What are nonfungible tokens (NFTs), and when did they come into existence?

The key to understanding nonfungible tokens is the definition of the term “fungible.” A good or asset is fungible when it is interchangeable with a good or asset of the same type; it is not unique. Currency—from dollar bills to bitcoins—is fungible. Therefore, nonfungible goods are those that are unique. An original work of art is a clear example of a nonfungible good. NFTs in their current form represent a collision of these two forms: currency, specifically cryptocurrency, and art. According to an article tracing the history of NFTs, they emerged in their current form around 2014, although there are competing timelines and origin stories that would trace their emergence to 2012. Of course, the current mania for them is much more recent—emerging pretty much within the last year.

The final key component that allows both cryptocurrency and NFTs to function is a technology that records who owns what: the blockchain. This digital ledger is a decentralized system that, because it is distributed across users and not subject to centralized control, indelibly records transactions. This permanence of digital record-keeping is critical to understanding the interaction between the art market and NFTs.

Why is permanent record-keeping so crucial for the art market?

In his 1935 landmark essay, “The Work of Art in the Age of Mechanical Reproduction,” the philosopher and cultural critic Walter Benjamin describes the importance of the aura of an original, authentic work of art. While Benjamin was commenting on the proliferation of photomechanical and photographic reproductions of works of fine art, his insistence on the importance of an original—be it a painting, drawing, or sculpture—remains central to both the aesthetic and financial values of the art world.

Part of that proof of originality is the concept of provenance, an artwork’s history of ownership. One of the critical ways the art world determines the difference between originals and fakes is by verifying a work’s provenance, ideally from the artist’s studio to the present owner. Without a demonstrated provenance—or one that may be compromised by illegal Nazi-era seizures or the looting of antiquities—works of art can become almost valueless on the open market. In the past, art historians and dealers have had to rely on a paper trail of things like auction catalogs and owners’ or artists’ posthumous inventories to verify an artwork’s provenance. However, these records are subject to loss or even forgery to pass off fake works of art. Blockchain and its permanent recording of transactions are therefore extremely attractive to the art world—including inspiring start-ups—for its potential to establish a work’s chain of custody and, consequently, its authenticity.

Why are permanent record-keeping and establishing an original work of art even more important for digital art?

While this possibility to pinpoint authenticity is helpful for paintings or sculptures, it is perhaps even more critical for the new frontier of digital art. The distinction between an actual oil-on-canvas painting by Vincent Van Gogh and a digital picture of that same Van Gogh is easy enough for even the nonexpert to detect. However, it is much harder (or even impossible) to distinguish between an original digital artwork, which may be a standard GIF file, and the GIF of that same image that became an internet meme. Consider “Nyan Cat,” which made headlines as one of the first significant NFT sales. By creating an NFT of “Nyan Cat”—an animation of a cat-Pop-Tart hybrid that became a meme in 2011—that could be indelibly recorded on the blockchain, suddenly a digital artwork whose proliferation was impossible to control—and therefore made any “original” valueless—could have an authentic original with the kind of financial value assigned to original paintings. “Nyan Cat” and a Van Gogh are now much more similar as valuable art assets than before.

Now the astute reader may be thinking: “But wait, the experience of standing in front of a real Van Gogh is clearly different from seeing an image on the screen. The experience of seeing the original ‘Nyan Cat’ GIF or an identical copy of that same gif is basically the same.” This is true; there is no distinction between the aura of the original and the copy that Benjamin described. Therefore, the primary difference is, in effect, financial. One is a certified authentic asset; one is not. The NFT of “Nyan Cat” is, in short, a certificate of authenticity for “Nyan Cat.” The viewing experience is no different, but that authenticity makes a world of financial difference. Suddenly, viral artworks—or other digital entities like tweets, Facebook posts, etc.—can be assigned the monetary value of one-of-a-kind assets priced in ways similar to more traditional artworks or important archives, like original copies of historical documents. In short, a whole new area of the market for art and archives has been established.

There are many complicated artistic, financial, and environmental ripple effects from this shift. Commentators ranging from artists themselves to ecological activists, criminal justice experts, and academics have started to grapple with these knock-on effects. The remainder of this explainer will focus on some of those issues—the good, the bad, and the ugly.

First, the good: What are the possible benefits of NFTs for protecting artists’ intellectual property and that of other cultural producers?

Artists have often struggled to protect their intellectual property and earn money from works of art that become famous but that they initially sold at a low price early in their career. In essence, if a work of art becomes a success, it is often the collector of that work of art—usually a wealthy private individual—who ends up capitalizing on an increased resale value. One of the famous examples of artists’ frustrations with this is when the pop artist Robert Rauschenberg confronted the New York collector Robert Scull after the blockbuster auction of the latter’s collection. Scull had bought works from the young Rauschenberg for a pittance and was later making a fortune on their sale—the artist was convinced this was unfair profiteering, even if it would help raise prices for new work he produced.

For more than a century, artists and their descendants have tried to assert their rights to capture a portion of this resale value through something known as the droit de suite, but enforcement is complex, and its success is limited. Some artists managed to integrate their rights into the structure of a work to enforce their intellectual property rights—the most compelling example is conceptual artist Sol LeWitt’s wall drawings. The work itself is not the wall drawing but rather a certificate that a person or institution purchases that grants them the right to install a specific wall drawing wherever they please. To sell the work, they have to sell the certificate and paint over the installed wall drawing. Transactions were policed by LeWitt’s studio and are now regulated by his estate, which can create some conflict—as it did in Houston a few years ago, when a family began to uncover a painted-over LeWitt in their home.

LeWitt’s use of certificates for wall drawings is the closest analog equivalent to how NFTs can allow artists to track the trajectory of their work and capture some of the resale value every time the work is sold. The NFT serves as a permanent certificate of authenticity that follows the work through its lifetime—something even more indelible than LeWitt’s closely monitored certificates. This can be a windfall for artists, particularly digital artists, seeking to retain ownership over what they create. Several commentators, notably New York University professor Amy Whitaker, have made this argument about the blockchain and NFTs.

The bad: How can NFTs create an unregulated market that can be used to sell stolen goods, launder money, and generally provide financial shelter for ill-gotten gains?

The art market is, compared to the larger market for securities, much less regulated. While some rules are certainly in place, people or shell companies can buy art and use it purely as a financial asset to shield money from tax bills or even launder it. The use of free ports, storage facilities that exist outside of customs oversight, has fueled this use of art as an opaque asset. Given the art market’s track record as an unregulated place for large financial transactions, it is worrying that NFTs have put it on a collision course with cryptocurrency, which is even more unregulated. As has already been observed, the combination of an art market commanding huge prices that must be paid in cryptocurrency may be a perfect storm for facilitating criminals’ money laundering or tax evasion and make law enforcement’s work of tracking financial crimes or cutting off bad actors’ financial resources even more difficult.

The ugly: What is the environmental impact of an NFT?  

NFTs’ dependence on cryptocurrency and blockchain, predominantly the Ethereum blockchain, demands an enormous amount of computer power. Like mining for a bitcoin, the creation of an NFT requires large amounts of energy, which in turn has a considerable carbon footprint. The exact size of this carbon footprint and whether NFTs can be made greener is debatable. Digital artists themselves are aware of the problem and have begun advocating for more energy-efficient approaches. Nonetheless, for the foreseeable future, NFTs will have an enormous carbon footprint. Like environmental pollution generated by other economic markets, this energy use represents a significant negative externality that has to be considered when making and purchasing NFTs—like mineral mining or the airline industry.

So what’s next for NFTs in terms of the environment, money, and art?

First: the environment. For better or worse, this question is tied up with much larger questions about energy efficiency and how we generate energy moving forward. The fate of NFTs’ carbon footprint is almost certainly directly related to the fate of increasing efficiencies in computing power and the future of green energy. Artists and coders with environmental concerns may be able to innovate a more efficient way to create NFTs in the short term, but in the long term, the source of energy used to make them—and how green that source is—will have the clearest effect.

Next: the money question. Over the long term, as a general class, art tends to be a less-than-thrilling investment. Its returns are respectable, but on average, they are not outstanding. Of course, there are exceptions to this rule and individual works that stand out for their appreciation—but these are not the norm. Therefore, on the whole, one would expect the long-term market for NFTs to follow this pattern. There will be exceptional sales, but the market returns will probably look like art market returns on average. Of course, if dark money wants to flock to this asset because of its lack of regulation, that could artificially inflate values, which is a phenomenon that fueled New York City luxury real estate prices for years.

For the art world, there is—as described above—a genuine interest for artists to engage with NFTs as a form to capture the value of otherwise reproducible digital work and to use the blockchain to track their rights to the value of artworks that they create. The incentive for them to continue to engage with this technology is there. Still, the strength of that incentive depends on whether or not blockchain delivers on its promise to be an indelible ledger. If these records can provide income and steady returns for artists, one would expect them to continue to use them.

There is—once again—a risk that the value generated by NFTs will instead create a new market for digital art that primarily allows collectors, dealers, and auction houses to capture any profits. Christie’s certainly saw this opportunity when it sold pioneering digital artist Beeple’s “Everydays: The First 5000 Days” for $69 million. And, as we know, there are NFTs that have been sold that could be just making the rich richer, including Twitter CEO Jack Dorsey, although he donated the proceeds of that sale to charity. Unfortunately, the long-run track record of the art market favors enriching wealthy collectors and intermediaries—only time will tell if NFTs can finally be a democratizer that empowers artists.