Moving real-world assets to blockchain — how NFTs are changing the way we digitize assets
Very often we hear about going digital — it’s the buzzword of this modern online era. However, we have to ask how many of us really understand what it means to be digital?
There’s a common misconception that once a computer is involved, something “goes digital”. The more accurate term for this is “going electronic”. To go digital is yet another hurdle for the world of technology and one that is yet to really go mainstream.
For example — traditional online banking is more electronic than it is digital. There are some digital elements in it but it is far from being completely digital. When you put in a request to transfer money from one place to another, the network merely relays messages to have balances updated on different accounts on either side. It is no different from how it was done for hundreds of years. The only difference is that the paper ledgers have now become Excel spreadsheets.
So what does it mean to become digital? A big part of it is in cryptography. Digital signatures — mathematically verifiable signatures that can prove the possession of a private key without revealing the key itself, is the basis of cryptography and by extension, cryptocurrency.
When dealing with a bank, an officer in the bank would verify your signature against what the bank has on file to check if it is really you who signed off on a cheque or standing instruction — this is a point of failure that has been exploited countless times throughout the course of history.
Digital signatures are much more trustworthy. In fact, every blockchain transaction is signed digitally — that’s how the blockchain knows that the transaction came from the account holder and no one else.
While digital signatures and cryptography are not 100% bulletproof, it is a significant step-up from mere electronic technologies that are just mechanical implementations of how we traditionally conduct financial operations.
A DIFFERENT KIND OF TOKEN
Most of us who have played with cryptocurrencies are familiar with cryptocurrency tokens and know about the ERC-20 standard tokens that reside on the Ethereum blockchain. These are still the go-to tokens for many digital assets. However, one size does not fit all. ERC-20 unlocked the possibility to tokenize fungible assets such as shares, voting rights, money, and loyalty points to name a few — but what happens when an asset is non-fungible?
To put into perspective what a non-fungible asset is, imagine a set of assets where each one is unique. One asset is not directly exchangeable for another. As time goes by, each asset can appreciate or depreciate in value, independent of the other assets in the set. Good real-life examples of these are trading cards and collectible card games.
In the popular game Magic: The Gathering, over 21,000 unique cards exist for the game over hundreds of subsets. A card from an early set printed back in 1993 called the “Black Lotus” broke records with it trading hands for a whopping $166,100[1]. Meanwhile, Basic Land cards that are essential to the gameplay are sometimes sold for a mere 10 cents or even given out for free.
Experimental “colored coins” on the Bitcoin blockchain were the earliest known experiment with putting non-fungible assets on the blockchain[2]. It was only when the Ethereum blockchain implemented the ERC-721 standard that the blockchain was open for business and ready to take on a whole new world of tokens — Non-Fungible Tokens or NFTs were born.
The most successful pioneering application was called Cryptokitties and it is exactly what the name suggests — tradable kittens on the blockchain. While it ran from the same contract, each kitten was unique. Each kitten had its own individual value. Even better, kittens could be mated with each other to breed new kittens. Every single operation took place on the blockchain. Every Cryptokitties kitten in existence was a blockchain asset. Each was unique.
Of course, this is also technically doable by spinning up a new ERC-20 smart contract for every single kitten that comes into existence — however, that would be a nightmare for maintenance and the gas required to transact on such a network of contracts would simply make it a pipe dream. ERC-721 changed that forever.
LIVING IN THE DAO
If you’ve read this far, you would probably already be aware of what a Digital Autonomous Organisation is. A brief refresher would be to say that it is an organization akin to a society or company that runs on the Blockchain.
This means that once a contract is deployed, it will autonomously take care of the tokens under it and handle the transactions that happen between them. Parameters such as prices, quantity, and more can all be managed autonomously.
In some apps like Rarible that sell collectible digital artwork, artists can interact with the DAO smart contract to tokenize their artworks and let the DAO handle the technical side of things.
DECENTRALIZED FINANCE
There’s no talking about the modern blockchain without taking into account its biggest disruption — decentralized finance or DeFi.
A powerful element of DeFi is how liquidity is handled in the ecosystem. An amazing balance between borrowers, liquidity providers, and token stakeholders all governed by a DAO creates a market where all three players create the forces required to drive it to become profitable.
Historically, art auction houses have been a source of liquidity for those who wish to put their prized possessions up as collateral. NFTs provide a new way to bring this into the DeFi space where prized NFTs can be staked for crypto liquidity. Companies like Nexo already provide fiat lending services when their users stake their crypto-assets. NFTs have the potential to take this further and even become another bridge between the worlds of Centralised Finance (CeFi) and DeFi.
WORK AND PLAY
Going back to where we started on this article, it may come as no surprise that in the electronic world, non-fungible items have been traded for several years now in a particular industry — video games.
The popular first-person shooter Counter-Strike: Global Offensive has a massive market for in-game cosmetics, especially decorations or “skins” for weapons. What started as a simple trading system where players can trade weapon skins with each other evolved into a massive marketplace managed by several companies specializing in trading in-game items across a variety of online video games from DotA 2 to Team Fortress 2.
Some of these companies have begun adopting NFTs. Opskins, a now-defunct popular weapon skin trading marketplace used a DAO on the Ethereum blockchain to facilitate trading. While they were shut down earlier this year by the Valve corporation for using bots to facilitate transactions, Opskins was an important proof of concept to show that NFTs can indeed play a big part in decentralized finance when paired with the right market.
In 2017, a company called Enjin conducted its ICO which later blossomed into a new dawn for NFTs and online gaming. Enjin offered an open ecosystem that anyone could build on and one spectacular use case was EnjinCraft — a Minecraft plugin that allowed Minecraft server owners to create their own NFTs inside their Minecraft server that could be synchronized via the blockchain and potentially show up in other Minecraft servers. NFTs could even grant users special powers in the game and allow them access to exclusive areas on the map among others.
While still in its infancy, EnjinCraft is a significant building block towards a new kind of DeFi. Gamers can now trade parts of their in-game inventory on the blockchain without even being in the game while avid traders can participate in the arbitraging without even being a player. This opens up a world of possibilities.
Groups like the Blockchain Game Alliance are also bringing together developers and companies across the board to spur the creation of new technologies in video games where assets can be integrated deeply with the blockchain. In a recent event, they discussed the idea of how NFT platforms can become lucrative entry points to aspiring game developers to give their game more exposure and grow their player base since a more connected inventory could give potential players a head start. It also opens new opportunities in the world of E-sports where NFTs can even take the form of prizes and achievements.
MORE THAN ONE OF A KIND
So you may ask — if everything is unique when it comes to NFTs, can duplicates of items exist?
The answer used to be no — up until ERC-1155 was implemented, bringing the NFT world to greater heights. ERC1155 brought the best of ERC-20 and ERC-721 together, allowing for “semi-fungible” tokens to exist.
This is how trading platforms like Opskins was able to operate. Not all CS:GO skins are unique. Furthermore, limited quantities also contributed to the rarity of items. Items with lower instances on any NFT platform would generally be rarer and one-of-a-kind tokens could appreciate in value when they become more sought after.
TRACK AND TRACE
At the Think 2018 conference in Las Vegas, International Business Machines — better known as IBM — premiered what they called the World’s Smallest Computer — measuring one cubic millimeter.
While it is nowhere near as powerful as even a Raspberry Pi, the computer was dubbed a “crypto-anchor” which allows it to communicate with other devices using its photovoltaic element and built-in LED. It’s also capable of signing messages with an embedded private key. IBM CEO Arvind Krishna, who was then the senior VP of IBM Research noted how these “crypto-anchors” can be used in tandem with a blockchain distributed ledger “to ensure an object’s authenticity from its point of origin to when it reaches the hands of the customer”[3].
It is potentially through these embedded technologies that an NFT can bring even physical goods into the digital realm — from simple goods like livestock and food to precious antiques, pairing one of these “crypto-anchors” to an NFT can give them a new home in the digital world. Pairing these devices with a DAO by using metadata on the blockchain to trace their every transaction can even prove to be useful for proving authenticity and history.
A NON-FUNGIBLE FUTURE
The world is full of non-fungible entities. NFTs are merely a step closer to bringing this aspect of our world into the blockchain and in turn, into the digital era.
Do ERC-1155 NFTs mean that non-fungible ERC-20 tokens are on their way out? Absolutely not. There will always be fungible assets as long as we have a system of currency. Security tokens and payment tokens are for the most part non-fungible. However, platforms like Aave have taken to using non-fungible tokens as governance tokens, allowing them to potentially serve more than one purpose.
NFTs have massive potential in the DeFi space, giving on-chain markets the ability to handle diversity in assets while allowing buyers to have ease of mind that they are trading exactly what they want to. There may be even more applications for NFTs that we are yet to find out — and how NFTs can play their part in current popular DeFi operations such as liquidity farming is yet to be seen though one day, we may just find a way to make that precious, rare little cryptokitty work for us.
Sources:
[1] https://www.polygon.com/2019/3/5/18251623/magic-the-gathering-black-lotus-auction-price
[2] https://opensea.io/blog/guides/non-fungible-tokens
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