A Short Introduction to Non-Fungible Tokens: Use Cases in Gaming, DeFi, and Digital Identity

 

Non-fungible tokens have been a source of considerable excitement in the blockchain community for quite some time now, and they show no signs of slowing down. Ever since the record-breaking sale of CryptoKittie “Dragon”, more and more projects working with NFTs have bubbled up. In this article, we provide a brief introduction to NFTs and present three use cases we find to be particularly exciting.

Authors: Maximilian Bruckner, Jonas Neber, Nicholas Peipp

 

Fungible and non-fungible

The concept of fungibility exists not only in the world of blockchain and tokens but is also founded in the real world. A fungible item is one that can easily be replaced by another item of the same kind, while a non-fungible item is unique and cannot simply be replaced by another non-fungible item. A good example of a fungible item is cash. If you borrow a 10€ note from me, you do not need to pay me back with the same 10€ note — any will do. In fact, in this case, it does not even need to be a 10€ note; You can pay me back with two 5€ notes as well, or ten 1€ coins, and so on. In contrast, a non-fungible item may be a plane ticket or a collectible trading card. You cannot swap your plane ticket with another, since the other ticket will not hold the same information as yours: there will be a different name, and it will be valid for a different airline and different flight at a different time. This basic concept is what distinguishes NFTs. Fungible tokens can be found in many forms: Payment tokens like Bitcoin or TetherUSD, settlement and governance tokens like Ethereum’s ETH, or even asset-pegged tokens. Non-fungible tokens (NFTs) on the other hand often do not have such a clear economic purpose. They are used to create verifiable digital scarcity and ownership and are often planted in the realms of crypto-art, -collectibles, and -gaming. Recently, they have been garnering more and more attention from the blockchain community as reflected in their sale volume (See Figure 1)[1]

 
Figure 1: Total USD in NFT sales per day, from 06.01.2020 to 06.01.2021 (nonfungible.com)

ERC-721

An “Ethereum Request for Comments” or ERC is a document written by smart contract writers in the Ethereum community, that details rules and standards Ethereum based tokens should comply with. These standards can not only be for tokens but also for name registries, package formats, and more. While developers are not forced to use them, most do due to the benefits provided: following an ERC standard ensures interoperability and easy assimilation into the Ethereum network. Generally, an ERC token standard will outline rules and provide a framework for how ownership of a token is decided, as well as how the token is created, transferred, and burned. ERC-721 is the first standard used for the creation of NFTs. The existence of this standard was an important step for NFTs because it allows for a much faster exploration of new use cases and a quicker introduction of NFTs into the network. In addition to ERC-721, we also have ERC-1155. This standard aims to combine the best of both worlds from ERC-20 and ERC-721.

 

NFTs in the gaming industry

For a long time, the gaming industry has managed to generate revenue out of collectible items (for example rare “skins” for weapons or outfits), in some instances reaching astronomical prices on the secondary market. The developers of these games often reap additional profit from the secondary market, since they own the marketplace and charge fees for transactions. Another example of digital collectibles reaching high prices are the infamous CryptoKitties. Rare “breeds” of these NFT Kitties have sold for over 500 ETH [2] in the past. Items like these skins, collectible players, or unique weapons in games are sitting ducks waiting to be tokenized — they are a simple way for NFTs to enter the gaming world. Amongst other uses, NFTs in games could take on the form of branded NFTs and memorabilia or gameplay relevant NFTs. Whatever the case may be, due to the nature of these tokens it will become imperative to be able to uniquely identify the NFT in question. ITSA’s ITIN provides a way to uniquely identify tokens without ever having to worry about forks again, which is especially useful when dealing with rare and valuable NFTs — it would be a shame for one of these to get lost due to a fork.

 

NFTs in decentralized finance

With the Defi hype from last summer still lingering on, it is worth taking a glance at NFTs in this framework as well. An interesting case can be made for NFTs used as collateral for loans. Here, the lender is a protocol of smart contracts offering borrowers fast access to liquidity in the form of cryptocurrency — much faster than traditional banking systems. The Tinlake lending protocol by centrifuge does exactly this and has already proven its concept by providing loans to a Singaporean digital grocer during the COVID-19 pandemic. Here’s how it works: Tinlake deposits the NFT they receive from the loan applicant (borrower) into a special deposit contract. Now, the value of the asset classes represented by the NFT can be standardized and translated into so-called Collateral Value Tokens (CVTs). These CVTs are deposited into the lending protocol, and the borrower receives a loan in the form of fiat-pegged payment tokens such as USDC. As we see more tokenization of assets, NFTs representing real estate or financial assets may become increasingly interesting for this use case.

 

NFTs in digital identity

Another highly interesting option of using NFTs is for purposes of digital identity, like using a non-fungible token to confirm your identity on a blockchain. This makes sense because NFTs, just like the identity and biometric data of each individual, are unique. One approach that is being pursued in this context is the idea of a separate decentralized ledger made solely and specifically for the storage of digital identity. This is being developed under the umbrella of Hyperledger, an open-source community. An important concept here is to let each individual choose who gets to see which part of the user’s identity profile, i.e. a company that one intends to apply to will only receive the application relevant data from a curriculum vitae and ID. The concept of NFTs for digital identity was further explored in a white paper presented at the Open Identity Summit 2020. The proposal details that users in a specifically built decentralized ledger can have their personal identity stored as NFTs in so-called IdTokens on an IdChain. Access to this token and view of the stored data can be granted to others through the creation of a public key. However, the data stored on the token can only be changed by the owner, whose biometric data serves as the private key.

 

Expectations for the future

It is hard to predict the future of anything living in the blockchain world — everything is constantly growing and moving very quickly. However, we still believe it reasonable to assume that NFTs will take on a larger role in the next few years due to their inherent collectible nature. They represent unique investment opportunities and show massive commercial potential especially in the gaming industry. Many large players are already using their resources to develop NFTs to compliment their products (such as LVMH and Microsoft, or even the watch manufacturer Breitling) and interest will only rise as the gaming industry fully catches on. Looking even further ahead and thinking more daringly, it is possible that we may see NFTs not only solve some problems in the area of digital identification but replace our current ID documents completely.

 

Become a member of ITSA!

If you as an individual (1) and/or your organization (2) are interested in supporting the cause of ITSA, we would be delighted to welcome you as a member. To find out more about the current projects of ITSA and our membership options, please visit us at www.itsa.global.

 

Remarks

If you like this article, we would be happy if you forward it to your colleagues or share it on social networks. More information about the International Token Standardization Association can be found on the Internet, on Twitter, or on LinkedIn.

Maximilian Bruckner is Executive Director at the International Token Standardization Association (ITSA) e.V., working to create the world’s largest token database including a classification framework and unique token identifiers and locators. He has a strong international background with significant time spent in Spain, South Africa, and Canada. Currently pursuing studies at the Frankfurt School of Finance and Management, you can contact him via E-Mail and connect on LinkedIn if you would like to further discuss ITSA or have any other open questions.

Jonas Neber and Nicholas Peipp are both students at the Frankfurt School of Finance and Management, nearing the completion of their respective Bachelor’s degree. You can connect with them via LinkedIn: Jonas Neber, Nicholas Peipp

 

References

[1] NFT market history overview

[2] CryptoKitties — Market Sales History