The Promises and Perils of NFTs: An Excerpt From 'The Everything Token'

The opportunities non-fungible tokens (NFTs) create can’t be realized automatically. At least as of 2023, there was tons of work needed before NFT technology could achieve its full social potential.

That said, high-value applications drive innovation, and so even then, we could already see those challenges starting to be addressed.

Excerpted from "The Everything Token: How NFTs and Web3 Will Transform the Way We Buy, Sell, and Create" by Steve Kaczynski and Scott Duke Kominers, in agreement with Portfolio, an imprint of Penguin Publishing Group, a division of Penguin Random House LLC. This chapter has been lightly edited from the original.

Infrastructure

Just as the internet uses a decentralized network of servers to store and propagate information, the blockchain platforms underlying the NFT revolution rely on decentralized networks of computers to process transactions. This protects the blockchain from censorship, expropriation and other forms of centralized control, but it entails high transaction costs at both the network and user levels.

In early 2022, the dominant blockchain for NFT creation and exchange — the Ethereum network—represented as much as 0.34% of the world’s daily energy usage because it used a computationally costly system to securely record transactions. While the Ethereum network’s 2022 switch to a new transaction processing architecture called proof-of-stake (POS) reduced its environmental footprint by more than 99%, throughput remained an issue — transaction costs for something as simple as sending an NFT to a friend could be as high as a dollar or more.

On the one hand, a dollar to ship an asset might sound cheap relative to postage costs (at least in the U.S., where it costs about $0.50 to mail a folded sheet of paper). But for digital assets that are just bits in a computer network, such costs are exorbitant, and prohibitive for many ordinary types of transactions. (Imagine if you and a friend wanted to trade Magic: The Gathering cards and had to pay a dollar per trade.)

Worse still, these costs typically scale with the level of network activity, which means they can be much higher at peak times. (Effectively, a high density of trading at a virtual gaming convention could gum up the network’s processing pipeline and raise transaction costs so much that nobody would actually want to trade.)

And all of that’s with only the relatively low number of people who were engaging in blockchain transactions at that time. The infrastructure wasn’t ready to handle Visa- or Mastercard-level transaction density of up to thousands of transactions per second.

Luckily, even as we were writing, these challenges were starting to be addressed — both through improved blockchain infrastructure design to increase throughput, and through a variety of solutions that process many transactions quickly and then encode them into the blockchain all at once through a single settlement transaction. In both cases, increasing the effective computational power of the blockchain has reduced the marginal cost required to execute a given transaction — much as widespread availability of cloud computing infrastructure eventually led to low-cost processing and storage.

Consumer access and protection

In parallel, as we’ve mentioned a couple times already, there are significant challenges around accessibility and usability of NFT technology. When we were writing this, many consumer digital wallets interacted directly with the blockchain itself, and were “self-custodial” in the sense that the user had absolute control of their digital assets and was personally responsible for their security.

The experience was thus a bit like the very early internet: Navigating crypto transactions required a sophisticated understanding of the technology and could be fraught with error. Even just purchasing an NFT sometimes required a consumer to interact with source code directly. Both digital wallets and transactions needed more intuitive interfaces separating user activity (e.g., minting an NFT, activating its utility, or sending it to a friend) from the technological “rails” making it happen.

Moreover, crypto transactions’ instantaneity and finality have meant that they lack many of the protections people are used to from most other online consumer services. Sending an NFT to someone else is like sending an email— as soon as the computer system has processed the transfer, it’s irreversible. This means if you type an address incorrectly, a digital asset could go to the wrong person, or even just be lost in the pipes of the network. Conversely, hacking or account compromise can lead to irreversible loss. (In late 2021, Bored Ape NFT theft was briefly so commonplace that “All my apes are gone” unfortunately achieved meme status.)

See also: Collectors Are Bored of Apes, Don't Want to Pay Royalties

And finally, there were challenges around fine-grained data control and privacy. As of mid-2023, while digital wallets gave users control of which platforms could interact with their digital assets in the first place, this access was generally all-or-nothing: Most available solutions did not provide a robust mechanism for users to filter a platform’s access to specific digital assets within a wallet. And at the same time, the data underlying users’ digital assets was often fully public on the blockchain. This limited the use of NFTs, and crypto more broadly, in privacy-critical applications like healthcare.

But again, solutions were in development — this time by wallet service providers, who had a lot to gain from improved accessibility and security, because that could drive broader consumer adoption. Scott’s first NFT purchase in mid-2021 had to be done with cryptocurrency and involved multiple failed attempts over the course of the week, even with a close friend helping him navigate the process.

By contrast, when Reddit launched its collectible avatars in fall 2022, the platform sold more than five million NFTs, many users paid using credit cards, and the process was so simple that many non-Web3-native buyers had no idea they were interacting with a blockchain at all. Meanwhile, numerous Web3 identity- and data-management solutions with greater degrees of privacy and user control were in development.

Diversity, equity and inclusion

But of course access to NFTs and other digital assets isn’t purely a technology problem. Digital divides are pervasive across socioeconomic, racial, and geographic lines; and with crypto technology, especially, the cost and complexity of entry have been barriers to access for many.

As we’ve mentioned, early NFTs during the boom of 2021 often required access to cryptocurrency to purchase — and carried significant price tags. The resulting consumer base skewed affluent, as well as disproportionately white and male. Then the next wave of NFT products by and large catered directly to those consumer demographics, further exacerbating the challenge of diversifying engagement in the space.

Without broader representation among the creators and consumers of NFT products and infrastructure, the technology could become regressive

Moreover, the tech industry has struggled to mirror the general population in the representativeness of its workforce, in terms of corporate leadership, employment, and who receives investment— and Web3 is no different.

Just like the internet, NFTs have the potential to create value for all types of people. And especially given the decentralized and open nature of public blockchains, there is in principle an opportunity for NFT space to become more diverse than many technologies that came before it — both geographically (instead of anchoring just in the few countries that host the dominant Web 2 platforms), and also in terms of who participates.

But without broader representation among the creators and consumers of NFT products and infrastructure, the technology could become regressive instead.

These inclusivity challenges are complex to solve, and the business world was continuing to address (and struggle) with them as we were writing this. We don’t claim to have a panacea for creating a more diverse and representative environment in Web3. But the first step towards fixing these issues is recognizing that they exist.

And, especially in the context of Web3, we are optimistic — or at least hopeful: Because of Web3’s focus on decentralized access and user control, it has the potential to upend traditional hierarchies and power structures. At scale, for example, it’s possible that Web3 could improve market access across gender, race and socioeconomic lines because it enables creators to reach consumers directly.

Likewise, the bottom- up community building NFTs enable can help people from a wide range of backgrounds create spaces to meet and collaborate. We know many NFT creators and collectors from underrepresented groups who share these sentiments, and have personally found success and belonging in Web3.

Companies like House of First are championing diverse NFT creators, and NFT brands like World of Women, People of Crypto, and Miss O Cool Girls are providing Web3 education and access to underrepresented groups. And numerous NFT collections have been created by and to support women, nonbinary, and LGBTQIA+ creators; racial minorities; indigenous groups; disabled communities; neurodiverse individuals; and people facing humanitarian crises.

So while in 2023 there was still a long way to go to improve equity of access and opportunity in the NFT space, these projects hint at what NFTs may eventually be able to achieve. As World of Women Chief Operating Officer Shannon Snow optimistically remarked, “Pushing forward the next generation of the web won’t happen overnight, and there are many challenges to overcome. However, innovations like NFTs . . . offer opportunity to reshape the world in the image of fairness and equality,” especially by leveling the playing field in terms of access to marketplaces for creative work.

Regulation

At the same time, as with any novel asset class, NFTs raise questions about regulation. At a basic level, it can be hard to even determine what type of asset an NFT is — and indeed, the answer might vary with the format of the NFT and the specific functionalities it has.

Because of Web3’s focus on decentralized access and user control, it has the potential to upend traditional hierarchies and power structures

Many NFTs, such as those that simply confer ownership of digital artwork or collectibles, have a narrow range of characteristics that make them analogous to commodities or physical property. But some NFTs have a range of characteristics, including features that make them analogous both to commodities and to securities; active secondary markets for this latter category of NFTs raise significant regulatory and policy questions given the different ways commodities and securities markets are regulated.

The challenge of disentangling the various types of NFTs — and how they should be regulated and taxed — was ongoing at the time of this writing. Of course, the fact that NFT assets might evolve and take on new functionalities makes the puzzle especially difficult. If an NFT starts as a simple ownership record, but later starts paying dividends based on the creator’s various products, does it morph from commodity into a security — and if so, what sorts of registration, disclosure and customer identity tracking processes would be needed? The form of the reward matters, too — giving out digital music NFTs as rewards to repeat buyers of concert tickets is very different from paying those ticket holders a share of concert revenues.

See also: What 'Line Goes Up' Gets Wrong (and Right) About NFTs

Beyond that, there were also regulatory challenges at the level of the broader crypto ecosystem, such as determining what types of consumer protection to mandate and how (to help solve the problems described in the previous section). Similarly, there was a need to sort out how NFTs should interact with existing rules around ownership and property — especially IP [intellectual property}.

Decentralization

Most crucially, in some ways, it also remained to be seen how much decentralization Web3 will truly support. There was a possibility that the need to aggregate computational power and data storage could lead to centralization in the infrastructure underlying NFTs and other digital assets. And there were also concerns that even if the infrastructure managed to be highly decentralized, platform centralization and market power could arise at the application layer — just like it had in Web2.

Some have speculated that the need to develop intuitive, accessible wallets and other platforms to support Web3 will drive a new form of centralization, concentrated on the platforms with the best consumer experiences. Plausibly, that movement might even be led by existing Web2 giants. (Certainly Facebook, with its transformation into Meta, is attempting to lead the charge.)

There were some instances of this sort of centralization in the early NFT market — for example, at one point, many platforms displayed images and other media associated to NFTs via reference to OpenSea, one of the top NFT trading platforms. When OpenSea removed an NFT collection, for example for copyright violation, the image references elsewhere broke, as entrepreneur and computer security expert Moxie Marlinspike observed in late 2021.

But even so, there were signs that giving individuals control of their digital assets was nevertheless having an impact on the structure of the market. By the end of 2022, OpenSea had several major competitors, all of which had launched by using public blockchain records of users’ NFT transaction history to offer rewards to active traders who chose to switch platforms. The ease of simply connecting one’s digital wallet to a different trading site made switching easy — and as a result, it was harder for any individual platform to dominate the market.

Meanwhile, when Web2 giant X (formerly Twitter) made its first foray into the world of Web3, it had to accept that users would want a different level of data control than they had previously. In particular, X had to open its platforms up to the possibility of users connecting and loading data out of their own private digital wallets without handing over control.