Why NFTs can be Amazing, but Not Just Yet; 5 Challenges of NFTs
In the past year, many people have been drawn into the Non-Fungible Token (NFT) collectibles, art, music, digital real estate, or digital fashion because they can relate to. A lot more than with the start of bitcoin. However, a large part of the billions in trading is done only by a very small group, and NFT trading is anything but mainstream.
The news about the million-dollar NFTs is mainstream, but the actual trading is not yet. So far, there have been three types of people buying NFTs. The speculators — the smart people, the insiders — who make all the money. The show-offs — those who want to show off that they are rich and can afford a Bored Ape, and the people who got in late and are trying to convince you to buy their NFT because they don’t want to lose money. However, this will change as the metaverse comes to life and NFTs hold actual utility.
A Traditional Gold Rush
The 2021 NFT hype is a traditional gold rush, but the hype is different from the ICO hype in 2017, which involved many scams raising funds from consumers driven by Fear Of Missing Out (FOMO). While there are certainly plenty of scams with NFTs, as we will see, with NFTs eventually offering real utility, speculation and extreme prices will likely disappear for the vast majority of NFTs simply because NFTs will become ubiquitous.
One of the great things that has come out of the NFT frenzy, though, is that for the first time, digital artists can get paid for their work and contribution to society. However, that does not mean that NFTs are without challenges. In fact, there are plenty, and if you are interested in minting or trading NFTs, it is important to be aware of them.
5 Challenges of NFTs
NFTs seem to solve digital ownership, but, as of yet, most NFTs do not consider copyright, actual legal ownership, piracy, theft or other human problems.
1. Who Owns the Underlying Asset?
NFTs prove that you own something that is hosted somewhere, but that does not mean that the underlying asset is truly yours. What NFTs address is that it shows that you made a transaction for a certain digital asset, so it is a verifiable receipt that indicates that you own the asset.
The actual NFTs — as in the actual digital artwork — are, ideally, stored on a decentralized file-sharing system such as IPFS, FileCoin or Storj, but they can also be stored on a central server such as AWS as it is often too expensive to store a large JPG, GIF, Video or MP3 decentralized. Instead, often just the web address of where the artwork is stored, is stored on the blockchain. If the items are hosted on a centralized location, the entity that runs that server can simply delete the item, even if you paid millions of dollars for it.
A token is a smart contract pointing to the location of that web address on the blockchain (that points to the server that stores your asset), which is stored in a digital wallet. As the web address is on the blockchain, that cannot be changed, but someone can remove the asset from the server making your immutable and expensive web address return a ‘404 not found’.
Unless your expensive artwork is stored on a decentralized storage system, you might own a receipt of a certain asset, but you certainly do not possess it, and the owner of the server where it is stored actually controls it and can delete it if wanted.
2. Centralization in a Decentralized Ecosystem
Therefore, it would be wise to use one of the well-known marketplaces such as OpenSea, but even that is no guarantee for success. While OpenSea uses the IPFS, since it is a centralized exchange, they also control the keys, similar to any centralized crypto exchange. If OpenSea decides to remove or freeze the digital asset because of a copyright infringement or other reason, your NFT becomes worthless, and this has happened already more than once.
For example, at the end of 2021, OpenSea stepped in to block the sale of stolen, expensive NFTs from collector Todd Kramer, a well-known art gallery owner, reportedly worth $2.2 million. Using a phishing attack, the NFTs were stolen from his hot wallet — a wallet connected to the internet. While it might be nice for Todd that the thief cannot resell his NFTs, it raises important questions about the decentralization of these NFTs.
3. Hacked Wallets and Blockchain Security Challenges
If it is stored on decentralized storage, only the user who holds the NFT should be able to access it and control it. To make matters worse, most NFTs — the pointers to where the asset is stored — are stored on a centralized exchange, which is similar to your crypto stored on a centralized exchange, and this means that if the exchange gets hacked, you can lose your valuable NFTs.
If the NFT is on your decentralized wallet and is on a hot wallet connected to the internet, you are responsible for the security. As Todd Kramer discovered, if you are hacked due to a phishing scam, you can still lose your NFTs.
To make matters worse, NFTs are stored on a blockchain. This can be Ethereum, Solana, EOS or any of the other few dozen blockchains that enable NFTs. These blockchains are kept secure by decentralized miners or stakes, the administrators, and the more administrators, the more secure a blockchain becomes as it becomes harder to perform a so-called 51% attack.
This is an attack where a group of miners hold more than 50% of the network’s hashing rate, and as they control the majority, they can reverse transactions that were completed while the group were in control. Meaning they could double-spend tokens, which is the entire promise that blockchains aims to prevent.
Blockchains that become the victim to a 51% attack will probably not live very long, and if your NFTs are stored on such a blockchain, your NFTs might become completely worthless. Of course, most of the NFTs reside on Ethereum, which has a broad adoption and is truly decentralised due to its age,. However, this comes at a cost as Ethereum’s gas fees, the price that needs to be paid to record a transaction, has gone through the roof, which makes the network prone to inequality to the extent that many organizations have tried to prevent in Web 2.0.
There are also other chains used for NFTs which will be cheaper to use, but these might be more centralized and, therefore, have weaker security. This all means that for NFTs to achieve mass adoption, transaction costs need to go down, ideally to zero or close to zero, while decentralization needs to go up to ensure that an NFT purchased today for $10.000 is still holds value in the future.
4. Fat Finger Mistakes
If you are unlucky, you bought an expensive NFT and either your wallet can get hacked, the security of the blockchain storing the NFT can be breached, or the centralized database storing your actual artwork can be hacked, and the criminal can delete the actual asset, in which case you still hold the NFT pointing to a web address pointing to a server, but since there is nothing on that server, you own nothing.
If that does not happen, then you still have your own responsibility to make sure that when you do sell your Bored Ape, you do not sell it for the wrong price, as happened to NFT owner Max who accidentally sold his bored ape for 0.75 ETH (around $3000) instead of 75 ETH (around $300.000). Before the owner could fix his mistake, a bot had snapped up the unique collector’s item by sending the transaction with 8 ETH (around $34000) of gas fees to ensure it was instantly processed.
These so-called fat-finger errors have happened before. While it is annoying for the original owner, it also shows a bigger problem that has been causing many debates around the world in the past years; net neutrality. The objective of net neutrality has always been to give everyone equal access to the internet and that internet service providers (ISPs) must treat all internet communications equally. Obviously, due to the gas fees, this no longer applies in the world of blockchain, which could pose a threat for the future, further increasing the digital divide and inequality.
5. Scams and Copyright Infringements
Unfortunately, that is not all, there are also plenty of scams and copyright infringements, or some call it satire or art in itself, of famous and expensive NFT collectibles such as the Bored Ape Yacht Club. One example is the Phunky Ape Yacht Club (or PAYC) which simply flipped the right-facing Bored Apes to face left and resold them, making around $1.8 million in the process.
PAYC has since been banned from centralized markets such as OpenSea, Raible and Mintable, which again shows the power these centralized markets have by creating a seamless trading experience for the masses.
Suppose you are lucky, and all works fine. In that case, you are still not yet out of the woods because it might very well be that the NFT you bought does not come with the right IP or copyrights, potentially preventing you from monetizing it and only using it as a nice image to view in your wallet or virtual home, which everyone else can do as well.
In fact, most NFTs sold in 2021 did not come with any copyright or IP, meaning that you cannot monetize the NFT, which is a crucial component for a vibrant economy. The collection of the Bored Ape Yacht Club does as we discussed, resulting in a vibrant community and steep prices, but most collectibles don’t, and all you have is a pointer towards an item stored somewhere, which is not a sustainable solution if NFTs are meant to achieve mass adoption.
If the above shows anything, it is important to always do your own research before diving in, as is the case with trading cryptocurrencies. Of course, this seems all very depressing, and it is, but it is not the end of the world. After all, it is still early days.
As the legal system catches up and the blockchain ecosystem continues to evolve and develop, i.e., truly decentralized storage of your digital assets, interoperable blockchains and minimum to no transaction fees become feasible, all the above problems will likely disappear.
Despite these challenges, NFTs are still a much better system than the current centralized approach, where a company can simply delete years of your work with a click of a button. NFTs that offer utility are amazing, and NFTs will define the metaverse economy, but we will first need to solve these five NFT challenges.
This article is part of my research for my fourth book, available for pre-order now: Step into the Metaverse: How the Immersive Internet Will Unlock a Trillion-Dollar Social Economy.