Part 1: A Taxonomy of NFTs (Collectibles and Assets and Digital Twins, Oh My!)
NFTs are Non-Fungible Tokens. NFT is a generic term for unique or one-of-a-kind tokens on blockchains contrasting them with generic interchangeable ones. Conceptually this is the difference between two dollar bills on the ground (fungible) or two baseball cards of wildly different values (non-fungible). In the first case, I don’t care which of the two I get, but in the second it could make a huge difference.
This broad definition of NFT includes an incredibly wide range of diverse applications with very different needs and rules. This three-part series will lay out a taxonomy for NFTs starting at the broadest definition and digging in deeper where the most immediate opportunities exist. Part one of the series will lay out the high-level categories, a strawman taxonomy. Part two will dig into the most common type of NFT which dominate the conversation today, consumer collectible and game NFTs. Part three will explore another common category, NFTs that are digital representations of real-world objects. If we can improve the precision of our communications about NFTs we can better deliver the infrastructure needed to advance their adoption.
Part 1: A Strawman Taxonomy
So if NFTs are every token (or object) on a blockchain that are “not fungible” — that basically includes everything except coins. That is quite a range. If we believe software is eating the world and tokenizing is how software will handle unique things, it’s a rounding error to say the broadest definition of NFTs cover just about everything.
NFTs are, at their root, a special type of token. Tokens are representations of things, often made to be traded.
Tradability is the first dimension of our NFT taxonomy.
We will have one very large category of tradable tokens and a smaller, but still important, one representing non-tradable NFTs. The best examples from the non-tradable category would be centered on identity, credentials and personal information. We’re not going to spend a lot of time dissecting these non-tradeable types; They’re largely non-transferrable and, although you might share this information, it’s not truly changing ownership (though they certainly are non-fungible and an important part of the potential eco-system).
Instead, we’re going to focus on the larger category, tradable tokens. Tradable tokens can be separated into those that are purely digital and those that are made to represent objects in the physical world.
Manifestation is the second dimension of our NFT Taxonomy.
Fully Digital NFTs
When the term NFT is commonly used it’s often referring exclusively to unique, tradable, fully digital, consumer tokens. Items that are purely digital have unique properties relating to their transfer which can be done entirely programmatically and fully online. These include “poster NFTs” like digital collectibles (e.g. cryptokitties) and game objects (e.g. SteemMonsters). Although not as widely discussed, tradable digital tokens come in other types.
NFTs representing Intellectual Property rights to things like software licenses, photographs, music or even patents need to handle complex ownership and revenue payment schemes if they are going to bring the transparency these markets require.
The final broad category of fully digital tradable tokens (and potentially the most confusing one separating FTs and NFTs) are financial instruments. NFTs can be used to represent futures or options or a variety of other products. Deciding which of these are fungible as well as which represent “real world” objects (as opposed to being purely digital) is an exercise left to the reader and those who are deep into those markets. Although security is important across the NFT spectrum, identity, hot and cold wallets and ironclad smart contracts are paramount for this category to continue to thrive.
Digital Proxies for Real World Assets
Moving from the fully digital token world into the realm of digital representations of physical things is segmented on the type of tradable object being modeled.
The area that has received the most attention to date is taking valuable real-world assets like real estate or vehicles or art and creating a digital twin for them. These asset-based NFTs can then be used to track providence and create an immutable history. Perhaps more importantly, creating NFTs of these assets can better enable fractional ownership. Essentially fungible tokens are issued against the NFTs representing shares of ownership of the larger asset. These blockchain enabled capabilities enhance the value of the underlying asset acting as a powerful motivator to progress on asset backed NFTs.
A different though related category are NFTs to track consumer luxury goods. For this segment, the prevention of fakes is the primary motivator. At the lower end of the consumer goods spectrum, it becomes less about trading the good or preventing fakes and more about tracing providence and reporting on the sustainability of the products consumers are buying every day.
Connected to the consumer product NFT pipeline are the enterprises and supply chains that create and deliver those products. NFTs representing real world components of larger systems (e.g. ethically mined metals or dangerous regulated chemicals) can be tracked more effectively and “traded” as they are moved between members in complex supply chains. Enterprises also benefit from representing major pieces of equipment as NFTs so they can be leased, serviced and resold more efficiently.
Major enterprise assets have similar requirements to the valuable assets mentioned above. Enterprises may also derive value from creating certain key paperwork associated with their pipeline as NFTs. It may be a stretch to put these in the category of NFTs tied to real-world objects, but it is not a stretch to see that a marketplace for accounts receivables could provide value and improve liquidity.
Bitcoin is described as a “sound currency”. This brings many advantages but also many new challenges. Similarly, cryptographically backed NFTs are “sound digital goods”. The requirements for platforms and marketplaces to support these are significantly more varied as both the types and purposes NFTs serve cover a significantly wider range than “just money”. Through a better industry-wide understanding of the most important types of NFTs and their varying needs, platforms and markets can be thoughtfully constructed to unlock the immense value in tokenizing the world.
To better understand how NFTs can be used we must first define what they are. Breaking them out into tradeability and how the NFT is manifested (purely digital or digital proxies) gives us more clarity into the what and why of the NFT, which makes for smarter implementations.
In Part two we will dig deeper into consumer collectible and game NFTs as there has been progress on those types. With a deeper collective understanding, the platforms and tools for them can evolve and that early positive momentum can continue to build.