What Is An NFT And How Do They Work?

Here You Will Learn What NFT Means, How They Work, How To Buy An NFT, The Future Of NFTs, And More!

When most people think of NFTs, they think of a picture of a digital ape.

Once you have finish this article, you will understand that a monkey picture is just the tip of the iceberg with NFTs.

What Is An NFT?

First, we shall address the technical aspect of what an NFT is. Then I will break it down into plain English.

What does NFT mean?

NFT is short for non-fungible token.

An NFT is a digital token. This token utilises the blockchain to prove the ownership and authenticity of a unique asset.

An NFT is a digital record or receipt of ownership!

What does fungible mean?

The word fungible describes something (an asset) that is not unique.

For example

A ford car is fungible. There are many identical ford models produced each year. They are not unique.

What does non-fungible mean?

Sometimes, car companies create a prototype car. They produce only one of these. It is non-fungible. The prototype can not be interchanged with another identical car because it is unique.

In plain English …

  • An NFT is a blockchain-based digital token.
  • This digital token represents a unique digital or physical asset.
  • The ownership of the NFT is verifiable on the blockchain.
  • The creation, transactions, and sales of all NFTs are recorded and transparent.
  • The legal agreement between all parties (Creator and owner) is shown in the smart contract and is indisputable.

We will expand on use cases for NFTs later in this article.

How long Has The NFT Market Been Around?

NFTs have been around since 2014. However, they only started to become popular in early 2021.

How Do NFTs Work?

NFTs are created through a process called Minting.

Minting enables an NFT to be published on a blockchain. Each NFT is validated and recorded on a blockchain.

Publishing is achieved using a ‘smart (digital) contract’ that manages the transferability and ownership of an NFT.

Once an NFT is minted, it is assigned a unique identifier. Each NFT has an owner and all information from minting to sales is publicly available.

Some NFT collections have 10,000 NFTs or more. Regardless, every NFT created is assigned a unique identifier and is distinguishable from the other NFTs in the same collection.

What Is A Smart Contract?

Smart contracts are the next evolution in contracts. They are self-executing digital contracts. At a simplistic level, smart contracts act as a tool to execute a sale agreement.

Each smart contract has the terms of the agreement between a buyer and a seller directly written into lines of code. These contracts exist across a decentralised blockchain network. The code in a smart contract controls the transactions and execution. Each contract is irreversible and trackable.

The genius behind smart contracts is they permit trusted agreements and transactions to be carried out between anonymous parties.

Traditional contracts take time, can be expensive, involve lawyers and fiat currency (you need a bank).

Smart contracts automate legal docs.
They remove the middleman, thus making them more affordable and faster than traditional expensive and time-consuming systems. They also remove the need for a bank.

Contracts can contain penalty clauses, ownership rights over an asset, royalty agreements, and literally anything you wish.

Because smart contracts contain the agreement details between all parties upfront, it removes the need for an intermediary.

How Do NFTs Use Smart Contracts?

Smart contracts can give legal rights over any asset contained or attached to them. This means an NFT can be attached to real-world asset ownership and rights.

For example

  • Ownership of an NFT may give rights to revenue share from a business.
  • Property, shares, and IP can all be attached to an NFT.

An NFT smart contract assigns ownership and reassigns it when sold or transferred. The use cases for this in the real world are endless.

What Are The Benefits Of A Smart Contract?

Blockchain smart contracts provide numerous benefits:

  • Increased speed
  • Efficiency
  • Accuracy
  • Trust
  • Security
  • Transparency

Automated agreements eliminate the possibility of third-party manipulation or errors. They also reduce the cost of creating a contract. Once the contract is signed, it is legally binding. Using the blockchain eliminates any potential data loss. Because smart contracts are encrypted, they are tamper-proof.

What Are The Disadvantages Of A Smart Contract?

Although smart contracts are the next evolution of traditional contracts, it is important to note that they are programmed by humans. Thus, during this process, it is possible for human error. They need to be double-checked and created correctly.

Another potential issue with smart contracts is legal jurisdiction and regulations. As this industry progresses, we should have more clarity on this.

What Are The Six Steps Used To Build A Smart Contract With An NFT?

  1. The Agreement
  2. The Conditions
  3. The Coding
  4. Blockchain Implementation
  5. Execution
  6. Recording

Now you understand the process involved in creating an NFT, let’s explore the most popular NFT categories.

NFT Categories

  • Digital Art

    There are a lot of creative NFT artists that have produced one-of-a-kind digital art. There are also popular NFT collections that have fantastic artwork which is sort after by digital art collectors.

  • Collectibles

    Baseball card collecting has been popular for decades. You can purchase digital collectibles from the official collections in sports and more.

  • Gaming & Metaverse

    This is one of the biggest markets for NFTs. When you own a gaming NFT, you gain access to the game or metaverse. Some metaverse NFTs allow owners to set up a virtual store, office, and more.

  • P2E (Play To Earn)

    At one point, Axie Infinity had over one million players who earned an income from playing their game. We are early in this niche and, it will grow over time.

  • Intellectual Property (IP) & Royalties

    We believe this is the niche that will help NFTs grow. Some NFTs give owners a revenue share of a song, movie, and even real-world businesses.

  • Photography

    Gifted photographers upload their photos onto NFT and sell them.

  • Events

    Some NFTs allow holders access to real-world and virtual social events.

  • Avatars And pfps

    You can create a virtual persona and use it online.

Why do people purchase NFTs?

There are numerous reasons people purchase NFTs.

  • Trading And Speculation

    As with any asset class, people with good investment knowledge, skills, and technical analysis (TA) are successful at finding undervalued NFTs and reselling them for a profit.

  • Collectors

    With some NFTs already worth millions of dollars, savvy art collectors are investing for the Long-term in digital art. Investors believe rare digital art is a store of value and will increase over the years.

  • Access To Investment Groups

    Certain NFT collections are owned by interesting and successful business people.

    Many top NFT collections have created private investment groups. If you own one of these NFTs, you gain access to one of these clubs.

    The clubs allow you to chat with other investors, network and hone your investment skills.

    Some clubs even hold real-life meet-ups for their holders. Socialised networking.

  • Whitelists (WL)

    Top NFT groups are often allocated some of the best new NFT mints. Holders gain early access to owning a potential blue chip NFT.

  • Gaming And The Metaverse

    One of the most popular NFT niches is gaming. Holders gain access to a metaverse and gaming platforms. Some NFTs even allow holders to start a virtual business inside a metaverse.

  • Fun

    NFT collecting is fun. You meet interesting people and become part of something.

  • Social Engagement

    Holders of rare and valuable NFTs use them as their social profile pictures (pfp)

    You are instantly seen as a successful investor and you gain more social followers which you can monetise.

  • Income & Revenue Share

    There are NFTs that give the holder a percentage of an NFT project’s revenue. Holders of these NFTs receive an income.

How To Analyse An NFT Collection

The more knowledge and experience you have in NFT investing, the more equipped you are at finding the winners and avoiding the losers.

Here is a simple checklist you should follow before you purchase an NFT.

  1. Why are you purchasing this NFT instead of another one? Every time you purchase an NFT you must ask yourself this question! Opportunity cost.
  2. You need to evaluate their social media accounts.
    • Do they have a following?
    • Are the followers real or bots?
    • Look at their posts. The posts should be informative and not just retweets.
    • Do their posts receive comments and retweets? Are the comments positive? Do they answer their investor’s questions satisfactorily? Does the team come across as professional?
    • Investigate all their socials. Do they have a good following in their discord or telegram group? If a project has 50,000 followers on Twitter but only 100 in its discord, it is a potential red flag.
  3. The Team
    • Is the team experienced in their field?
    • Is the team professional?
    • Is the team doxed (Identifiable)?
  4. Working Product, Platform, Tokenomics, & Website.

    When an NFT project has a working product or utility that solves a problem and is in demand, there is a higher chance the project is successful.Look at the quality of the website or platform. Does it look and function well?

    Is there staking? What utilities does the native token perform? Can you sell this token on a DEX? What is the lockup period? How many NFTs in the collection are staked? Is the staking escrow?

  5. A Roadmap & Whitepaper
    Well-thought-out NFT projects should have a clear and informative whitepaper or roadmap.You need to analyse these to see if they make sense, are achievable, and give investors value.
  6. The Art
    You can purchase an NFT collection on Fiverr for a few hundred dollars. The NFT you purchase should be of the highest standard and not look like it took five minutes to create.
  7. Collaborations?
    Does it have any, and with whom?
  8. Go to Twitter spaces and listen to the team.
    Good NFT projects will often join live discussions on Twitter. Listen to the team. Do they sound capable and professional? Do they have a clear vision for their NFT project? You can join Twitter spaces and ask the founders questions!
  9. Contact Investors
    If you know anyone already invested in an NFT project, contact them and ask what they like and dislike about the project.
  10. Liquidity & Volume
    Some NFT projects may have a high floor price but not many buyers. There may come a time you need to sell your NFT, and you could struggle to find a buyer.
  11. Well Funded
    An NFT project may promise the world in its roadmap and whitepaper, but do they have the funds to succeed?
  12. Charts & TA
    It can be difficult to analyse NFT charts, but some technical skills are useful.
    • Is the daily volume increasing? Are people buying or selling?
    • Are whales sweeping the collection?
    • Are there experienced investors involved?
Here is a chart of y00ts, a popular NFT collection on Solana.
In this chart, you will notice the volume and floor price are increasing.

Always look at the listings. If you see listings increase there must be enough demand to meet the increased supply.

The ideal scenario is the volume and floor price increasing and listings decreasing. Traders often look for this as a supply shock can lead to an increase in floor price.

If you want to conduct a deeper analysis, you can look at the number of holders in an NFT collection. Ideally, you want to see a lot of holders as opposed to a few large holders.

In this example, you will see at least a third of the collection is held by one person. You will also notice very few holders own more than ten. This is good.

You will see the digital wallets of the holders here.
Now click on one of the top holders of a collection, and you will see the other NFTs they hold and what traits too. If they also hold blue chip NFTs, it is usually a good sign that smart money is investing.

It is worth noting that all NFT collections have selloffs, or corrections. A little retracement is healthy as new investors that purchase an NFT for a lower price help to form a solid floor, which increases the chance of a recovery bounce.

What Gives An NFT Its Value?

Just like most assets in the real world, the value of an NFT, is derived from its perceived value and demand for that asset from buyers.

For example, a digital art NFT may be created by a famous artist or already have a sales history helping to establish an underlying floor price. You may receive a passive income from owning an NFT. The income received dictates the value.

Basically, an NFT reflects the value of the thing it represents.

Where Can You Buy NFTs?

We have created an NFT marketplace resource directory. You will find the top NFT marketplaces where you can trade NFTs.

Click here to see the top marketplaces.

The Future Of NFTs

The NFT market exceeded $41 billion in 2021 and actually outpaced the entire global fine art market! It has grown to an extent investors can no longer ignore it.

NFT are set to evolve over the coming years, we think NFTs and intellectual property will be a growth niche.

We believe in the future, everyone will interact with NFTs in one way or another.

We hope you enjoyed reading this article, visit our crypto and NFT blog for more articles.

Would you like to learn where to spend your cryptocurrency, or learn more about this fascinating topic?

Visit us today at spendingcrypto.com

Jonathan Titley


(NFT industry magazine and project reviews)


All information in this article is for educational purposes only.

Jonathan Titley
Author: Jonathan Titley