On Appropriate Applications of NFTs

  • Commentary
  • August 2, 2020

While tracking the recent spike in the ubiquity of DeFi governance tokens, the Smith + Crown research team noticed a somewhat curious instance of their adoption by a project adjacent to the sector: Rarible, a platform for creating and trading non-fungible tokens. Recently launched, the RARI token serves as the platform’s native, pure governance token and is distributed to users based on trading activity. Quickly acknowledging the dubiousness of this attempt to mimic the apparent success of the COMP governance token, our team noted that Rarible likewise provided a relevant case study in illegitimate applications of non-fungible tokens.

Of the two main classes of non-fungible cryptoassets marketed on Rarible, ‘tokenized’ digital artwork is the most prevalent. Notably, this does not refer to NFTs used to track and authenticate real-world pieces of art, which Smith + Crown considers a legitimate and promising use case for the technology, but refers to digital artwork or collectibles created specifically to be represented by the NFT. That is, the token’s code merely indicates to an off-chain platform which artwork and other attributes should be displayed. The process is similar to CryptoKitties’ translation of NFT codes in ‘cattributes’ and associated artwork. The issue with such applications, however, is that the NFT itself does not contain any artwork, and provision of artwork is solely dependent on the off-chain platform’s actions, making the benefits of NFTs’ conferring of provable and immutable ownership completely negligible. There exist no trustless or cryptographic assurances that the off-chain application will continue to translate a token’s code in a consistent manner, and, if Rarbile decides to turn one’s artwork into a black square or Dapper Labs decides one’s unbred Gen 0 Kitty into a Gen 34 with a weeklong cooldown period tomorrow, there is nothing the user or the associated blockchain can do to prevent them from doing so.

A similarly ailed instantiation of NFT technology is non-fungible tokens that confer real-world benefits. On Rarible, for example, there exist tokens that confer special access to and services from entertainers. However, as is the case with the aforementioned digital artwork, the NFT itself has no intrinsic value and instead only serves to indicate to an external party–the entertainer–what value should be delivered to the token holder, who has unilateral, unchecked power in this regard. That is, any trustless or cryptographic mechanisms providing secure ownership of the token are incapable of ensuring the delivery of the promised benefits by the entertainer. The only means by which the equation of token ownership to benefits received can only be enforced are real-world, legally binding agreements and, if such measures were enacted, the threat of civil or criminal penalties would presumably negate the need for cryptographic assurances. While one could argue that tokenization of such contracts may better allow for transfers thereof, there exist few, if any, examples of such NFTs garnering demand sufficient to facilitate liquid markets therefor.

The distinction between the deployment of NFTs to serve as legitimate vehicles for tracking and authentication and their use in the above manners is less than clear on a project-by-project basis—perhaps intentionally so. Just as the terms and characteristics of ‘blockchain’ and ‘cryptography’ were invoked by dubious token sales to generate a false sense of security during the 2017 ICO boom, NFTs today may be spuriously equated with cryptographic assurances that value supposedly conferred thereby will be securely and trustlessly delivered. However robust, blockchains, their consensus mechanisms, and the cryptography underlying them are built to assure fair transfer of value only thereon. Any equation of a blockchain’s codified guarantees to those supposedly conferred by token ownership but ultimately dependent on the actions of an off-chain actor are dubious. The latter is technically unenforceable, and actors involved in such agreements are subject to the same risk of default faced by parties in any other handshake agreement.