What Are NFTs and How Do They Work? Non-Fungible Tokens, Explained

August 16, 2022 - 19 Min Read

While the crypto market can be extremely unpredictable and volatile, there’s no shortage of avenues to make money in the cryptocurrency space. While staking, lending, and trading can be a great way to make gains on your investment, the earning opportunities aren’t limited to what you can make from earning interest or trading tokens. There are other money-making crypto routes to take, and one of the more popular options for crypto enthusiasts is investing in non-fungible tokens, or NFTs.

There has been a ton of attention placed on NFTs over the last few years, and for good reason: Business is booming. Whether it’s digital art NFTs or NFT trading cards, crypto enthusiasts have continuously flocked to marketplaces where you can buy or sell these collectible assets — and it has led to big money being injected into this space. By the end of 2021, almost $41 billion had been spent on NFTs over the course of the year. And, while it’s impossible to predict what will happen in the future, the NFT frenzy is likely to continue growing over time.

NFT growth has led to big artists and big investors jumping into the space, but there’s still room for the smaller guys to take advantage of the meteoric rise in NFT popularity. You may even be tossing around the idea of joining in on the NFT craze, and for some crypto users, that can be an excellent plan. Before you take the leap, though, it’s important that you understand how NFTs work and how to buy them. Otherwise, you may end up in over your head. Here’s what you need to know.

Key takeaways

  • The NFT market surpassed $40 billion in 2021 as investors flocked to these unique digital assets in the midst of the crypto hype.
  • Non-fungible tokens aren’t a type of cryptocurrency. They’re an asset that proves ownership of a digital or real item.
  • These types of assets can be a smart investment for some people, but they won’t be right for every crypto enthusiast.

What are NFTs?

Non-fungible tokens are a unique type of tradeable crypto asset that are used to prove that a person owns certain items, either real or digital. These assets are bought and sold online, and the assets are encoded using the same technology that’s used to mint many cryptocurrencies types.

NFTs may seem a bit confusing, but the premise behind it is actually quite simple. With NFTs, when ownership of an item is purchased and the custody is transferred from one person to another, the process takes place on a blockchain. The process allows for a traceable chain of ownership to be “minted” into a token that’s associated with the item’s ownership.

It’s this series of blockchain-based actions that provides irrefutable evidence of ownership that can be traced and validated. And, because NFTs are issued on a decentralized network, there is no centralized party that can revoke the items. This enables true, censorship-resistant ownership.

That doesn’t mean that ownership can’t be transferred, however. The same NFT technology can also be used to resell the item down the road. When the item is resold at a later date, a new series of actions occurs on the blockchain, and there is a minted, validated ownership transfer that takes place, allowing anyone with interest in the item to track how ownership changed hands over time.

How NFTs differ from cryptocurrency

It’s important to note that while NFTs use the same blockchain technology as cryptocurrency, an NFT isn’t a type of cryptocurrency. Rather, an NFT is a crypto asset that utilizes blockchain technology to prove ownership of a piece of art, an album, or a tangible asset. The token that’s minted during the process of creating an NFT is tied directly to the item; it’s not a token like the ones you can purchase on exchanges or platforms that offer crypto for sale or trade.

That said, it can be traded or sold like cryptos, and you hold the ownership of an NFT in your wallet where you store your crypto. So while there are parallels between the two, there’s no overlap in terms of NFTs being crypto, or vice versa. They’re two separate types of assets, both of which use blockchain technology for minting and validating purposes.

How NFTs work

An NFT basically doubles as a certificate of ownership. It can note the deed to a home, art, or basically any other item, and the digital certificate makes it easy to prove ownership by allowing the immutable public transactions on the blockchain to be traced to the owner. That doesn’t mean ownership can’t be transferred, though. It can — and the new ownership is proved in the same fashion.

What’s perhaps even more interesting about NFTs is that it doesn’t stop copies of digital assets, like art pieces, from being made. This lets artists create licensed copies of an image and sell them, but each one will have its own special metadata to prove it’s different from the original.

Let’s say you’re an artist and you want to create a piece of digital art and mint 500 copies in a series of limited exclusive prints, much like other types of artists do with physical prints of their paintings or drawings. The goal is to sell these copies and transfer ownership of them to the people who buy them.

Well, it may not seem possible with traditional digital art, but you can do that with NFTs. While each owner looks at the same image in their crypto wallet, they aren’t the same. Each copy you create is uniquely identifiable from the others via the metadata that each minted NFT token contains. The owner of the original artwork can retain their higher-value asset without fear that these copies will devalue their artwork.

The easiest way to understand it is to think of it as a series of copies, all of which are numbered and authenticated. The person who bought the original has the highest-value piece in their wallets, while those who purchased the copies have numbered reprints of the original, which are still valuable, but not as valuable as the original piece.

And unlike physical art, in which good forgeries are making it harder to authenticate pieces, it’s impossible to fake an NFT. All transactions are stored on a public, tamper-proof ledger, so it’s free to use Etherscan to verify the authenticity of a potential purchase.

What NFTs are used for

Over the last few years, NFTs have primarily been associated with digital art, virtual real estate or other assets. That’s due, in major part, to the fact that numerous artists and musicians have utilized them as part of their album or art sales. In numerous cases, NFTs of digital artwork have sold for millions of dollars, which helped put NFTs into the national news spotlight.

In turn, most people currently associate NFTs with digital prints of art or music. But the potential use cases expand well outside of just digital art. For example, these types of assets are increasingly being used to validate ownership of real assets, like real estate — and there are plenty of other current and potential uses for NFTs.

To reiterate, there are use cases popping up left and right for NFT technology, but some common items that can be minted as an NFT include:

Digital artwork

As noted, crypto art has generated some of the biggest NFT headlines, such as the $69M Beeple NFT auctioned by Christie’s auction house. Because art NFTs are some of the simplest to create, there’s been an explosion of them, with more and more creators discovering how to mint their work. Some artists even mint Computer-Assisted Works (CAWs), which are AI-generated art pieces.

There’s also a wide variety of marketplaces, and what distinguishes one from the next is level of curation. Some marketplaces are very strictly curated by a team, which makes it easier for a collector to determine that the marketplace is offering potentially valuable NFTs for purchase. These types of marketplaces tend to favor work by established artists, and the stiff competition can lead to bidding wars.

On the other hand, open marketplaces will require more manual filtering, but they tend to offer more potential for finding a diamond in the rough. Other marketplaces include KnownOrigin, MakersPlace, Magic Eden, Rarible, and SuperRare.

Collectibles

Collectibles are usually released as a set, with each piece conforming to a visual motif or theme. While it can vary, collectibles are usually designed to have traits and a rarity system.

Some of the earliest NFTs were actually collectibles. For example, CryptoPunks, released in 2017, is considered to be one of the oldest Ethereum NFT projects. As such, the collection is prized and hoarded by collectors due to the historic significance of the project.

NBA Top Shot, released in 2020, is another popular project. Buyers can collect short clips of famous basketball plays, known as Moments, via this project. Because these NFTs are essentially sports cards, the project has an avid user base filled with basketball fans. It also helps that Top Shot is affordable — about $9 for a pack of three Moments — and offers easy payment processing via credit card.

Other notable collectible projects include Bored Ape Yacht Club, Clone-X, and Moonbirds. OpenSea also has a collectibles category.

Gaming

Numerous blockchain games also use NFTs to issue their in-game items. Because of this, players truly own their assets in the games, which leads to the gaming economies having actual monetary value in which people can earn by playing.

Play-to-earn was initially cemented by the Pokémon-inspired Axie Infinity. Each pet Axie is an NFT, and the pets can be used in battle to earn tokens. In some parts of the world, it’s possible to make a living simply by playing Axie.

Game NFTs also layer in utility, which differs from collectible NFTs. For example, the Sandbox Game issued NFT land plots. The land could be traded like any NFT, or the land can be developed or rented out. If you’re interested in this type of NFT, the Play to Earn magazine keeps track of all the different blockchain games.

Music

NFTs are a visual medium, so music NFTs are often created as video clips, but have also evolved to include album NFTs. And if the artist is popular enough, there can be big money in this type of NFT.

For example, the musician 3LAU earned over $11.6M by auctioning 33 NFTs of his Ultraviolet album. The top-tier NFT included a custom song and exclusive access to music. Depending on the artist, NFT music purchases may also include premium perks like lifetime VIP tickets and backstage passes.

3LAU and RAC are two of the best people in the space to follow. There aren’t any music-dedicated NFT platforms yet, but NiftyGateway has facilitated drops for big names such as Steve Aoki, Odesza, and Halsey.

Real estate and real property

One of the less common uses of NFTs is the creation of non-fungible tokens as a representation for physical properties. For example, the blockchain can be used to issue an NFT that allows a buyer to assume ownership of a property — and it can occur within a matter of minutes.

NFTs are also used to prevent cyber fraud that occurs during other types of digital transfers of real estate. Prior to the introduction of NFTs, digital transfers were rife with integrity and security issues, but NFTs remove those potential issues by utilizing the blockchain’s safety measures while also guaranteeing authenticity of ownership.

The key benefits of NFTs

There are numerous key benefits to NFTs, including:

  • Proof of ownership: One of the main benefits of NFTs is the irrefutable ownership that is minted and traceable. For example, both digital and physical artwork can be at risk of forgery, but NFTs provide clear proof of ownership that can be tracked and traced — meaning that there’s no easy way to deny ownership to the rightful party.
  • Ability to streamline transactions: Transferring property ownership for a property can be a big hassle because it takes a tremendous amount of paperwork. With an NFT, the transaction process is streamlined, and the buyer can typically assume ownership of a piece of real estate within minutes.
  • Cannot be manipulated: The same blockchain that protects crypto from being manipulated also removes the risks of manipulated NFTs. The metadata is unique to each transaction, and the transactions are immutable, meaning that the data entered into the ledger is irreversible. No changes can be made to it after the fact.
  • Scarcity: With NFT art or music collectibles, the collections are generally issued in short-run or limited supply. This makes certain items scarce, which, in turn, helps increase the value over time. That’s not the case for every NFT, of course, but the reason why collectors flock to them is because there’s a higher-than-average chance of the scarcity causing an uptick in value.
  • Potential to earn royalties: The blockchain provides a clear ledger of transactions that occur, which means that there’s a chance to earn NFT royalties on the secondary sale of these items, especially when it comes to artwork or music. For example, should the owner of the rights for exclusive NFT music want to allow for a secondary use of a song, they could approve the use and collect royalties — and the blockchain ledger allows them to prove that they are the ones who should be earning the royalties.

How to buy NFTs

1. Start by purchasing Ethereum.

Most NFT markets use Ethereum to complete transactions, so you’ll want to purchase Ethereum on a crypto exchange. You have plenty of options for crypto exchanges, so choose the one you feel most comfortable with and buy enough Ethereum to pay for the transactions you want to make.

2. Transfer the ETH to your crypto wallet.

You’ll need to move the ETH you purchase to your wallet in order to pay for the NFTs you buy. If you’re using a centralized exchange, like Crypto.com, you have to complete this step in order to pay for your NFT purchases.

3. Connect to an NFT marketplace of your choice.

There are numerous marketplaces that specialize in the sale of NFTs, so pick the one that aligns with what you want to purchase. Some of the options are outlined below. Once you’ve connected your crypto wallet to a marketplace, you can browse the marketplace and make a purchase with the Ethereum in your wallet (or whatever token the marketplace uses).

Note, though, that many of these marketplaces work similarly to eBay, but you pay with your crypto assets instead. You’ll likely bid for an NFT rather than outright purchasing it for a set price, but it can vary depending on the marketplace.

4. Take ownership of your NFT.

The NFT token that proves you own your newly-purchased NFT will be held in the wallet you used to connect to the marketplace.

NFT marketplace options

OpenSea.io

OpenSea.io is an NFT marketplace that operates on Ethereum, and it hosts a variety of digital collectibles. The options on this marketplace include video game items and digital artwork, and it’s free to sign up and browse what’s offered on this site. That can give you a good idea of whether it offers what you’re looking for. It also offers an easy process for users who want to mint their own NFTs.

Full OpenSea.io Review

Rarible

Rarible is a top NFT buying and selling platform, and users can also take advantage of other features, like tools that allow them to create and mint their own NFTs — no coding skills required. As with the other NFT marketplaces, it offers a variety of digital assets, including a ton of digital artwork. In addition to the assets it lists, Rarible also launched the first governance crypto available in the NFT space.

Full Rarible Review

SuperRare

SuperRare is an NFT social network that doubles as a marketplace for NFT buying and selling. Each of the NFTs listed on this platform is unique, and you can buy or sell original pieces on the site. Top artists are also listed right on the homepage, adding to the “social” element of this platform.

Full SuperRare Review

Magic Eden

Magic Eden burst onto the NFT scene throughout 2022, culminating in reaching a unicorn valuation in their first year of operation. Magic Eden quickly became the largest Solana NFT platform with almost 97% of daily Solana NFT trading volume, and has recently moved into the Ethereum NFT space as well.

Full Magic Eden Review

LooksRare

LooksRare is another very popular NFT marketplace with a few unique features. Users are able to place bids across an entire collection, rather than just a specific NFT. The 2% trading fee is close to the lowest in the industry, and LooksRare also offers the ability to earn and stake the LOOKS token, which reward token holders by granting them the fees generated by the LooksRare platform.

Full LooksRare Review

Final thoughts on NFTs

While the crypto market is hard to predict, the massive growth in the NFT market shows that the NFT frenzy may just be getting started. And while this type of asset is quite different from your traditional crypto assets, it can be a solid investment for the right investor. Before you take the leap, though, make sure you’ve done your homework and are sure that NFTs are right for you. Given the collectibility asset, it may not be a cheap route to take — but it could also pay off for the right person.

Frequently asked questions

  • Non-fungible tokens: Are they safe?

  • Are NFTs a good investment?

  • Which blockchains support NFTs?