My Problem with NFTs

I’m not a lawyer. This is not legal advice. This is my personal opinion on something that bothers me and that is crypto currencies in general, and today’s special installment, NFTs. Non-fungible tokens. There is more information here. https://en.wikipedia.org/wiki/Non-fungible_token

Let’s talk about what’s interesting about NFTs.

Well, first, what is it? At the core it’s a contract that lets you prove ownership of something. Let’s consider this very carefully. You don’t get something you get proof of ownership of something. So it’s not a car, it’s at best “pink slips”. In principle you can create proof of ownership of anything you like but in practice putting an NFT wrapper on some things is just goofy. I’m reminded of a Mitch Hedberg joke about the need for a receipt when you buy a donut….

“… I can’t imagine the scenario where I have to prove that I bought a donut. Some skeptical friend? … ‘I got the documentation right here!’”

OK, so you can prove you own …something… what else? Well, you can transfer that ownership according to pretty much whatever rules you like. So the token is not fungible but it can in principle be transferred if that’s desired. So you could pay for an NFT that entitles you to some donuts and sell the NFT (not the donuts) and the person with the actual donuts would know who the current owner is, i.e. who to give the donuts to. To “cash in” the NFT you transfer it to the donut provider. So, is it like donut futures? Well, kind of. Importantly, it’s not an actual donut. It’s not an actual car. And it’s not art.

The NFT itself is unique but it says nothing about the thing it claims ownership of. You might get full rights, no rights, or anything in between. This is frequently VERY unclear. NFTs for digital art are in my view especially bad at explaining this. What is it that you get exactly when you have an NFT for some high quality JPEG? Really not much more than proof that you paid for it. If that means something to you — like you can show your skeptical friend that you are a Patron of the Arts then by all means go for it. But if you think you are going to be the only person who can view that JPG just because you own the NFT you are going to be majorly disappointed. For starters, the most common way digital art is bundled into an NFT is with a URL to some web site, stored in the clear. It can be more secure than this but frequently isn’t. Trying to get a straight answer on the true exclusivity of your purchase can be very difficult indeed. And it can require a level of sophistication that most buyers simply do not have. I believe a lot of NFT transactions border on criminal fraud.

It’s not all bad let me give you some examples of legitimate uses that are pretty clear.

1) you win a prize at Super Cool’s US website; they give you an NFT that lets you get a free Super Cool WizBang at any local retailer

2) you play online Super Cool Game Thing; they give you NFTs you can present to any Super Cool Game Thing Tournament proving your Achievements

3) you buy an NFT for a VIP seat for Super Cool Theater Presents, an awesome playhouse; they admit you and take you backstage

There are problems with all of these.

First, why bother with an NFT at all? Unless you need the asset to be transferrable and ownership to be publicly visible, with no controlling entity the NFT is redundant. A simple statement plus a digital signature would likely suffice.

In example 1 things are somewhat interesting because corporate HQ can readily create tokens and any franchise can see they are valid and safely cash them in with no back-end connection between corporate and HQ needed. That’s kind of useful I guess.

In example 2 similarly anyone putting on a tournament can verify your creds without any backend connection. But are achievements transferrable? Well, no, so what’s the point really? Maybe if you are entitled to a prize?

In example 3 you could create a secondary market for VIP seats with clear ownership chain or you could gift them without the theater having to be involved. I guess that’s useful but don’t try to do that in front of the theater because such transactions are very slow and take signficant time to settle before you can be sure there was no duplicate sale.

All of these are somewhat like the Donut Futures example. It’s clear that you are not trading an asset but rather the right to something. You’re trusting whoever it is to actually let you cash in. The benefit, if any, is the fact that no central authority is needed to make the transfers. However, in practice, creating NFTs usually requires a service fee. But in principle that doesn’t have to be the case.

What are some less-good cases?

Consider an NFT wrapping a JPEG. Anyone who ever had the NFT for the JPEG could have saved it, so viewing rights are hardly exclusive. Whether or not retaining copies of the JPEG is allowed is likely part of a complex license that’s associated with the NFT that nobody talks about. If and how enforcement happens, and who has to do it, is also not part of the NFT. Remember the NFT is not art: it’s proof of (current) ownership of the art, or a share in the art, or some license to some aspect of the art conferring some rights. This can be super complicated. This is IMO a very poor use case for NFTs because people are likely to be very confused by what it is they are getting — and hence the danger of fraud. It’s just as bad if the NFT is for music. Or anything else readily duplicated. It’s less bad if the NFT is for a Giant Tractor but even then, understanding the terms is super important. Tractor for a Day is very different than Pick Up Your Brand New Tractor At Any Authorized Super Cool Tractor Outlet.

As far as art goes, a much better use case might be something like an NFT that entitles you to commission art of your choice. The picture might be shared later, but only one person, you, will get to choose the subject.

But again, unless you need the asset to be tradeable on the open market, with no central authority, you don’t need an NFT anyway. And frankly other options are cheaper. Auctioning Art is much more straightforward than creating an NFT. And digital signatures cost nothing.

NFT tech has enabled some artists to get paid for good work. The problem is that the buyer frequently does not understand what they are actually getting. I’m in favor of artists getting paid for good work. I’m not in favor of dubious contracts with unclear benefits to the buyer.

Are legitimate uses possible? Yes. Are typical uses actually typically legitimate? Uh… mostly not so much. Are there other, simpler mechanisms most of the time? Pretty much for sure. What recourse do you have in case of fraud? Ummm…. caveat emptor peeps.

Disclaimer: As always, the above is only approximately correct. The truth is I think much more complicated than the above which does not make things better. Consider for instance just the problem that transfers cannot be both instantaneous and verifiable if there is no central authority. You get the idea.