By Mark Munger
I still encounter people who ask me to explain what a blockchain is or are confused as to how cryptocurrencies, NFTs, and smart contracts relate to blockchains. Here is my attempt to relay my view of the technologies. This may take multiple blogs, though I’ll attempt to keep it simple. I’m also writing these to get out quickly, so any errors or statements you believe are misleading or wrong, please comment and let me know what I missed.
What is a Blockchain?
A Blockchain is an internet ledger storing data with new data added as a group called a block. These blocks are connected to each other with links forward and backward forming a chain of blocks or you guessed it, a blockchain. Blockchains were designed with certain features that make them a perfect tool for databases where transparency, vast distribution, and the ability to trust that data is valid and not corrupted or manipulated.
A Blockchain is a great tool for digital assets and securing historical data, especially historical public data that is transparent, distributed, decentralized, and not modifiable. Immutable is the word used to describe blockchain data that cannot be changed.
These characteristics make it the wrong tool for most databases. For instance, these characteristics are generally not desirable for the contact book on your phone (I would like some contacts to be permanently deleted with no history), though it can be a great tool for public phone books where historical data is preferred for research.
Blockchains are tools to be used. Like many development platforms, they have unique features that enable new software applications. Blockchains can also be misused much like people who use Microsoft Excel to write documents. Blockchains are decentralized and distributed such that copies of them are mirrored on other computers making the data very accessible and secure from being changed. Cryptology enables data security ensuring that transactions and data in the blockchain is valid.
The concept of a blockchain has been around since the 1990s. The concept was to digitally track documents and verify their authenticity. That concept has expanded and now tracks everything from land titles to organic food and artwork ownership to digital currency.
Blockchains are most useful in public databases as the features noted above can be limiting, lacking flexibility and speed. The process of creating a block, also called mining, takes much more effort and coordination as an application must submit data to be added for verification rather than just write the changes into the database. Data can also not be erased once validated and written. Imagine not being able to change the contents of a cell in a spreadsheet and needing to create another cell or another entire spreadsheet to make an update! While being immutable is a desired feature to track the history of land ownership, it is not ideal for other types of data.
Blockchains allow any type of data to be stored from basic info like account information to complex data such as a digital representation of songs and movies. It can also be programming code that runs in the blockchain. Smart Contracts is one term used for this code.
Blockchains provide excellent transparency and audit trails while securing and distributing data. This limits the types of applications they are useful for. One of the first and best-known use cases for blockchains is digital or “Crypto” currencies.
Bitcoin was the first cryptocurrency created by a person or persons going by the name Satoshi Nakamoto in 2008. To understand the reason behind Bitcoins creation, we need to look at the currencies of sovereign nations today. Nations today use a FIAT system where a currency is valued by government assets and the government’s ability to create income through taxes and fees. As such, the government controls the value and amount of currency in the system. There are pros and cons to this. Bitcoin and other digital currencies were created to address the cons.
Bitcoin is only about 13 years from its inception. While it has proven value, as a “teenager” it still wouldn’t, IRL, be able to drive a car or purchase alcohol. While a very gifted teenager, it is still just a teenager and hasn’t grown to know how to interact with all “adults” yet. And not all adults are ready to trust or interact with it…yet.
Digital Currency (Cryptocurrency)
Digital Currency, or Cryptocurrency, is how most people were introduced to blockchain technology. Bitcoin, Ethereum, Dogecoin, ADA, and others have become household names and the subject of many front-page articles. Most are decentralized currencies, or money, in that no human has direct control of making or distributing them. Most are mathematically limited in quantity to be scarce and secured by cryptography for ownership and exchange. I write most as some digital currencies are controlled by a single person or entity. There are a lot of scammers out there and due diligence is required.
Before we dive too deep into digital currency as money, let’s define what money or currency is. Most of us, including me, do not have a degree in macroeconomics or think about the definition of money. In general terms, 3 features make a currency. It is a unit of measure, a store of value, and a medium of exchange.
Unit of Measure: When cooking, it is helpful to have shared measurements. My handful is different than your handful, we agree on what a “cup” is and use that. It becomes a standard unit of measure. And when I say “1 cup of water,” we all know what that is. We know when we see $15 that it costs 15 dollars. Similarly, we have an agreement that 1 dollar is 100 cents.
Store of Value: This is the ability to have something and keep it for use later. Stories of trading beads or shells are an example of a store of value. It was agreed those beads and shells had value, and you could carry them in your pocket until you wanted to spend them by exchanging them for something else.
Medium of Exchange: The value of currency in most people’s minds is in exchanging it for other items, such as exchanging the shells and beads from the previous example for food. Value is being exchanged – the food has a specific value (to feed people), the shells have an agreed-upon value, and the two can now be exchanged, the process of buying and selling.
Currencies with these 3 characteristics are useful in their own ecosystem. Where much debate comes is the conversion of one currency to another. Why is that shell worth more than that bead and what causes the exchange value to change? If someone finds an area with thousands of shells, then the value of a single shell may decrease compared to a bead. Similarly if a government prints more currency, the value of the currency will decrease.
An important and real-world example is the Zimbabwean dollar (ZWD) from 2008 and 2009. One month the exchange rate was 1,000 ZWD to 1 US Dollar. A few months later due to the government printing money and inflation, the exchange rate was 300 trillion ZWD to 1 US Dollar. Bitcoin and other cryptocurrency fluctuations are blips compared to this. The 2018 Venezuela Bolivar and the 1923 German Mark are similar examples of currencies fluctuating wildly in value.
Almost all government currencies today are FIAT money. FIAT money, like the US Dollar, has no inherent value with its value entirely based on the government which backs it. The government owns the currency and has complete control over it. The currency is worth what people, and governments, feel it is worth. While most digital currencies, like their government equivalents, derive their own value, some called Stable Coins are based on existing government currencies. Stable Coins are non-government-backed digital currencies that set their value one-to-one with a government currency. Some governments are creating their own Stable Coins called Central Bank Digital Currency (CBDC). Stable Coin holders store money in those tokens just like a bank account. There are some advantages such as paying a higher interest rate than banks, though not all Stable Coins may be risk-free.
One question asked is, “Why do I need this new technology?” which is a reasonable question as many people see this much like their digital wallets at their bank and even compare it with the online services PayPal or Zelle. These are based on physical (FIAT) currency, and PayPal and Zelle are responsible to ensure you don’t send the same dollar to 2 people. They are centralized. When you go digital and decentralized, it is very easy to copy a digital representation of money. The digital representation, or “token”, needs to be secured such that it is used and transferred in a transaction and not just copied. Thus, one of the biggest obstacles that needed to be overcome in decentralized digital currencies was the double-spending problem.
Tokens, the digital representation of currency, could be easily copied and needed a consensus system where the same token could not be spent twice. When I spend my token, it must be verified I own it, then verified I am transferring it to another wallet. The two most popular systems are Proof of Work and Proof of Stake. The work on consensus sysems guarantees that there is indeed a single unique token available to transfer and after validation, the system transfers ownership from one party to another. All this without human or third-party trust or intervention.
Smart Contract
“Trusted third parties are security holes” – Nick Szabo
Contracts are encountered daily by most people. This morning when I signed up for a newsletter, I had to click “I Accept” the conditions in order to receive the newsletter. This is a type of contract we enter into regularly. For a larger item like a house, we enter into a contract to buy the house, we pay money to the owner, and then they give us title to the house to show we now own it. In this process, there are lots of “agents” we work with to facilitate this transaction. These are trusted third parties that the seller and buyer agree to trust as intermediaries. Some agents provide value in the form of work such as providing title insurance, while others, like an escrow agent, are only involved to facilitate the exchange. Once a set of mutually agreed-upon conditions have been met, the escrow agent ensures money is taken from the buyer and deposited in the seller’s account and the title is transferred into the buyer’s account.
Smart Contracts are logical decision programs that run on a blockchain. In their simplest form, they can act like the escrow agent holding monies or other assets and exchanging them in real-time when the conditions of the contract are met. These are purely logical decisions though the decision criteria could be subjective giving one of the parties the ability to insert a cancel or delay decision. A whole blog or book could be written on Smart contracts though in general think of them as another tool enabled by Blockchains that makes decisions.
Distributed Autonomous Organization (DAO)
A DAO is an independent entity defined by a smart contract. DAOs are created with a smart contract that operates under a clear set of transparent operating codes much like an operating agreement for a company creation. Most are simply based on a few decisions and can grow to include voting by owners of the DAO’s membership tokens. Owners of the DAO’s tokens act like shareholders. DAOs as entities can own virtual and even physical assets depending on the government regulations where they are created. They can be focused on a single transaction or be created to live forever managing whatever token or assets it was created for. DAOs become entities without a CEO where all decisions are automated or at least crowdsourced by all owners of the DAO’s tokens as defined by their smart contract(s).
Non-Fungible Token (NFT)
NFTs are digital certificates of ownership. In some cases, the asset owned could be copied into the token which is the case with digital art. In other use cases, the token may point to an asset or be a record of ownership of a physical asset such as a land title. It may also include information such as a certification of authenticity secured by a digital signature of the artist or creator.
Why call it a Non-Fungible Token? Fungible is a term for an object that can easily be replaced with another object and have the same value, characteristics, and outcome. It does not have to mean it is one of a kind unique. To be fungible, the utility an object provides can be accomplished without difference with another one of the objects. In money, it means that I can pull out a dollar bill from my wallet and replace it with a different dollar bill and it has the exact same value and meaning. Don’t confuse a serial number on a dollar bill with uniqueness as the utility of payment doesn’t differentiate between bills. Something can be fungible even though it has some non-fungible features like a serial number. Some uses of NFT’s may not be 100% non-fungible in utility and benefit though a serial number may make it unique.
An NFT can show you have ownership of something. It could be a ticket for entry into an event, membership in a club, or ownership of the artwork.
To be non-fungible means that it is unique and cannot be substituted for another. Humans are non-fungible at least until cloning becomes a thing. Let the clone wars begin.
NFT Types
Art is the #1 use thus far. The NFT represents ownership of the artwork and a digital copy of the artwork is usually embedded within the NFT. The most famous and notable one at the time of this writing is a work by Beeple called “Everydays: The First 5000 Days” which sold for $69 Million. Memes as art are also popular with the Doge Meme selling for $4 Million. Smart contracts around NFT can enable the artist to receive a percentage of the value their artwork NFT is resold for. This is something that would be very difficult to control physically but in an NFT form, happens automatically.
A new form of artwork as an Avatar has grown wildly popular. These are called “Profile Pics” or PFPs and are a collection of related unique avatars. You may have heard of them as Bored Apes, CryptoPunks, Lazy Lions, Hashmasks, Moonbirds, and others.
Music NFTs are another type where a right to the song is sold. Artists like Kings of Leon and Deadmau5 are leaders in this area along with Grimes, Haleek Maul, and 3Lau. Buying music and some other types of NFTs is much like buying a song on Apple iTunes. You own the right to use the song, but generally have no commercial use, royalties, or copyright claims. There may be other benefits provided by the artist such as access to pre-release listening sessions or other exclusive online events, or seating preference at concerts. At a minimum, the artist knows who their patrons are, with no entity in the middle to withhold or profit from the artist-patron relationship.
Video and GIFs can be owned via NFTs. Most are clips or loops with Sports garnering the biggest piece. The video clip for the “LeBron James Kobe Bryan Tribute dunk” was sold for $387,600.
TWEETs! This is the internet creating the internet. You could put a book, magazine, or other periodicals in an NFT. You could put a letter or other document in an NFT. What do we hear most about? NFT Tweets. Alas, Jack Dorset sold the first tweet ever on Twitter for $2.9 million.
Domain Names. Currently, domain names are managed by the ICANN organization. While generally thought to be autonomous of governments, this is not entirely true. Similar to cryptocurrencies, we can debate the pros and cons of a decentralized domain naming service. I created VALCROS.ETH as my Ethereum address which points to my Ethereum wallet. It is meant to make it easier to communicate with my wallet. It cost me about $40 to register though capitalism is still involved in pricing as I read Budweiser paid around $100k for the beer.eth address.
One item that makes a pretty clear transition to being an NFT is playing cards and trading cards. When issued as official NFTs, you can trace them back to their origin, have clear ownership, and they never get bent or stained, or even marked! New types of cards include God’s Unchained and Sorare.
Items from games, such as skins and attire, are another type of NFT. In the future, you may be able to take skin from World of Warcraft to Fortnite. We may also see full characters, creatures, and weapons move between games. Think of how the Multiverse works with Marvel characters popping into other marvel characters movies. There is a lot of connectivity definition that needs to be done but this is the future. For today, games like Axie Infinity have produced Axies, which is one of the most popular game NFTs today.
One step further, we have the commercialization of skins. Your Bored Ape can already be outfitted with Adidas wear. Other brands such as Ralph Lauren and Balenciaga have developed fashionable NFTs.
We then start to get into some cool features with the “Metaverse.” A Metaverse allows users to interact in a virtual world as in Snow Crash, Matrix, or Ready Player One. This is not the Facebook/Meta metaverse but something decentralized and controlled by the users. You can buy, sell, and trade virtual items and virtual real estate. Decentraland and The Sandbox are the ones gaining early popularity.
While the concept of the blockchain has focused on public documentation and ownership such as land titles, pensions, digital identifications, and other assets, this has moved to NFTs as well. As stated, an NFT on a blockchain is simply a certificate of ownership with a pointer to something else. That pointer could be a real-world asset or entitlement.
Membership NFTs. These are the most exciting. Putting online structure and transparent management in an NFT for membership or as a ticket for entry has value. In 2022, the Super Bowl created Super Bowl LVI commemorative NFT virtual tickets. Wine clubs, fan clubs, and recurring concert events are but a few examples where NFTs are making an impact. An NFT purchase doesn’t need to be the final transaction, as ownership of an NFT could be just the entitlement to be able to purchase something else. It could also be an upfront fee and a monthly fee that if fees are not paid, the NFT automatically becomes invalid.
NFT Value
An NFT derives its value from whatever virtual or tangible item it is attached to. The artwork has value in the eye of the beholder and in the value of owning the original instead of a reproduction. Marketplaces and exchanges have been created to assist in the purchase and management of NFTs. While I do not endorse any of these, I will issue the same caution as I did with Cryptocurrency. Do your homework and ensure you have the keys to the NFT. Letting a third party manage your keys, while less complicated, puts your trust in a third party.
Popular NFT Marketplaces include:
- OpenSea (opensea.io)
- Catalog (catalog.works)
- Sound xyz (sound.xyz)
- Foundation (foundation.app)
- Arpeggio (arpeggi.io)
- Formfunction (formfunction.xyz)
- Groovetime (groovetime.com)
- Heat (heat.ooo)
- Beatfoundry (beatfoundry.xyz)
Patron (consumer) Relationship
In ancient Greece, wealthy individuals used to hire and support artists to create and entertain for them. The word “patron” traces its root back to this time. Today, to be a patron of the arts is to be someone who appreciates and supports artists. NFTs have become a good way to show patronage!
Blockchains and NFTs are allowing online communities to come together to directly support artists. Some, via DAOs, allow members to vote on 1 or more artists who then receive direct payments in the form of grants to pursue the creation of their art. If interested here are a few to check out.
- MusicFund is a popular DAO where members donate and then all the members vote on the top 3 artists every month. These artists in turn receive Ethereum tokens as grants to pursue their craft.
- Audius and Audius Grants
- Naoise DAO (Noisedao.xyz)
SUMMARY
I have only scratched the surface in this very long blog. We are currently going through what some call a crypto winter with prices on cryptocurrencies and NFTs down anywhere from 30% to 90% from their all-time highs. The amount of new technology enabled by blockchains cannot even be measured yet as it is still being created. To criticize it in its infancy would be a disservice to humanity, though I do believe the misuse of the technology by some has shown the need for early regulation.
The best way to stay current on these technologies is through blogs, podcasts, and posts on Twitter and LinkedIn. Find both people who share your views and find others you disagree with and follow them. That is the best way to learn with an open mind and be able to take advantage of all blockchains and their related technologies can offer.
Comments, agreement, and disagreements for debate are always welcome.
This article may not be reproduced without the expressed permission of the author.
