verify that I am the real owner and can't find the real owner themselves, the purchaser will hand me the cash.