What Are NFTs? A Technical Breakdown for Beginners

author: Cyrus Taghehchian
  • Insights

How NFTs Work

Most “what are NFTs?” guides give a brief, one-sentence description of how NFTs work. The rest of the information in these types of articles will give practical applications of NFTs beyond works of art and perhaps a few more important details. These guides are perfectly useful in most cases.

This article is instead meant for those who have no programming experience, but who wish to dive deeper into the underlying technology behind NFTs. This technical overview will also serve to highlight the power of NFTs and why they are so important as a concept. However, some technical details will be skipped to avoid confusion.

Therefore, this article is both a “how” and a “why”.

Both NFTs and Cryptocurrency are stored on the Blockchain

To understand the significance of NFTs, we first need to understand how blockchains work.

Simply put, a blockchain is a method for storing information. That’s it.

It is called a “blockchain” because it is a “chain” of “blocks”.

Each block can only hold a certain amount of information before a new block is created to store further information. The Bitcoin blockchain, for example, can hold 1 MB of information per block. That is the equivalent of 6.25 Bitcoins per block.

Other blockchains, like Ethereum, hold other types of information as well, including NFTs. Neither cryptocurrencies nor NFTs are ever stored in a digital “wallet” or a hard drive or anything else. These digital or physical devices can only store proof of ownership. The actual data is stored on the blockchain and never moves.

There are many stories of people “losing” their Bitcoins in a hard drive, but what they lost was access to the tokens that are still stored on the Bitcoin blockchain to this day.

A Blockchain is a Distributed Ledger

Now, let’s get into why the concept of a blockchain is so powerful and what that means for NFTs.

Normally, information is stored in a single source. This single source might be your personal device, or “on the cloud,” which is a large collection of storage devices in a building somewhere. If that data is lost, changed, or sequestered, it can be very difficult to retrieve it.

Blockchains are stored on many devices at the same time. It is a “distributed ledger” of transactions. Each device stores the same copy of the same ledger. Every time a new block is added to the chain, each device confirms that it is adding the same block to its own chain.

This is why blockchains are considered to be so secure. It isn’t some powerful, complex, unbreakable algorithm that protects the information. Rather, it is the simple concept of storing the same copy of the same information on many different devices, one piece at a time.

A similar concept can be practiced in real life. If four roommates all keep a ledger of grocery store trips and each individual confirms the purchases of the other as soon as they walk through the door, at the end of the month they should have four identical ledgers.

But if one of them claims to have paid $500 for groceries one day when the other three have $300 written down for that day, they can reasonably assume he is lying. If that individual had been in charge of storing the information, they could have easily falsified the information.

On the other hand, this is also a good example of how a blockchain could possibly be manipulated. If three of the individuals collude to change some of the data, the fourth individual will be outnumbered and will lose. This is called “consensus”. A strong blockchain will have very many devices in the network to protect against a coordinated effort of this nature.

The Similarities and Differences Between Cryptocurrencies and NFTs

NFTs are not much different than any other cryptocurrency. Both are “tokens”. NFT means “Non-Fungible Token”. That means that cryptocurrencies are “fungible” tokens.

The quickest way to explain this is to compare them to pennies. A Bitcoin is similar to a penny in that each penny is the same. Each penny is worth a penny. Each Bitcoin is worth a Bitcoin. It doesn’t matter which penny or Bitcoin you have. That’s what “fungible” means.

An NFT is similar to one of these pennies. Let’s imagine that we cut that penny into a star. Now that penny is unique. It is no longer “fungible”. It is not worth what the other pennies are worth. It is often worth less. But it could easily be worth more if used correctly or if there is some significance behind it. It could have sentimental value or could be used as an identifying marker.

This is what NFTs are used for. Each NFT is a unique digital ID that can be attached to many different things. Recently, these digital IDs are commonly attached to works of art or pictures. What is important is the claim of ownership. This claim cannot be faked. Often, the art is not as important as the ID itself. In these cases, the art can be considered a decorative emblem on the ID.

What This Means for NFTs

There are three major components here that make this technology so important, and each component is absolutely vital. If any one of these components fails, the others fail as well.

  1. Ownership

The blockchain stores digital assets such as Cryptocurrencies and NFTs. Because of the high level of security, these digital assets can be considered “scarce” which is what makes them valuable. Anything that can be easily duplicated cannot be considered scarce.

NFTs are highly unique digital assets that can theoretically be attached to anything. This can help prove ownership of a wide range of other assets, including digital art, real art, real estate, video game assets, and real-world products. They can also be used as a ticket into private communities, private events, and can unlock private content.

NFTs are very simple and extremely versatile. Each one is 100% unique; the only one of its kind in the world. But this component is only made possible by the next two.

  1. Custody

“Possession is 9/10ths of the law.” Simply put, if someone else has custody of your goods or information, those assets belong to them until you come to claim them.

The custody of information is one of the biggest problems facing our society today. As all of our daily activities move into the digital world, activities that were once perfectly free and simple to accomplish are now a service provided by someone else. That service often has fees and rules.

These gatekeepers and middlemen have undue power and control over our activities, and many of these activities are absolutely vital for society to function properly: To store information. To communicate. To buy, sell, and trade goods. In real life, we can do all of these things without any trouble. You can talk to your friend in person and sell them your couch.

But online, middlemen like Facebook and Amazon control the flow of data and put a price on it. Amazon charges money for the simple act of buying and selling goods, something that society cannot do without. They charge exorbitant fees and decide who can and cannot use their platform. They also manipulate data and user traffic to favor their own products and partners.

But isn’t the Amazon marketplace little more than stored inventory data? Why do they get to control how human beings transact online?

This is why custody of information is so important. In fact, this is why no individual or entity should ever have custody of information that society cannot function without.

The blockchain is a neutral third party that holds custody of information in a vault that is at once highly secure but also highly accessible to all users. It is the same as putting an indestructible locker in the middle of a field where my cubby can only ever be opened by me alone.

When people ask “what does the blockchain do that a centralized solution cannot do better?”, this is the answer.

  1. Immutability

Of course, the previous two components would be worthless if the information was not immutable. This means that information on the blockchain is nearly impossible to delete, duplicate, or fake.

The reason why a Bored Ape NFT is able to retain such incredibly high value is that not a single authentic, fake Bored Ape has ever been created (aside from projects with ripped-off artwork), nor have any Bored Apes ever been destroyed. Those in the Bored Ape community know that their NFT is perfectly safe (unless they are careless with their personal information).

The permanence and provenance of the blockchain can be applied to any other industry to ensure the same security and value provided to the Bored Apes community or any other NFT collection.

NFTs are the First Digital Assets

Cryptocurrency was the first digital currency. NFTs are the first digital asset.

That digital asset can be very simply described as a digital ID, which may not seem like much, but the ability to prove ownership and transaction history with 100% certainty on a publicly accessible platform has incredibly broad implications. This means that we no longer need to entrust our right to exist to individuals and privately owned institutions that only answer to themselves. We can instead put our trust in a secure, neutral third party instead.

The blockchain is more than a way to store information, it is a way for human beings to organize and self-govern in an inherently democratic environment. We can use this to become self-reliant down to the individual while remaining intrinsically connected as a global whole.