What is an NFT?
Imagine you have one Bitcoin. This Bitcoin is the exact same as any other Bitcoin. Swapping your one Bitcoin for another Bitcoin still results in you having an identical Bitcoin.
There is nothing special about the specific Bitcoin you have, it's just one of millions of Bitcoins.
These are called fungible goods - items that can be replaced by another identical item.
Your Bitcoin can also be divided into fractions: you can sell 0.001% of your Bitcoin.
But what if every Bitcoin had a unique ID? The one Bitcoin you own has an ID of #420. Suddenly it's unique - only one Bitcoin can ever have the ID of #420.
The Bitcoin you own has become non-fungible, i.e. it can't be replaced by an identical item. It has become a non-fungible token (NFT).
Other Bitcoins can obviously exist that look exactly the same and are worth the same. But no other Bitcoin will have an ID of #420. It has become unique.
The problem we have introduced with assigning a unique ID to your Bitcoin is that if you sell a fraction of your Bitcoin, you are experiencing a paradox called the Ship of Theseus: at what percentage is your unique Bitcoin no longer unique?
If you sell 0.001% of it, you could argue that it's still your unique Bitcoin #420.
But what if you sell 20% of it?
51% of it? 99% of it? At what point do we say it's no longer Bitcoin #420?
To prevent this from happening, we remove the ability for your non-fungible Bitcoin to be divided into fractions. It can only ever be bought, sold or traded as one whole Bitcoin.
We have made your Bitcoin indivisible.
Since only one Bitcoin exists with the ID of #420, it can be used to prove ownership.
Let's say a very popular night club opens up, and the only way to get into this night club is to own a Bitcoin with an ID between #420 and #520.
Your Bitcoin is now even more unique, because it's one of only 101 Bitcoins that has access to this nightclub. And because your Bitcoin is more unique now than it was before, the value of it has likely gone up. It can be sold for a higher price than other Bitcoins.
We have introduced scarcity as a market mechanic to set a unique value on your Bitcoin. All because we could assign it a unique ID!
Now imagine that instead of just having an ID of #420, we also add the ability to add metadata to your unique Bitcoin. This metadata can be text or even image files.
You also happen to be an artist creating illustrations of monkeys wearing fun outfits.
One day you decide to upload one of your illustrations to the metadata of your Bitcoin. You have instantly made your Bitcoin more unique than others.
Other people could of course grab a screenshot of your art and upload it to their Bitcoins to make them similar to yours, but no one can ever own your unique combination of ID #420 with your artwork. Bitcoin #420 holds the original artwork.
The artist can also add commission to the metadata, so every time Bitcoin #420 is sold on the market, the artist gets a cut from the sale.
We have now created a recurring income for creatives that never existed before. NFTs have become the street art of the digital age.
Let's say you play a game in which you can buy spaceships. All that happens on a technical level when you buy a ship in the game is that your new ship's ID is assigned to your account ID. That is how the database knows you own that ship.
But this means that if you want to sell your ship, the database has to update the ship's owner ID in the database. And this is the only way to transfer ownership.
Because a database change inside the game is the only way to transfer ownership, the user can not sell the ship outside of the game without having to inform the game that this has happened.
If the ships instead were NFTs, ownership is tied to a user's wallet. The game checks a user's wallet to see what ships the user owns. No in-game database record needed.
Because of this, a user is now free to sell, buy, trade or swap their ships without being logged into the game. A secondary market has been created that doesn't require game resources.
The most common argument against NFTs is that anyone can just take the image file on an existing NFT and mint their own NFT using the same image file, essentially creating an exact replica.
So if that is true, why are people spending six figure sums on cartoon monkeys that have no utility?
Because the argument that something doesn't hold value just because you can perfectly imitate it, is simply not true. You can have exact replicas of every Da Vinci painting in existence, but they won't be worth anything no matter how accurate they are.
Why? They are perfect replicas, after all?
Same argument can be made for music, books, movies, TV shows, etc. You can download a copy all you want, but no one would buy it from you. Only the creators of those mediums could sell the product, because they hold ownership.