What Is A NFT (Non-Fungible Token)? And How Do They Work?

Investing
Updated: 8th Sep 2021
Written by Parker Pope
Share this article
Bitcoin backed by
What Is Bitcoin Backed By?
Satoshis in Bitcoin
How Many Satoshis Are in A Bitcoin?
Investing
June 26, 2021
Written by Parker Pope

Disclaimer: This post contains references to products from one or more of our advertisers. We may receive compensation (at no cost to you) when you click on links to those products. Read our Disclaimer Policy for more information.

NFTs are everywhere! You almost can’t read a finance article without hearing about a ludicrous amount of money being exchanged for an NFT.

There are stories and case studies offering plenty of insight into how they work and what they can be used for.

Even though the hype may be enough to turn most investors off, the news we see expounding the massive sums NFTs are being thrown for is potentially hiding the truly fascinating blockchain technology that could be used to make our lives a bit less complicated.

What Is an NFT?

First, we should start with the fact that NFT stands for “non-fungible token.”

Let’s break down at least two of those words because it will help understand what the thing itself is.

What is a Non-Fungible Token?

It’s easy to throw NFTs into the same vein as cryptocurrency, but they are quite a bit different. It’s best to explain one word at a time.

“Fungible” is a word used to describe something in an economic setting. If you and another person have the same item – let’s say a Bitcoin token – and you exchange them with each other, you will both still have one Bitcoin.

The same idea holds for cash because your $1 bill and someone else’s $1 bill are exactly the same. That is because each designated denomination of a currency is fungible.

If something is non-fungible, there isn’t anything else like it, so it can’t be exchanged or valued like currencies.

The token is literally the digital code you store in a digital wallet and exchange for money, but it helps to think of it as a single denomination of a cryptocurrency.

So, putting these words together, a non-fungible token is a unique digital object, typically coming in the forms of art, music, or videos.

NFTs can also refer to video game currencies. There is even talk of NFTs being applied to real estate, but more on that later.

>> More: Explore the Best Cryptocurrency Exchanges

How Do NFTs Work?

NFTs are generally built using the same blockchain network like Ethereum, so a ledger tracks who owns the token.

This means that each NFT comes with a relatively unquestionable ledger identifying the owner, so the potential for forgeries is almost non-existent.

NFTs keep their identification details firmly embedded in the code for the token so it cannot be changed.

Some NFTs come with programming that allows the original creator to receive a certain amount of royalties with every exchange.

This could be a benefit to digital artists whose work tends to change hands several times.

The other interesting characteristic of NFTs is that the owner can replicate the original. The case for this is Cryptokitties from 2017.

The owners duplicated the original NFT to create various unique replications of the original as part of the Cryptokitties game.

Owners of the duplicate Cryptokitties could come together to breed their kitties and get more variations with unique attributes.

What Do You Get When You Buy an NFT?

As mentioned previously, NFTs can be art, music, videos, or other assets, but the code for those tokens must be stored somewhere.

The private keys to your NFTs are generally stored in a digital wallet similar to Bitcoin and other cryptocurrency. Using your keys (or passwords), you’ll be able to access your NFT, which is stored on the blockchain.

There are two types: software wallets and hardware wallets.

Most NFT marketplaces (more on those shortly) will require you to use a software wallet.

Hardware wallets come with more security, but software wallets allow the transactions to be far smoother, and you run a slightly higher risk of losing a hardware wallet.

How Do You Buy or Sell an NFT? (Step-by-Step)

#1. Choose a NFT Platform

First and foremost, choose an NFT platform you like. Some only offer one kind of NFT, while others offer several.

You should also be sure to look closely at the fees that each one charges as they can be higher or lower. When you’re buying a $15,000 piece of digital art, fees can certainly eat into the value.

Most of these platforms operate as auctions where the buyers place bids (similar to Ebay).

That being said, each offers a slightly different set of features that cater to the various kinds of NFT collectors.

  • Foundation: this platform allows users to upvote art and put it front and center. However, artists who create NFTs must buy “gas” to make sure they are able to post their ideas.
  • Rarible: This platform is a bit more user-friendly with more features, but it is also a full website as opposed to an app.
  • OpenSea.io: This platform is by far the slickest and offers “rare digital items and collectibles.” Most of the art posted is genuine art, though it’s perhaps more in the eye of the beholder than a fact.
  • Nifty: appropriately named Nifty offers users the ability to receive notifications when certain artists drop new items.

Fees are certainly a factor to look into before buying or selling on any of these platforms, but the security leaves something to be desired.

Read through all of the fine print before diving into these, so you understand not only what is required of buyers or sellers but also what is not required of them.

#2. Create a Digital Wallet

There are several digital wallets available, and they all provide roughly the same service.

However, it’s important to choose your NFT marketplace first since not all digital wallets are accepted by every NFT marketplace.

MetaMask is accepted by most of the markets listed above, though as with all things NFT, make sure you do some homework on the fees and costs of using any wallet.

#3. Buy a Cryptocurrency

NFT markets only accept payment in cryptocurrencies, appropriately.

Once you have your digital wallet, you can go to a crypto exchange to buy some and store the keys in your digital wallet.

Gemini

Gemini will offer all of the majors, of course, but they also have a larger offering of alternative coins or altcoins.

You can also earn interest on your coins by opting into the Gemini Earn program.

>> More: Full Gemini Review

Coinbase

Coinbase is one of the best known in the US and consistently reviewed as one of the best for any cryptocurrency investor.

While the fees can be quite high, the user interface is extremely good, and, as one of the best-known exchanges, you will have better liquidity in your trades than others.

>> More: Full Coinbase Review

eToro

eToro offers 15 cryptocurrencies and allows you to match trades with those of high-profile traders.

However, eToro is very limited for those you simply want to acquire cryptos for the purpose of buying NFTs.

The service is also not available in every US state.

>> More: Full eToro Review

Kraken

Kraken can be a bit difficult to navigate for beginners and, since it’s not a US company, some options may not be available in America.

However, the low fees are extremely attractive whether you have less capital to work with or make big trades regularly.

#4. Buy or Sell an NFT

Once you have your crypto coins with their password stored safely in your digital wallet, you can finally go and bid on your favorite NFT!

When you finally win your shiny new NFT, remember that you aren’t actually storing the NFT on your wallet – it’s just there to track the access keys necessary to locate and prove ownership on the blockchain.

If you’re selling NFTs, your cryptocurrency can now be used to get set up on the platforms and post your art, music, or video in NFT format.

How Does NFT Relate to Crypto?

While they all live in a world of blockchain, NFTs and cryptos are quite different.

Cryptocurrencies, as fungible assets, are constantly growing their blockchain with each transfer of coins, whereas NFTs are fairly static and do not see the liquidity that one might find with cryptocurrencies.

However, since NFTs are mostly built on the Ethereum blockchain network, they are very closely related in their programming.

In fact, many markets require prospective buyers of NFTs to use Ethereum since it is the easiest to transfer on the system, though this isn’t always the case.

>> More: Find out how to Buy Bitcoin

Why Are Non-Fungible Tokens Important?

Some of the NFT hype lately is related to just that – hype.

NFTs are new and interesting, and they have to be experimented with to find out what value they offer.

Now that we have more information about them, there is more discussion about NFTs being used in real estate since they provide very strict ownership confirmation and can be transferred relatively easily.

The technology operates very similarly to the deed for a house, except the contracts, signatures, escrows, fees, and pre-authorizations that are required for the current homeownership system make it an extremely slow and cumbersome process.

Technically speaking, an NFT is designed to convey exclusive rights to something.

Since they can manage the contract automatically, properties could eventually be bought and sold online without much effort, just like buying a TV from Amazon.

Should You Buy NFTs?

It depends very heavily on your appetite for risk and whether the NFT will add something to your life or not.

As an investment, there are far better avenues you can search for returns in your portfolios, and almost all of them have fewer risks involved.

If, however, you see a piece that can add to your business, your brand, or just your life, then sure, and NFT is worth it.

What Was the Most Expensive NFT Ever Sold for?

The current record for the most expensive NFT ever sold is a collection of 5,000 pieces sold by the artist known online as Beeple.

His collection sold at the well-renowned auction house Christie’s for over $69 million.

How Do You Make an NFT?

Believe it or not, you don’t need to have a doctorate in cryptographic programming to make an NFT. First, you choose which blockchain network you want to use.

Let’s say you choose Ethereum (which is the largest for the NFT market). The next steps aren’t dissimilar from buying an NFT:

  • You will need an Ethereum wallet that supports ERC-721. You’ll see this in the features of a digital wallet. It’s basically the standard for Ethereum-based NFTs.
  • Then, you’ll need only about $50-100 in ether (ETH) and store the keys in your digital wallet.
  • Choose a market you’d like to list your NFT on and follow instructions for creators.
  • For OpenSea, as an example, you’ll connect your wallet and go through the sign-up process
  • Lastly, you simply upload your work into the platform and follow the rest of the instructions.

What Are the Risks of NFTs?

Not only are the NFTs extremely “hype” expensive, but that value could disappear overnight.

There is almost no liquidity in these markets, and the value they hold is based on nothing other than the demand for them.

There is also risk involved in even exposing your monetary assets and personal information to the marketplaces, which don’t aren’t exactly being set up with security as the first priority.

If, however, you see an NFT that might help your business, brand, or just your lifestyle, it may be worth it.

It’s ok to dive in and at least get something, not because it’s expensive but because it will enrich your life.

Bottom Line: What Is A NFT?

As a refresher, NFT stands for “non-fungible token.”

It is a unique digital object, sometimes art, music, or videos, that can be bought, created, and sold at several new marketplaces.

NFTs are more than likely here to stay for a while.

They are currently in the news often as various sorts of trivialities that happen to make several people very rich, but many of these are right place/right times events.

The idea of an NFT, though, has many far-reaching implications.

Blockchain Technology was always going to be a strong drive into the future when it comes to contracts and decentralized finance, but NFTs are just the first iteration in this new experiment.

Parker Pope
Parker Pope
Parker has spent over 10 years studying the financial markets. He currently manages his own portfolios by trading options and futures, and he’s excited to share his experience with those interested in a hands-on approach to their investments. No fancy tricks or indicators, just a commitment to understanding risk management and knowing the “why.” While he invests actively, he’s built a wealth of knowledge about personal finance and commits his efforts to writing about topics to help people take control of their finances.