The Ultimate Guide to NFTs

What Is an NFT?

A token

NFTs are tokens. This means that they don’t have their own blockchains. There is a Bitcoin blockchain and an Ethereum blockchain. But there is not a Bored Ape Yacht Club blockchain or Crypto Punks blockchain (these are NFTs, by the way). Instead, Bored Apes and Crypto Punks exist on the Ethereum blockchain. All NFTs are tokens that do not have their own networks.

Non-fungible

NFTs are non-fungible. They are not interchangeable with one another. If Joe wants to sell a television to Lisa for 100 U.S. Dollar Coin (USDC), he doesn’t care which particular USDC coins he gets from her. Each USDC coin is interchangeable with every other USDC coin. This is because USDC is a fungible token.

But non-fungible tokens are not interchangeable. If Joe wants to trade a television for two Vortimer the Volatile Gods Unchained cards, he will be very upset if Lisa gives him two Pack Stalk Gods Unchained cards instead.

The reason he will be upset is because Gods Unchained cards are not interchangeable with each other. They are non-fungible!

Video Game NFTs vs. Digital Art NFTs

In the future, there may be many different types of NFTs. But today, most of them fall under two categories: video game NFTs and digital art NFTs.

Video game NFTs

Prior to 2021, most NFTs were video game items. Spells of Genesis featured collectible trading cards that existed on the Bitcoin Counterparty Network. It was released in April 2017.2

Later that year, CryptoKitties was released on the Ethereum network. It allowed players to breed collectible digital cats. The appearance of the cats was determined by the genetic traits of the parents. If a player was successful at breeding a cat with a unique look, they could sell it for much more than its breeding cost.

CryptoKitties exceeded $1 million in trading volume within a month of its release.3

After CryptoKitties’ success, the blockchain gaming market grew very quickly. Today, there are hundreds of active blockchain games,4 including Gods Unchained, Axie Infinity, Splinterlands, and Star Atlas.

Some newer blockchain video games are also part of the crypto metaverse.

But recently, these video game NFTs have been eclipsed by ones that feature digital art.

Digital art NFTs

In 2021, the NFT market became bigger than ever before. But it wasn’t because of blockchain gaming. Instead, the new craze was digital art NFTs. These were NFTs that referred to pieces of digital art.

The digital artist Beeple sold his Everydays: The First 5,000 Days NFT for $69.3 million on March 11, 2021.1And from there, the market continued to climb. Edward Snowden’s Stay Free sold for $5.4 million, Ross Ulbright’s Genesis Collection sold for $5.93 million, XCOPY’s Right-click and Save as Guy sold for $6.57 million, and many other digital art NFTs sold for millions of dollars.6

This caused mainstream financial news channels like Bloomberg and CNBC to take notice of NFTs for the first time, and the public became more aware that this was a new type of digital collectible.

But how exactly does a digital art NFT work? And what is a person buying when they fork over millions of dollars for a copy of Right-click and Save as Guy?

In the next section, I’ll explain in detail how NFTs work.

How NFTs Work

We’ve already gone over the basics of what an NFT is. But in this section, I’m going to take a deeper dive into how the technology of NFTs actually works.

First, let’s begin with the problem that NFTs attempted to solve: how to sell digital art to collectors.

Centralized digital art?

Digital art has been around ever since computers have existed. But before NFTs existed, digital artists sold their work as physical prints. During this time, not many people were interested in physical versions of digital art, and prints didn’t sell for much. Beeple has even stated that he used to sell copies of his work for $100 a piece.7

But digital artists could have sold their art as centralized digital items instead. Here is the process a centralized digital art store would have needed to follow to get started.

1. Set up a central server, with a database that contains all of the art items and information on who owns what.
2. Allow each user to create an account with a username and password.
3. Set up a bank account and allow users to deposit funds into the account.
4. Set up a process that allows users to withdraw cash.
5. Create a debit card and credit card payment process.
6. Create an auction platform within the store’s app so that users can trade art.

Although a digital art store could have taken these steps, it would have faced many problems trying to attract collectors. Collectors would have needed to trust the store not to run off with their money. They would have had to wait one to three days for a bank deposit to go through. If they used debit cards to make deposits, they would have needed to pay hefty card processing fees.

If a collector wanted to cash out the proceeds of his art sales, they would have needed to pay these same debit card fees again or else wait for a bank transfer to go through. In addition, art items would have likely been spread among multiple art stores, and users who held an item in one store would not have been able to sell it in another store.

Collectors would have also needed to trust the art store not to close down or go offline, since if this happened, all of the art would disappear.

Because of these problems, digital art stores never took off, and most digital artists were left having to convince collectors to buy physical prints of their items instead.

The NFT solution

Here is how NFTs solve the problem of how to sell digital art.

Ownership is recorded on a blockchain network.

With an NFT, ownership of the item is recorded in a smart contract.

So the developer can’t censor NFT transactions or shut down its servers and erase the collector’s receipt of ownership.

Cryptocurrency is used as payment.

NFTs are sold only on decentralized NFT marketplaces like OpenSea. These marketplaces can’t be accessed without a cryptocurrency wallet, and the NFTs in them can be purchased with cryptocurrency only.

This means that collectors don’t need to use the banking system to deposit cash into the marketplace, so they don’t need to wait for bank transfers or pay debit card transaction fees. They also don’t need to trust the marketplace not to run off with their money, since the code that handles the auctions is immutable.

NFTs can be moved between marketplaces.

Since the token or ownership receipt is stored on a blockchain, it can be moved to any marketplace that exists on that blockchain network. Using a bridge, the token can even be moved from one network to another as long as the new network uses the same codebase as the previous one.

Content is stored on a decentralized storage platform.

Blockchains aren’t capable of storing large amounts of data cheaply. So the actual pieces of art are stored on a decentralized storage platform like the InterPlanetary File System (IPFS).

A hash of the digital art file is stored in the token itself. This hash can be used to find the art file on the IPFS and to verify that it hasn’t been tampered with. For more information on how hashing works, read our guide to cryptography.

Because the art is stored on a decentralized network, the collector doesn’t need to worry that the image will disappear if the developer shuts down.

So that’s how NFTs work; that’s how they allow digital art to be collected and traded without all of the problems caused by central servers and centralized payments systems.

Now, you’re probably wondering, “How can I know if an NFT will go up in price?” In the next section, I’ll discuss some factors that often make an NFT go up or down in price.

NFT Price

We all want to know whether a particular NFT will go up or down in price. But of course, no one has a crystal ball that will allow them to predict this. Still, there are a few traits that most successful NFTs have in common. Here is a list of them.

• Utility: Many successful NFTs serve some kind of purpose and provide utility to holders. This is especially the case with video game NFTs. For example, if the NFT represents a car in a racing game, you can bet that a faster car will be worth more than a slower one.
• Trait rarity: In general, NFTs that have rare traits are likely to be worth more than NFTs that have common traits. For example, there are 10,000 Bored Apes, but only 83 of them have the trippy fur trait. And these 83 apes often sell for much more than the average ape. So if you’re looking at a new NFT set and wondering which items will sell for the most in the future, you may want to try to find one with a rare trait.
• Aesthetic factors: Some NFTs, well, they just look cool. Obviously, opinions differ as to what is aesthetically pleasing. But if you spend a lot of time browsing through NFTs, you may develop a knack for spotting which looks sell well. So while considering other factors, you shouldn’t count out the purely visual elements of an NFT.

Unfortunately, an NFT that has these traits may be expensive to begin with. So if you pay too much for it, you may not be able to turn a profit when you eventually sell. That’s why choosing an NFT project can often be more important than choosing the right NFT.

In the next section, I’ll discuss how to find NFT projects in their early stages.

How to Find an NFT Project

Many NFT projects start off with items that have rock-bottom prices, but their items later explode in price when they are discovered. For example, the first Axie Infinity characters were available for a few dollars apiece when the game first came out in 2018. But they rose to around $200 apiece in 2021.

Here’s another example: CryptoPunks were actually free when they were first released. Collectors needed to pay just the “gas cost” to mint and receive them. But today, the cheapest CryptoPunks sell for $3,000 apiece.

But for each viable NFT project, there are many more that never attract interest and whose items become essentially worthless. So how can you tell the difference between a viable crypto project and one that is destined to fail? Again, we don’t have a crystal ball, but here are a few factors to consider.

Social media activity

A viable NFT project will generally have strong social media activity. Its Twitter page will usually put out posts several times a day, and it will have plenty of followers.

On the other hand, if you find that a project has little to no social media presence, this is a sign that it may fail to get noticed.

In this case, its items may become worthless even if they are unique and visually appealing.

So if you’re looking for a hidden gem in the NFT market, consider looking for one that has a strong social media presence.

Website

A project’s Twitter page will generally link to its website, and this website will provide more information about the project. If a website looks professional, this may encourage collectors to be confident that the project will be around for the long haul.

On the other hand, a poorly designed or ugly website may lead collectors to believe that the developers don’t believe in the project enough to spend money on it. This may scare collectors away and lead to the project failing.

So when you’re shopping for a new NFT project, you may want to check out its website to see how professional it looks.

Discord and Telegram communities

When a collector wants to get to know others in a project’s community, they often join the Telegram or Discord group associated with the project. If these groups are active, collectors are more likely to stay involved with them.

On the other hand, if a community has almost no discussion occurring in it, this may lead collectors to get bored. And if they get bored enough, they may sell their items and exit the community.

Having strong Discord and Telegram communities is an important factor in the long-term success of an NFT project.

Sales volume

Yet another factor in an NFT project’s success is sales volume. When an NFT community is growing, collectors will often trade their items with each other on a regular basis. So a growing sales volume can indicate growing interest in the project.

Conversely, if a project has little to no sales volume, this may indicate that collectors aren’t excited about the project and aren’t emotionally invested in it. This may be a sign that the project will not succeed over the long term.

For more info on how to find viable crypto projects, check out How to Determine If a Crypto Coin Is Safe.

These are factors to look for when trying to find an NFT project that will become popular over time. But once you’ve found a project to invest in, you’ll need to figure out where to buy it. In the next section, I’ll discuss some places where you can purchase NFTs.

Where to Buy NFTs

NFTs are usually sold on NFT marketplaces.

To use a marketplace, you’ll need the native coin of the network and a wallet that is compatible with the network. For example, if you want to use OpenSea, you’ll need an Ethereum-compatible wallet and either ETH or MATIC.

You’ll also need to make sure that the NFT you want to buy is available on the network you are planning to use. For example, Balloonsville is a popular NFT project on the Solana network. But you can’t buy Baloonsville items on the SnowFlake marketplace, because SnowFlake runs on Avalanche, not Solana.

Below is a chart with a list of popular NFT marketplaces. I’ve also listed the network(s) that each marketplace runs on.

All of the marketplaces below can be accessed with a Metamask wallet, except for the last two (Solana) ones.

If you’re looking for a place to buy the native coin for any of these networks, check out our guide on How to Choose a Legitimate Crypto Exchange, or take a look at our Coinbase review.

While you’re buying and trading NFTs, make sure to avoid the common NFT pitfalls I list in the next section.

NFT Pitfalls to Avoid

There are many great NFT projects around that are completely legitimate. But there are also scams and other pitfalls to watch out for. Here are a few to be aware of.

Phishing scams

Some NFT websites may be phishing scams. For example, a website claiming to offer a particular NFT collection may create a legitimate-looking pop-up box that asks for your wallet seed words. Once you enter your seed words into this box, the attacker has complete control of your wallet and can steal all of your crypto and NFTs.

To help avoid this type of scam, don’t enter your seed words while browsing the web. Your seed words will be needed only when you install or reinstall your wallet. So if it looks like your wallet is asking for this info while you are on a website, this is probably a scam pop-up created by the site.

Your wallet will often ask for your password, so it’s OK to enter this while browsing. But it will not ask you for your seed words once it has been set up.

Fake sites/contracts

Another technique used by scammers is to create a fake website with fake contracts. In this case, the site will not ask you for your seed words. Instead, it will feature buttons that are supposed to do legitimate functions (like start an auction, for example), but these buttons will make function calls to malicious contracts.

These sites are often made to look like popular NFT marketplace sites. For example, over $1 million in NFTs were stolen from OpenSea users in February using this technique.8 The scammers sent emails to victims informing them that they needed to “migrate” their NFT auctions.

The victims clicked through links in the emails and ended up on a fake OpenSea website. Once they got to the site, they pushed buttons and confirmed transactions in their wallets giving away all of their NFTs.

To help avoid this type of scam, make sure the site you are on has the correct URL for the marketplace you want to use, and ensure that there are no warnings that the site has failed its certificate check. If you have any doubt at all, check the contract address when it comes up in your wallet, and ensure that this address matches the one listed in the marketplace’s public documents.

Pump-and-dump scams

Some NFTs projects may be pump-and-dump scams. In this case, the scammer hypes up the project on Twitter, YouTube, and other social media networks. Then insiders trade the NFTs back and forth using marketplace auctions. Each time they trade the items, they offer a higher price, making it look as if demand for the items is increasing. This is often called “wash trading.”

Once enough fake trades have been created through wash trading, collectors become consumed with fear of missing out (FOMO), and a buying frenzy begins. The insiders then sell all of their NFTs, crashing the prices of the items. Afterwards, they end all marketing, and the items become worthless.

To help avoid this type of scam, remember that most NFT projects take months or even years to realize significant gains. You may pay $5 for an item, leave it in your wallet, and find out a year or two later that it is now worth $650. That’s usually how gains are made in this market.

If you see an item going parabolic after it was just released, this may be fake demand, and it may be a pump-and-dump scam. So you may want to stay away from it.

So these are some common NFT scams to avoid. For more general crypto scams to watch out for, you may want to check out our resource on common crypto schemes to avoid.

Wrapping Up

The NFT market exploded in 2021, and many investors now want to know how they can get in on the action. But it may not be clear what exactly NFTs are, how they work, and how to choose the right NFTs to maximize your chances of profiting from your collection.

The NFT market is changing. While it used to be dominated by video game items, digital art has now become the main category of NFTs in most marketplaces. In the future, there may be other types of NFTs, including ones that represent physical items, music albums, movies, and other collectibles.

Be sure to check back with this article as time goes on. We’ll update it as NFT technology evolves.