NFTs & Blockchains Simply Explained in 2022 for Super Confused People — The Future of the Internet or The Biggest Scam of Our Generation
This is a written version of a video essay produced for Laurie’s Wandering Mind on Youtube.
Disclaimer
None of the information shared in this video should be construed as financial advice. You are highly encouraged to think critically, ask lots of questions, do your own research and consult with qualified professionals before forming an opinion on the subject matter and before making financial decisions.
I might be a little late to the game, but lately I’ve been seeing everyone from celebrities to business coaches and influencers talk about NFTs, a 13 billion dollar marketplace. There is some really big hype around NFTs and digital art and it feels like if you don’t get in now, you’re gonna miss out on this cultural phenomenon. But what the heck is an NFT anyway? Since I didn’t understand anything about any of this, I decided to dive deep into it and spend hours researching the topic. If you are anything like me a few days ago and want to get an understanding of these concepts and new popular technologies, I’ve tried my best to distill the information I found in this video, so keep on watching! I want to acknowledge that I am not a professional and am not giving any kind of financial advice in this video, if you find any flaws in my reporting please correct me in the comments, it will be very appreciated!
In today’s article, we will first go over what NFTs and blockchains are, then we’ll go over some the common critics of the use of such technologies such as environmental impact and their implicitly exclusionary nature, the inherent risks of a speculative market like NFTs’, the propensity of scam and fraud, as well as the potential future of NFTs and similar technologies. If you want to skip to sections that most interest you, there will be time stamps in the video bar as well as in the description box along with some additional resources. Make sure you stay til the end if you want to understand if this is the peak of a tech bubble or the eve of a complete digital revolution!
What is an NFT?
So what is an NFT? NFT stands for Non-Fungible Token, fungible meaning replaceable. The most popular forms of NFTs we see these days are digital art, but there are a lot of other possible applications, as we will see shortly. NFTs are basically crypto collectibles: they are similar to collecting art pieces, beanie babies, limited edition sneakers or baseball cards. It is based on the concept of digital scarcity, meaning there are only finite amounts available which makes them valuable, in theory. An NFT acts as a digital certificate of authenticity. Through blockchain technology, which we will demystify in a minute, it confirms the ownership of a specific digital asset. Now, it is important to note that NFTs gives the owner exclusive ownership of the original and its certificate of authentication, but the art itself may still be reproduced hence why I can feature examples of NFT pictures in this video. It’s kind of like how there is only one real Mona Lisa and it’s hung at the Louvre, but there can be copies and prints of the Mona Lisa circulating around the world.
The potential of NFTs goes beyond simple image ownership though. Right now, an NFT can do more tangible things or have utilities like give its owner access to an exclusive membership club or community like the Bored Ape Yacht Club, the sales of which have surpassed $1 billion. An NFT can also give the owner access to digital assets in video games like in Ubisoft Quartz beta, or music, lines of codes for specific applications, sports memorabilia like NBA Top Shot, and has even been used as a wedding ring by a tech couple last year. Another kind of NFT that is emerging consists of investment in ongoing projects similar to buying early stock in a company or a Kickstarter campaign. Projects can range from video games (MMO), cartoons, movies, comic books, or pretty much anything else. Quick side note, there are infinite amounts of places to purchase NFTs from but the platform currently positioning themselves as sort of the Amazon of NFTs is called OpenSea.
In his video, “Line Goes Up — The Problem with NFTs”, which I will reference multiple times today, Dan Olson creator of Folding Ideas, explains that NFTs were the first native use case of cryptocurrency and were mostly developed as a way to do something with existing cryptocurrency since crypto was effectively nonfunctional as a currency and had very limited real world applications. As of right now, crypto and NFTs are mostly treatable as an investment. By the way, the type of cryptocurrency used for trading NFTs is Ethereum, more on that in a minute.
But we are still in the infancy stage of those technologies and haven’t seen or even imagined their full potential. Or so fervent NFT owners claim at least. After all, the market of NFTs which saw its first massive boom in 2020 came to be worth $338 million, but has now surpassed $13 billion. In fact, a very successful story comes from Pablo Rodriguez-Fraile, a collector who bought a Beeple NFT for $66,666 and resold it for 100 times that just 4 short months later. Alternatively, a lot of people opposed to the technology are weary of the amount of scams reported and see it as a possible get rich quick scheme or as a new form of gambling. I highly encourage you to educate yourself on both sides of the issue before choosing if you want to invest in these new technologies. I will have a lot of additional resources from both sides in the description box.
How Does Blockchain Work?
Now let’s see how blockchain technology actually works. A blockchain is an openly distributed ledger. It stores encrypted information on who owns a given digital asset, who sold it and when, to ensure authenticity. It is a system that records transactions and is very hard to tamper with making fraud and piracy a lot less likely than other online transaction forms. Blockchains are very hard to tamper with because they are decentralized meaning they are being distributed in multiple places. This video by Simply Explained goes into more detail about how blockchains function will be linked down below. Essentially, by using a system of proof of work which consist of having multiple people on a network also called nodes verify the information through computing “puzzles” and for the information be rendered valid, the peer-to-peer network must create a consensus. If any information added to a block didn’t match with the rest of the nodes, it would be intercepted. It’s obviously very complex and sophisticated but that’s the basis of it.
The Environmental Impact of Blockchains & NFTs
One of the biggest criticism of blockchain technology is its environmental impact. Because of the redundancy of proof of work, the process to add blocks to the chain we discussed earlier, blockchains are incredibly energy inefficient. Because the same computation basically has to be performed on all the nodes of the peer-to-peer network, it takes a lot of energy. It’s an inherent part of blockchain technology design to use lots of energy to prevent tampering.
Partially because of the recent increased interest in NFTs, the energy consumption of Ethereum has skyrocketed and will likely only get worse. In fact, Ethereum now uses about as much electricity as the entire country of Libya. It’s important to acknowledge that not all Ethereum transactions are generated NFTs and therefore not carbon dioxide emissions generated by the cryptocurrencies used to buy and sell them can be attributed to them.
Here is what The Verge shared regarding Ethereum consumption: “Take “Space Cat,” an NFT that’s basically a GIF of a cat in a rocket heading to the Moon. Space Cat’s carbon footprint is equivalent to an EU resident’s electricity usage for two months, according to the website cryptoart.wtf. That website used to let people click through the estimated greenhouse gas emissions associated with individual NFTs until creator Memo Akten took it down on March 12th. Akten, a digital artist, had analyzed 18,000 NFTs and found that the average NFT has a carbon footprint somewhat lower than Space Cat’s but still equivalent to more than a month’s worth of electricity for a person living in the EU.”
Note that there is an alternative to proof of work called proof of stake that may take less energy considering since it requires less validators functioning on a bounty basis rather than a collective consensus, but since it is not the dominant practice, it is beyond the scope of this video. Other potential solutions include building another “layer” on top of existing blockains allowing transactions to happen”off-chain”, or powering the systems through clean energy according to an article from The Verge which will be linked below.
NFT supporters will also likely point out that anything we do on the internet also has an environmental impact. Every time you scroll instagram, its servers are using up energy to render your feed for instance. Instagram has headquarters that also need to be powered up, etc. Their point, which isn’t invalid is that everything we do online consumes energy so it’s not fair to only focus on the environmental impact of crypto rather than the internet as a whole.
NFT Mining is for Rich People
Since we were just speaking of energy consumption, you may ask yourself, but what is it that causes all this need for energy in the first place? The answer is the gear and rig required to mine and validate cryptocurrency blockchain transactions. Acquiring such equipment comes at a hefty cost which is why mining is implicitly exclusionary and only reserved for the wealthy. While I realize that the primary way people think of making money through trading NFTs is by buying and selling them, there is actually money to be made by being a part of that peer-to-peer network that validates blockchain transactions. I will not go into the intricacies of mining cryptocurrencies such as Ethereum because that is super complicated, but essentially there is money to be made from each validation a node provides. Dan Olson covers a bit more on that in his video I mentioned earlier if you are interested.
It’s All Fake: The Problem with the Speculative Market of NFTs
The next problem we run into with NFTs is that the system is essentially based on pure speculativeness. The market which is based on the value of digital assets is easily questionable: Is ownership alone enough to render a piece of digital art valuable? Is scarcity even possible in terms of digital art that is infinitely digitally replicatable? And let’s be honest here and acknowledge that a lot of those digital collectibles are not particularly great visual pieces of art either, right? Some of them look like they were drawn by kindergarteners.
In essence, NFTs are just another type of investment. The actual asset is essentially worthless but its value is derived from what it might be worth in the future to someone else. As Dan Olson explains vividly and thoroughly in his video, the basic structure of a speculative currency or asset’s value is to bet that as an owner, you will be able to resell it at a higher price later. As he calls it, it’s basically a “bigger fool scam” where the entire economy relies on more people joining in, driving up demand which will allow the current owners to offload their fictionally valuable asset onto the next person (the bigger fool). Eventually the market will run out of new adopters, and therefore, the people most likely reap the rewards of this new technology are its earliest adopters.
At this point in time, it’s very possible that much of the hype is created and fuelled by the current owners of those digital assets, in an effort to entice in prospective buyers. Although, that may or may not be conscious. Success stories of NFTs being sold for 100 times more than purchasing price mere months later, may be used as this kind of propaganda to build credibility for an economy that lacks all tangibility. It may also help current owners self-validate their “investment” confirming their foresight in the wealth-producing future of digital economies. You can even observe this underlying toxic positivity that highly polices doubt in an effort to reinforce the collective illusion in discord channels and other pro-NFT communities.
The people most at risk of being taken advantage of in all of this are the ones with some disposable income and potential anxiety about their financial future, who may not have extensive knowledge of the inner workings of the technology and are potentially susceptible to being misled. This all feels a bit analogous to MLMs (multi-level marketing).
NFTs may also have a legitimate future. Maybe the market will move towards a more sustainable market that is not so hyper inflated and maybe the technology will shift to more tangible things rather than focus mostly on digital art. it’ impossible to know if it will actually last right now.
In the end, what is important to remember is that in a market of such speculative nature, everyone is basically betting that someone else will buy them out for more than they bought in down the line, which is similar to the stock market in a way.
Scams & Fraud
The NFT market being so new and unregulated, it is unfortunately quite susceptible to scam and fraud despite the intentionally difficult to alter nature of blockchain technology. The flaw in the NFT market doesn’t lie on the blockchain side of the equation, but rather on the user’s side.
Stories of scams and frauds have been share all over the internet ranging anywhere from pump and dumps, rug pulls and Ponzi schemes, to phishing and sending fake links. There have also been reports of insider trading and stories of users allegedly purchasing their own NFTs to artificially inflate their value. And because of the unregulated nature of the market and its lack of governing authority, there are basically no recourses for victims of these scams aside from sharing their stories on social media in hopes it will handicap scammers ability to perpetuate their schemes.
There’s also numerous stories of NFT projects raising large amounts of capitals and then canceling the projects and the owner walking away with all the money and the owners of the project’s NFT being left with completely useless and worthless assets, recent examples include NBA Star De’Aaron Fox and porn star Lana Rhoades who each pocketed $1.5M for their respective projects before ditching them.
As Dan Olson mentions in his video, “The one market that cryptocurrency has successfully disrupted is the market of fraud. Think of this this way: a big population of people have willingly self-identified that they have substantial disposable income, poor judgment, low social literacy, a high tolerance for nonsensical risk, and are highly persuadable.”
The Promises and Pitfalls of NFTs
We have talked pretty extensively about issues surrounding NFTs namely the environmental impact, the cost of mining crypto, the illusions of NFTs’ speculative market, and the risk for scams and fraud, but now let’s see what are some of the potential benefits and problems for the different groups of people involved with NFTs: artists, buyers, and online content creators.
For Artists
For artists, selling their digital work as NFTs is a potentially good way to make money since there is not a large market for digital art outside the NFT marketplace. There is also a feature that enables artists to essentially be paid royalties each time the piece is sold, but note that this isn’t inherent and must be specified in the original smart contract drawn during the first sale. A lot of artists thought it was included in an NFT sale from the get-go and unfortunately forfeited their rights to such passive compensation. The other major issue is that the person putting the artwork on the market may not be the person who created the artwork, sometime people going as far as profiting off of the work of a dead artist.
For Buyers
The main benefit for buyer is obviously the potential for its value to increase and then make a profit upon resale. It also gives the owner bragging rights, with a blockchain entry to back it up which I guess is valuable for some people. It can also allow the buyer to support specific artists they like. But let’s keep in mind a lot of the viral NFTs we’ve seen are computer or AI generated too. The main issue for NFT buyers is that the expectation of higher returns is actually a complete gamble. That means it can be costly, just as it can be profitable… Also, NFT owners must be aware that they in fact do not own the copyrights to the art but rather just the certificate of authentication. The image isn’t actually stored on the blockchain because it is very large in terms of data and would make blockchain exponentially more inefficient and expensive. Rather, the blockchain points to a server hosting the image through a URL. That leaves the original image dependent on the server for its survival. If the website it is hosted on was to shut down, the original image could be gone forever. Some NFTs do come with more tangible benefits like access to exclusive memberships, and other things I mentioned earlier.
For Content Creators
Finally, some benefits that have been mentioned as hypothetical for content creators include the possibility to release their own NFT token in sort of a Patreon style. The creator could release tokens that could give their owners access to exclusive content from them or even access to live events. It would also allow supporters to buy NFTs from smaller creators and let their value accrue as the creators grow. They could then cash out their investment sort of like the stock market. This last possibility sounds a bit Black Mirror to me in the way creators’ self-branding efforts become even more commodified.
Decentralization, Web 3.0, Digital Wallets & Their Inherent Flaws
I kind of want to side bar for a couple minutes before concluding to talk about Web3 and decentralization even though it doesn’t quite fit seamlessly with the rest of the video, I feel these topics should still be addressed today because NFTs are often talked about in the wider context of decentralization and DeFi (Decentralized Finance).
So, we see a lot of NFT adopters talk about decentralization which is the basic tenant of web3 or web 3.0, but what does it even mean?
For a bit of background, Web 3 is basically the next evolution of the internet and is mostly still hypothetical at this point. The first version of the internet, Web 1.0, consisted of read-only static pages and was a great way to access information. Soon after Web 2.0 appeared and connected the web. Web pages became dynamic and interactive, two-way communication through emails, instant messaging and video conferences became possible, social media were invented and e-commerce was developed. The main criticism web 3 enthusiasts have about web 2 is that it relies on centralized control. In essence, it allows large tech companies to monopolize the control and is based on the storage and selling of data to third parties in exchange for free use of their platforms. We are talking about platforms like Google and Facebook (or Meta now), etc. The other main flaw of centralized power is that they are prone to web failures since the data exchanges happen at a single centralized point.
Web 3.0 aims at decentralizing the internet. At this stage, Web 3 is still mostly speculative and theoretical. There is an obvious overlap between these internet stages of evolution and no clean break. Web 2 is not going to disappear or become obsolete any time soon, but people are talking about the possible next iteration of the internet. One of the way web 3 could revolutionize the internet is through digital wallets and decentralized finances (DeFi). These would basically allow us to have only one account that would be used for all of our online activity rather than multiple accounts on various platforms. In theory, Web 3 could also give us more control over our digital footprint, it could also affect data protection and privacy laws. It may also use more advance machine-learning and AI in its algorithms. Finally, another one of Web 3’s promises is the development of DAOs or Decentralized Autonomous Organization which would essentially democratize platforms and allow the users of platforms rather than profit-seeking shareholders to hold the power. Web 3 is also based on the principle of peer-to-peer network we know from blockchains to effectively disable the single point of failure flaw from web 2.
Now, Web 3 is still mostly hypothetical but there are still some very big flaws in its concept. First, the idea of a digital wallet may solve the multiple accounts issue of web 2 but it also comes with the significant risk of having your entire digital identity and potentially financial information in a single place. Furthermore, the whole concept of DAOs still relies on governance tokens which most likely will have to be purchased to have users vote on the direction of the platform so it isn’t that different from the current shareholders’ models. The last point I will bring up is that some web 3 enthusiasts talks bout having medical records, legal disputes, deeds to houses, etc. essentially moved to public decentralized blockchains which has some pretty unethical and potentially harmful risks. It could turn into a dystopia very quick. Obviously there is so much more about to understand about web 3 but hopefully this is a quick introduction to the concept.
Final Thoughts
In closing, some major flaws of NFTs that should not be understated are the inherent security flaws, the environmental impact, the risk for scams and fraud, and the risk of investing in a speculative market. Additional flaws I did not have time to go over at length today include the issues with privacy of an openly distributed ledger and the potential risk for harassment, and other potential flaws of the blockchain technology. Ultimately, with NFTs, you may win big but you could also lose it all.
Lastly, I want acknowledge one more time that I am not an expert and this video is only intended to give a general idea of what NFTs are. Everything is in infinitely more complex. So yea, I’m not an expert or professional. I do have half a finance degree under my belt from a few years ago before I switched majors but I am completely out of my depth with all of this and I am completely unqualified not only to give financial advice but also to interpret any financial trend. So if I made any mistakes, I deeply apologize and please correct me!
Hopefully, this was somewhat insightful. also don’t click any cryto/NFT links in the comments, they are probably scams. Let me know your thoughts in the comments!
