What are Non Fungible Tokens and How Do They Work? | NFT or Non-Fungible Tokens Explained

The term “NFT” stands for “Non-Fungible Tokens”. NFTs have acquired massive momentum, especially after the massive sale of Beeple at Christie’s. Although blockchain-based games such as Cryptokitties received massive global attention almost 7 years back in 2017, the realm of NFTs exploded in 2021. It was at that time when multiple transactions achieved all-time records. 

Just like the rest of the world, the United Arab Emirates also had its fair share of NFT exposure. The DIFC came up with multiple exhibitions revolving around NFTs. Moreover, the Emirates Post issued a renowned NFT collection of stamps for the celebration of UAE’s “Year of the 50th”. This blog will shed light on what are non fungible tokens and how do they work. Let us dive right into it:

What are Non Fungible Tokens and How Do They Work: Understanding What is an NFT and How Do NFTs Work 

An NFT is unique digital tokens which exist on a specific blockchain and cannot be duplicated or recreated. To put it simply, NFT is something unique or representative of something unique which is recorded on a particular blockchain. 

Coming to their creation, many NFTs are tokens created on blockchains with the help of smart contract protocols and stored virtually on digital crypto wallets. NFT tokens are unique, and uniquely identifiable.They can neither be traded or exchanged for another NFT featuring the same traits or characteristics. 

As of now, the ERC-721 protocol is the leading one used for minting or creating NFTs. The two leading blockchains which are highly dominant in the NFT space or are popular NFT entities are Ether or Ethereum Blockchain and Polygon Blockchain. 

What is a Token? 

A token refers to a digital representative of rights, values, as well as obligations which are electronically created, stored, and transferred, with the help of DLT or Distributed Ledger Technology or similar tech avenues. In simpler words, a token contains references to numerous digital files.

In most cases, cryptocurrency based digital assets are dependent on cryptography as well as distributed ledger as a vital part of their default or perceived value. They are made, stored, as well as transferred using a DLT-based app with the help of:

  • A particular address.
  • A key (public) which corresponds to the specific address.
  • Another key (private) which also corresponds to the same address. 

From the legal perspective, tokens represent the control of the asset which is underlying, which may or may not be subject to proof of ownership. 

Different Kinds of NFTs

There are primarily two types of NFTs:

  • Digitally-native NFTs: Digitally-native NFTs are also natively digital. Moreover, they are not representative of real-world assets. This category of NFTs includes collectibles, assets which are available inside games, digital artwork featuring digital signatures, to name a few. 
  • NFTs Which Represent Other Assets: This kind of NFT tokens feature links to numerous real world assets like artwork, property, diamonds, etc. 

The Process of Integrating NFTs into Businesses

Given below are the steps following which NFTs can be integrated into businesses:

  1. Determine the Use of NFTs

The first step involves answering the important question of what the NFT will be utilized for? Some famous and early-adapted use cases have been in the field of digital art & collectibles. Two examples of famous NFT art includes Crypto Punks and the Bored Ape Yacht Club. The National Basketball Association League stepped into the NFT sphere with its collector series called NBA Top Shot.

  1. Identifying the Suitable Blockchain Technology

The majority of NFTs are constructed on a single blockchain, which is why the list of factors include cost of transactions, the readily-accessible ecosystem of apps, as well as the degree of decentralization. Multiple blockchains may be needed for the creation of the NFT due to the limited interoperability which exists between chains currently. 

  1. Minting NFTs

A cryptographic key is utilized for the creation of tokens on the blockchain which represents a specific price or cost of digital media, such as the name, description, as well as edition size. Hence, it is advised to look for providers who mint as per custom smart contracts. Similar to Bitcoin mining, minting NFTs can prove to be highly valuable. 

  1. Deciding on the Storage

NFTs can be minted specifically to have a digital content file or a particular reference to the digitized content. The digital entities have the capability to either get stored on the blockchain directly with the help of decentralized storage solutions such as Arwaeve or on centralized storage, like the usual cloud storage service providers. 

Minting an NFT directly on the BC makes sure that it is actually immortal. However, it is important to note that the costs as well as energy required for this endeavor are massive. Taking the help of other storage avenues means that the digital entity points towards the digitized file, similar to an address. Therefore, the NFT’s lifetime is dependent upon the provider of the cloud storage service. 

  1. Storing & Accessing Safely

There are options when it comes to storing NFTs. They can be stored in digital wallets which can be:

  • Non-custodial unrestricted, i.e., your wallet remains in your control.
  • Non-custodial restricted, i.e., in an ecosystem which can be limited.
  • Custodial, i.e., with third-party or outside providers.
  • On-platform, i.e., limited to the platform’s ecosystem only.

Two examples of non-custodial wallets include Opensea and SuperRare. When using NFTs wallets, the NFT’s custody is the responsibility of the customer. 

  1. Distribution

When it comes to distributing NFTs, there are numerous NFT marketplaces which can be explored and used. However, there are certain factors individuals should consider when choosing a marketplace. Here are two primary factors to consider when chosing an NFT market:

  • Whether they permit purchasing using flat or digital currency.
  • Whether they permit card payments

Some of the popular kinds of marketplaces are: 

  • Open marketplaces, which are usually non-custodial in nature.
  • Closed marketplaces, which also feature their own storefront as well as branding. Moreover, they also take NFTs’ custody.
  • White-labeled marketplaces.
  1. Engagement

As per the increase in their overall values, NFTs can be conveniently traded. However, there are a variety of other use-cases which hold the potential to unlock enhanced value with the community of NFTs. Some of the use-cases include the usage of NFTs in order to establish a mechanism based on loyalty or incentives in an attempt to reward specific behavior as well as gamification. 

NFTs can facilitate the fans of the gated or closed communities to vote on specific outcomes or results within the community and gain rewards in addition to experiences. They may also be utilized for collating fan-related data, all while safekeeping the fans’ identities or avatars, thereby gathering useful information with the addition of data protection built within the functionality. 

Legalities Surrounding Non-Fungible Tokens

  1. Intellectual Property Rights – Who is the owner of the NFT, and who is the owner at a time of the copyright?

Reaching assets’ provenance is made very convenient thanks to the usage of NFTs, as they are made on blockchains which support or are compatible with programmable smart contracts. Accordingly, NFTs may also be safeguarded by software copyright within NFT creation’s jurisdiction.

When an NFT acts as an ownership proof or a title which is pointing at an asset in the real world, the proof cannot be changed or altered, thereby offering protection to the individual who is its legal owner. 

Trademarks are also subjected to similar treatment, primarily because the NFT’s origin is embedded onto the blockchain. This same condition applies to patents as well. Most of the major brands have gotten the job of extending their respective trademarks to digitized assets done, as an integral part of the complete move in the direction of making forays in the direction of metaverse and metadata.  

  1. Terms of Contract

The protection of the NFT creator’s legal rights can be enforced in numerous ways. Naked NFTs are unique NFT and are gaining prominence nowadays, where the sale of the NFT is done without IP rights towards the intrinsic work attached. All the rights which are attached to the artwork like copyrights, trademarks, as well as other different intellectual property rights stay as the marketplace or NFT creator’s sole property. 

This facilitates the creator in deriving residual value directly from the NFT’s subsequent transfers. i.e., transferring tokens between owners. When it comes to other IP, owners might be restricted from indulging in commercial use as well as reselling the underlying artwork’s derivative products. 

The Regulation of NFTs

There is no comprehensive regulation around Non-fungible tokens as of yet, primarily because they can be a representative of anything, right from digital pieces of art to physical assets. NFTs can also be given the classification of security or utility tokens, or other, based on the asset’s nature as well as the rights it inflicts onto the token holders. 

DIFC – Dubai International Financial Centre

A security token is a token which confers rights as well as obligations which are:

(I) similar to those conferred by shares, debentures, or investments (future contract); or

(II) highly similar in nature, effects, or purposes, to those conferred upon by investments. In effect, it is a token which acts as security such as equity, debenture, etc., and therefore is considered a specified investment by DFSA.  

On the other hand, utility tokens are representative of specific rights within a closed system. In most cases, they stand the outside regulation’s purview. This small loophole paved the way towards ample STOs or Security Token Offerings acts as ICOs or Initial Coin Offerings, by dodging the classification of security token as well as by laying claim to the rights to utilities of the future of NFTs without the organization or company being in the existing realm at the time. 

This is one of the main reasons why the majority of regulators begin with the token’s definition, and evaluate it as per the substance and not the form. The initial portion of the DFSA’s “Digital Assets Regime” encompasses security tokens.

The regime’s second part is usually expected to encompass all about utility, payment (cryptocurrencies), and fiat or stablecoin tokens. NFTs would ideally come under the category of security or utility tokens as per this classification.

ADGM – Abu Dhabi Global Market

The virtual assets framework of the AGDM refers to a digital or virtual asset as a value’s digital representation which can be traded digitally and functions as:

  • An exchanging medium; and/or
  • An account’s unit: and/or
  • A value storage

The definition of virtual world asset does feature “ownership’s representation,” which is why NFTs might not fall under FSRA Regulations’ purview. 

SCA – Emirates Security and Commodities Authority

The most recent iteration of the Crypto Asset Regulations provided by the Emirates Security and Commodities Authority (SCA) captures those NFTs which are Security or Commodity Tokens (i.e., those which have been traded on exchange). 

Accordingly, the traded as well as brokered NFs on marketplaces which work like or as per a peer-to-peer method may not fall under the latest regulations. There might, however, be certain AML requirements which market participants would need to abide by. 

Establishing NFT-based Business in the United Arab Emirates | Buying and Selling NFTs

As clearly evident, the realm of buying NFTs as well as selling them is still very fresh. Non-fungible tokens can be used in numerous varieties of application, and we strongly feel that leading charge of the development of locally-grown marketplace of basic as well as expensive NFT may be a solid business plan which will bring with it immense success potential.

Although it is quite early to completely comprehend the potential applications’ extent which revolve around NFTs, we encourage interested individuals in exploring any opportunity of establishing a business revolving around NFTs as there are high chances of it becoming a successful business venture. Due to the heavy supply and demand of NFTs, chances of success in business endeavors are very high. Contact us today to discuss more!

This blog is intended for informational purposes only. The content is provided “as is” and we make no representations or warranties of any kind regarding its accuracy, completeness, or suitability. Any reliance on the information is at your own risk. We are not liable for any losses or damages arising from the use of this blog.

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