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How do NFTs work?

The tech behind non-fungible tokens looks complicated at first glance. Here’s what you need to know.

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NFTs, or non-fungible tokens, are digital files that have been tokenized on a blockchain. Non-fungible means something that’s unique and can’t be changed or replaced with something else.

If you’re unfamiliar with crypto or NFTs, that explanation might sound like gibberish — let’s break it down further to clarify what it means.

How do NFTs work?

First, let’s briefly cover cryptocurrency and blockchains and what they are.

Cryptocurrency is a digital currency not regulated by a government, bank or other centralized authority. This detail places crypto in decentralized finance, often called DeFi. The most well-known cryptocurrency is Bitcoin.

Instead of a large entity regulating cryptocurrency, it relies on networks to verify transactions and ownership. This is done with blockchains, which are public ledgers on a network.

Each block contains recorded data that’s added to the blockchain after the information has been verified. Once verified, the data can never be changed. This is where tokens come in.

Non-fungible tokens (NFTs) are created using a digital file, like JPEG, GIF, WAV and more. It’s added to a blockchain and turned into a unique token with its own identifiable data.

Once it’s verified on the blockchain, the token can be put into circulation for people to buy, sell or display. Putting a file on a blockchain is called tokenizing.

Since each NFT has its own unique identifiers, transferring ownership to someone else is easily verifiable. An NFT’s value is set by its utility, rarity and demand.

What makes NFTs different from cryptocurrency?

One of the biggest differences is that cryptocurrency is fungible. This means all units of Bitcoin (BTC) are equal to each other and are interchangeable.

NFTs are not universally equal in value. If you were to swap one NFT for another, you could lose or gain value in the transaction because each NFT is one-of-a-kind, making them non-fungible.

NFTs are also indivisible, unlike coins. You can own part of Bitcoin, but you can’t own part of an NFT.

However, cryptocurrency and NFTs do have a relationship. An NFT’s value is expressed in currency, typically cryptocurrency. Most NFTs are on the Ethereum blockchain, so many require Ether (ETH) to purchase them.

What are smart contracts?

Smart contracts are programs built on blockchains. They’re self-executing contracts that do their thing once the conditions are met, without involving a third party.

For example, consider how creators earn royalties with NFTs. When you create an NFT, the platform you use to place the file on the blockchain agrees to pay you a percentage of the final sale price and each subsequent sale automatically through smart contracts. Creators can earn anywhere between 1% to 15% or more of the secondary sales — forever.

Since all transactions involving an NFT are tracked on the blockchain, you can see the original creator, ownership history and view the smart contract — and this information can never be altered.

NFTs are indestructible but can be “burned”

It’s not possible to erase the information on a blockchain the way you can remove a file from your computer. All the information on a blockchain is recorded and verified multiple times. So completely destroying all information around an NFT isn’t possible simply because of how a blockchain works.

Information on a blockchain isn’t stored in one place — it’s spread out between multiple computers, called nodes. The nodes all work together to verify information in bundles called blocks. Since there’s not one single server where information is stored, removing information off a blockchain isn’t possible. You can add more data but not remove it.

However, you can “burn” an NFT, which means permanently removing it out of circulation. To do this, you send it to an unspendable address. This action is irreversible — but that NFT’s history before burning it remains on the blockchain.

NFTs are verifiable

On a blockchain, all transactions and data are verified on the network using a unique address. This makes it extremely difficult — nearly impossible, really — to hack and change an NFT.

Creators also build digital signatures in their NFTs, like a unique autograph. This works to further prove the NFT’s authenticity, similar to a watermark on a photograph or logo.

What can NFTs be used for?

An NFT can be almost anything since, technically, the only limitation is it has to start as a digital file. Art is the most popular genre. NFT art is typically meant to be created, sold or displayed — it’s been called an evolution of fine art collecting.

But NFTs can have real utility aside from bragging rights.

A great example of NFT utility is gaming. NFTs can be playable game characters, in-game items, little monsters that battle each other, clothing for your avatar in a gaming metaverse — the list goes on. And once you’re done with a specific gaming NFT, you can sell it on the marketplace.

Popular genres of NFTs include:

Why would anyone buy an NFT?

Reasons why investors, gamers and collectors may be interested in NFTs include:

  • Flipping NFTs. NFTs can be bought and resold with the hope of earning a profit. There are many NFT marketplaces for users to trade and auction off their digital assets.
  • For gaming. NFTs can be playable game characters, items, pets and all other things you might find in a traditional video game. However, in crypto NFT games, once you’re done with an item or character, you could try your hand at selling it on an NFT marketplace instead of letting it sit in your inventory.
  • For bragging rights. It sounds shallow, but collectors are big players in the NFT sector. Collecting NFTs is similar to people who collect antiques, trading cards, sports memorabilia and the like.
  • To display in the metaverse. A metaverse is a virtual environment where players or users can play, explore, chat and use NFTs. Some metaverse games, like Decentraland, let players dress their avatars in NFT clothing and decorate their virtual real estate with art NFTs.
  • To earn. Buying an NFT may also open up opportunities to earn, either through gaming, flipping or creating to earn royalties.

What formats can NFTs be?

It depends on the marketplace, but generally, NFTs can be these formats:

  • JPEG
  • GIF
  • MP3
  • MP4
  • OGG
  • WAV
  • PNG
  • FVG
  • WEBM
  • CLB

A digital file typically needs to be smaller than 100MB to be tokenized.

NFT ownership rights

When you buy an NFT and approve the transaction, you agree to own the address of that NFT. The NFT is then sent to your digital wallet, and the private keys protecting that wallet prove you have ownership.

The NFT itself is like a receipt that proves the digital asset is yours. However, owning an NFT doesn’t automatically give you reproduction rights.

For example, if you were to buy a CryptoKitty NFT, then start making copies of that digital file to be minted and sold, you could run into legal trouble with the original creators of CryptoKittes. In other words, it means that owning a specific CryptoKitty doesn’t allow you to print copies of that image and put it on t-shirts for you to sell. The intellectual property rights for that image still belong to the creator.

Where can I get NFTs?

NFTs are typically bought and sold on NFT marketplaces. Some markets specialize in niches, like NBA Top Shot that mints and sells official NBA trading cards and highlight clips. Or, you could receive an NFT via crypto wallets.

There are mixed marketplaces, like OpenSea and Gate.io’s NFT MagicBox, that allow creators to mint and sell their own NFTs in multiple genres, such as art, music, gaming and more.

If you want to start collecting or creating your own NFTs, compare the various marketplaces, including their compatible wallets, royalty percentage, accessibility and cryptocurrencies they accept.

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1 - 4 of 4
Name Product Categories Services Blockchains Payment methods
Gala Entertainment
Gala Entertainment
Gaming
Buy, Sell
Ethereum, Binance Smart Chain, GALA
Cryptocurrency
Blockchain gaming platforms where you can earn Gala and NFTs through playing.
Upland
Upland
Sports, Gaming, Music, Metaverse
Buy, Sell, Mint
EOS
Credit card, Cryptocurrency, PayPal
Upland is a blockchain-based game where you can buy, sell and mint NFT properties mapped to the real world. Receive a 4500 UPX bonus for signing up
Splinterlands
Splinterlands
Collectibles, Gaming, Trading cards
Buy, Sell, Stake
Hive
Cryptocurrency, PayPal
Splinterlands is a digital, play-to-earn, collectible card game built on hive blockchain technology.
Binance NFT Marketplace
Sports, Collectibles, Art, Gaming, Music, Trading cards, Domain names, Metaverse (Virtual Worlds), Memes, DeFi, Mixed
Buy, Sell, Mint
Ethereum
Credit card, Debit card, Cryptocurrency, Bank transfer
A peer-to-peer marketplace supported by one of the worlds largest cryptocurrency exchange, Binance. Not currently available to U.S. residents.
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Where do I store my NFTs?

After an NFT is bought, it’s sent to a crypto wallet, also called a digital wallet. These wallets can be a downloadable piece of software, or hardware that you plug into your computer.

Crypto wallets have a private key, which is a long string of random numbers with hundreds of digits. This private key is what proves you have ownership of your digital assets.

Wallets are protected by a passphrase, which is a long string of random words that need to be put in the correct order to unlock the wallet. For example, “car, grass, castle, particle” and so on. The passphrase is generated when you set up the wallet.

Defining characteristics of crypto wallets include:

  • Hot: A hot wallet is software, often downloaded as a browser extension. These wallets are always online and considered convenient. Typically free to download and use.
  • Cold: A cold wallet is a piece of hardware that’s plugged into your computer. These are generally considered to be safer than hot wallets, since they’re only online while they’re on. Many are about the same size as a thumb drive or external storage device.
  • Custodial: The private keys of the wallet are stored and protected by a third party.
  • Noncustodial: The user has control over how and where the wallet’s private keys are stored and protected.

Protecting the private key and passphrase of your crypto wallet is very important. Never give out your wallet’s information. If someone gets hold of it, they could take the NFTs or cryptocurrency — and recovery isn’t likely. Once those assets are gone, they’re likely gone forever.

We recommend storing your wallet’s passphrase offline for more security, even if it’s written down on a piece of lined paper. Some people even go as far as writing down the passphrase and storing it in a safe deposit box.

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Editor, Banking

Bethany Hickey is the banking editor and personal finance expert at Finder, specializing in banking, lending, insurance, and crypto. Bethany’s expertise in personal finance has garnered recognition from esteemed media outlets, such as Nasdaq, MSN, Yahoo Finance, GOBankingRates, SuperMoney, AOL and Newsweek. Her articles offer practical financial strategies to Americans, empowering them to make decisions that meet their financial goals. Her past work includes articles on generational spending and saving habits, lending, budgeting and managing debt. Before joining Finder, she was a content manager where she wrote hundreds of articles and news pieces on auto financing and credit repair for CarsDirect, Auto Credit Express and The Car Connection, among others. Bethany holds a BA in English from the University of Michigan-Flint, and was poetry editor for the university’s Qua Literary and Fine Arts Magazine. See full bio

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