What are NFTs? 7 things to know before you buy

Market tracker DappRadar data further revealed that some of the world’s top brands like Coca Cola and Gucci have also sold NFTs. NFT sales volume totaled $24.9 billion in 2021, compared to just $94.9 million the year before. It has now become extremely hard to miss the onslaught of conversations around NFTs. So what exactly are are they?

What is an NFT?

An NFT is a non-fungible token. And what this means is, an NFT is a unique token on the blockchain which can not be replaced with something else. NFTs can really be anything digital, including drawings, music, photographs, videos and any type of digital file. It is interesting to note that digital art is not the only way to use NFTs though, as they can be used to represent ownership of any unique asset, like a deed for an item which can be digital or even a physical item. Basically, these tokens are transferable but non replicable tokens on the blockchain.

How does it work? 

NFTs work like digital collectibles that are unique, one-of-a-kind, that can not be exchanged for another token like it can done when it comes to other cryptos. “A creator of these tokens launches it on a blockchain and offers it for sale. The buyers again can offer it for sale to secondary buyers either directly or through marketplace platforms,” explains Sathvik Vishwanath, co-founder and CEO Unocoin Technologies Ltd. 

What are the risks associated with buying NFTs?

Currently, there are several risks associated with crypto-collectibles as NFTs possess significant market risks including financial and regulatory risk. As we have witnessed the many cases of frauds, experts feel that any digital underlying can be easily replicated and can lead to counterfeiting which is one of the most important risks associated with NFTs

Amit Jaju, Senior Managing Director, Ankura India, who is a digital forensics expert explained, “crypto-collectibles are not controlled by any one entity and therefore you are responsible for your own security (unlike with fiat currency where banks hold your money for you). If you lose the private key (similar to a username) associated with an NFT, then no one else can access it and you will be unable to spend or transfer the NFT. This means that if you lose your private key then you are at risk of losing all the value stored in that NFT.”

Another risk is associated with fragmentation of data, Jaju explained, “if you buy an ERC-20 token, for example, which bundles many different types of NFTs, then a single token is just a number on the blockchain. If you wish to trade this Ethereum ERC-20 token for another form of crypto-artefact then that requires reading and processing the data associated with each NFT in that bundle.” So the more NFTs bundled into a token, the larger the risk of fragmentation.

What the buyers can do to safeguard against these risks

According to Jaju, buyers can avoid risks by ensuring they have a trusted source from where they are buying the NFT directly or over a platform. Additionally, buyers also must review relevant terms and conditions associated with the transaction including exclusivity and responsibility of the platform in case of a breach.

“It is important for the buyer to validate that the creator of the token he is buying is genuine. The other significant risk the buyer poses is in custodying the NFT – he needs to be cautious about hacks and fraudsters and he should take care of the token as if it is real cash,” Vishwanath noted. 

In addition to this, to prevent cyber breaches, buyers should backup their private keys and explore hybrid wallets, and all other basic security measures associated with protecting a crypto wallet.

Does the volatility in crypto markets impact NFTs?

The value of NFTs is determined by a variety of considerations, including their scarcity, the demand for the underlying artwork or even the artist, and the prices of underlying cryptocurrencies. “Many online marketplaces that trade NFTs are based on blockchains. The Ethereum blockchain currently powers the most popular ones. If you want to trade NFTs through one of the most popular marketplaces, you’ll almost certainly need ethereum’s native currency, ether, for the transaction,” Jaju said.

The crypto markets and NFTs are not directly co-related when it comes to prices of tokens and coins, Vishwanath explained, “however, many people try to buy NFTs using other crypto coins or tokens and hence if the crypto market is dull, the buyers prefer not to buy NFTs at that moment as the buying power of the cryptos would be less.”

Interestingly, not all NFTs, track the prices of their underlying crypto. “Even though crypto markets are down overall, NFT market OpenSea has seen $2.3 billion in trade so far this year and is on track to break its monthly volume record if the trend continues,” Jaju said. In the future it is likely that the demand for an NFT may impact the value of a crypto currency due to demand.

Many online marketplaces that trade NFTs are based on blockchains. The Ethereum blockchain currently powers the most popular ones. “If you want to trade NFTs through one of the most popular marketplaces, you’ll almost certainly need Ethereum’s native currency, ether, for the transaction,” Jaju added.