The Problem with NFTs

By Adrian Pieroni on June 10, 2021 • ( Leave a comment )

Around February of this year, in the midst of the still-pending cryptocurrency boom, a sub-category of digital assets started to really take off. By March, NFTs, which stands for Non-Fungible Token, were in full swing. Suddenly, anyone from high school students to major celebrities were rushing to partake in the frenzy of either acquiring or minting their own unique additions to the blockchain. Anything from photos, videos, and digital paintings, to music and 3D sculptures.

NonFungible.com reported that by the first quarter of 2021, over $2 billion worth of transactions had taken place in the NFT market. Musician Grimes sold almost $6 million worth of digital art via digital asset marketplace Nifty Gateway, who are partnered with Sotheby’s. Twitter founder Jack Dorsey auctioned his first ever tweet as an NFT, the final bid closing at $2.9 million. UFC Heavyweight Champion Francis Ngannou sold NFTs following his knockout victory over Stipe Miocic. The proceeds of the sale, $580,000, was actually more than his disclosed purse for the fight itself that earned him the belt.

Even Star Trek icon William Shatner sold NFTs, in the form of collectible digital trading cards that feature images of his life and career. While NFTs have in some shape or form been around since the early 2010’s, clearly the turn of this decade has seen them reach unprecedented attention.

Despite the hype, in many regards serving as a speculator’s dream, NFTs come with inherent issues that threaten to hamper widespread and enduring adoption.

For starters, they don’t exist, in the sense that they are not a physical asset that you can hold in your hand. NFTs are essentially a digital certificate of ownership. The value is effectively determined by the issuer, who is typically the original author of the content that is being tokenized.

Having said that, the tokenized content itself is not stored on the blockchain, as blockchains have generally not been developed to the point where they can handle anything more than a few bytes of data per transaction efficiently. NFTs function more like a simple URL that designates the address and proof of ownership of the tokenized content, which is stored elsewhere on a server/hard drive, and can be subject to “link rot”, the process of directories and their corresponding hyperlinks becoming severed over time, posing a serious threat to information preservation and the ability to access and move files. For collectors who prefer the traditional experience of tangible ownership, NFTs might not be the most ideal investment.

While NFTs present a very real way to authenticate digital assets, their internet-based nature also serves as a double-edged sword in that it provides opportunities for exploiters of intellectual property to simply appropriate, tokenize, and sell other people’s content without their consent.

To compound the issue, this can be done without risk as per the pseudonymous nature of the blockchain, which makes it difficult to verify the identity of the issuer and the authenticity of the subsequent tokenized content. From a legal standpoint, this is very difficult to monitor and enforce, as the blockchain is an almost completely unregulated paradigm. Currently, even the most famous artists and celebrities who have issued NFTs, do so in partnership with established platforms such as OpenSea, who at least provide an option to appeal copyright infringement.

Technically speaking, however, there is no way to verify the authenticity of any given copy, as the hash (see: alphanumeric signature generated by an algorithm) that links to the artwork can be replicated when the same encryption algorithm is used.

What this means, is that the only truly unique and distinguishable aspect of an NFT, is that of the transaction itself. The NFT and its corresponding hash contain the seller’s wallet address, and the address for the smart contract that recorded the transaction from the seller to the buyer, but this in and of itself does not verify the originality of the artwork. It tells you that you own, at the very least, a copy of the original, but does not tell you whether or not it is the original copy.

There is theoretically nothing to prevent the endless production of copies of copies, which presents the issue of obfuscation, the loss of ability to parse data in a sea of noise. Many prospective collectors may desire something more substantial in regards to exclusivity and verification of ownership.

As with pretty much anything on the internet, NFTs are not immune to the threat of being hacked and stolen. Collectors of traditional assets can appreciate that any aspiring thieves have to actually be physically present, and deal with various obstacles such as security cameras, alarms, Doberman Pinschers, reinforced vaults, disgruntled shotgun-wielding owners, private security forces, and worse. NFTs can be stolen by a 19-year-old computer nerd from the other side of the planet, sitting in his boxers covered in Doritos crumbs.

The digital nature of NFTs presents security risks no different than that of any other computer and internet-based system, such as email, cryptocurrency exchanges, or your own personal computer account itself. Furthermore, the immutable nature of blockchain technology means that any successful theft is recorded on the digital ledger as a legitimate transaction. There is no governing body, no central authority that you can appeal to if your passwords or private keys are compromised.

The relatively nascent NFT phenomenon is in its “wild west” phase, characterized by lack of regulation, a practically non-existent bar for entry, and subsequent saturation lending itself to true bubble mania economics. Originally devised to allow artists to exercise control over their work, it has become clear that more time and innovation is required before the technology can mature to the point of serving as a reliable medium of ownership.