NFTs, the Metaverse, and Everything Web 3.0

Chapter 4. NFTS and DAOs

NFTs—Non-Fungible Tokens

Mack Flavelle of Axiom Zen was facing a challenge. He had come up with this great idea for a game that combined the delight and discovery of a FarmVille game, where you plant a seed and then see what sprouts, with the collectibility of CryptoPunks, limited edition digital images that resemble 8-bit old school Nintendo characters.

His idea was to breed cats on a blockchain. Each cat would have unique characteristics and would be represented by a token (see Figure 4-1).

Figure 4-1. Breeding cats on a blockchain.

There was only one problem—that technology didn’t exist. You see, at this point, tokens on a blockchain were all the same, meaning that if two people each hold 5 bitcoin, they each possess that same value. This property is called fungibility, which means interchangeable.

Fungible: The same, or indistinguishable.

Enter Mack’s friend and cofounder, Dieter Shirley. Whereas Mack was “the Kitty Guy,” Dieter was the tech guy. Like Satoshi Nakamoto and Vitalik Buterin before him, Dieter started with a whitepaper for what he called the ERC-721 Non-Fungible Token.

ERC: Ethereum Request for Comments.

Non-Fungible: Different or unique, and therefore, not interchangeable.

Note

Most groundbreaking blockchain projects typically start with a whitepaper that clearly explains the need and the technical solution. By soliciting comments and feedback from the decentralized developer community, this open source approach helps build early community and consensus.¹

Soon, this whitepaper led to one of the most robust and well-written smart contracts of the time and allowed for a viral pandemic of kitten collectors and kittenvestors that created so much congestion that it actually brought down the entire Ethereum network, but that is another story (see Blockchain Success Stories, Chapter 6: “CryptoKitties: Blockchain-Based Collectibles”).

To understand this concept, think about a traditional collectible like a baseball card or a comic book. Although they may all initially sell for the same price, the prices change over time based on the performance of the player or the comic. Common, everyday players or issues of comics with modest followings have little value. What if you have been following a player since the minor leagues and think he will be better than most scouts predict? Or you read the very first issue of a comic and believe it is destined to develop a cult following? You seal it up, put it away for safe storage, and hope it appreciates in value. Then when the time is right, you sell it for a profit.

With NFTs, you can do the same thing, except they are stored safely in your digital wallet. While most cats were worth only a few dollars, some people were buying and then later selling cats with special characteristics for exorbitant profits. One cat, Celestial Cyber Kitty (see Figure 4-2) sold for $140,000. This led not only to speculation in the digital kitty market, but also to interest in this entirely new market of NFTs.

Figure 4-2. Celestial Cyber Kitty—would you pay $140,000 for this cat?

Why did Bitcoin receive so much interest even in its early days? It offered the promise to get rich quick by getting in early and then getting out. This is not a new phenomenon. However, once the window for turning $100 worth of bitcoin into $10,000 in less than a year had passed, the focus shifted to the next big thing. When the artist Beeple sold his digital artwork at an NFT auction for $69 million, suddenly NFTs were that thing, as people who knew nothing about Beeple, digital art, or NFTs took notice.

Three years ago, the two questions typically asked by business leaders considering entering the blockchain space were: Can we put our business on a blockchain? If so, should we put it on the blockchain? Any company that announced doing anything blockchain-related suddenly saw a spike in their valuation. Now, the two questions being asked have become: Can we make this asset into an NFT? If so, should we make an NFT?

To answer these questions, we first need to understand what it means to own an NFT, and what the value proposition is. The simplest explanation is shown in Table 4-1. Essentially, an NFT allows you to edit the third column, or the current owner of the NFT.

Table 4-1. The real value of an NFT—transferring ownership, but of what?

Name of NFT	Associated meta data	Current owner of NFT
CryptoPunk Wastor	975-38114-52-186	Melina Smith
Apple Blossom Kitty	368-42225-39-652	Doug Puzzoli

So, if you are the owner of that NFT, you can assign ownership to someone else in exchange for some mutually agreed upon value. But what does it actually mean to own that NFT? Do you have exclusive rights to that image? Not really. If a community of people recognize that you are the owner of that image and someone in that community is willing to pay you for the bragging rights of ownership, then I guess there is value there. However, there is nothing to stop someone else from screenshotting that image and sending it out to hundreds or thousands of people. Remember, Bitcoin was successful because Satoshi solved the double-spend problem. Each bitcoin could be accounted for, and no one could simply copy more digital money. This is not the case with the images associated with NFTs.

Looking back at the earlier example where someone paid $140,000 for the right to own Celestial Cyber Kitty, consider that you, the reader of this report, and countless others who have seen my blockchain presentations, have seen this image for free. I haven’t profited from this, nor have I sold this image on t-shirts; but when I reproduce it repeatedly in a new PowerPoint presentation by copying the slide from a previous one, no money is going into the digital wallet of the owner.

So then, what is the real value of owning an NFT? First, let’s explore it from a perspective of what it is not. The real value of NFTs is NOT:

• Owning digital images of collectible cats

• Owning videos of your favorite sport moments

• Owning digital art

Again, there is value if someone else perceives value and is willing to pay you for it, but you have no actual enforceable intellectual property exclusivity outside of any understood norms in a crypto community.

Further, if that NFT community happens to have celebrities of the status of Eminem or Snoop Dogg who pay 6 or even 7 figures to own an exclusive NFT, then owning an NFT in that collection conveys a certain amount of social status. Instead of wearing a diamond ring, driving a Lamborghini, or owning a condo in Vail, displaying your Bored Ape from the Bored Ape Yacht Club NFT collection on your social media page is the newest way to show that you have “arrived.”

So does this mean NFTs have no real value beyond status symbols and bragging rights? No.

The real value of NFTs is:

• Fostering the connection between content creators and their fans

• Providing access to experiences

• Provenance

• Monetization of file exchange

Let’s explore these. The first two bullets work together. By owning an NFT, you could access exclusive events with your favorite author, athlete, or celebrity. As we will explore in the next section on DAOs, NFTs can also be used to confer different levels of governance or authority.

Provenance, as we will explore in the supply chain use case (see “Blockchain in Industry” in Chapter 5), refers to the complete history of an item, including its authenticity. If we add columns to Table 4-1, the NFT can also show who has previously owned the NFT, how long they owned it, and the previous prices for which it was sold.

Now, compare that with traditional collectibles, like baseball cards or comic books. When you buy one, you know only the person from whom you are buying it and have no idea how many times the card or book was previously traded or for what price.

Last, consider the monetization of file exchange. Why are college textbooks so expensive? Because despite being used by many students over many years, the author will receive only a one-time payment on the initial sale. Only the used bookstore profits in future years. With an NFT, every time it is resold, the original creator can receive a royalty. This is a pain point that I have personally experienced. Sometimes, Blockchain Success Stories will be rising in the rankings on Amazon after a significant week of sales, only for me to find that the majority of sales came from used books, from which I don’t directly profit even a single cent.

Four Types of NFTs

In order to bring this real value to the marketplace, there are four types of NFTs:

Generative (procedurally generated art)

Based on randomly varying specific traits, a nearly infinite number of possible images may be created, complete with metadata. CryptoKitties and Bored Ape Yacht Club are common examples. For our older readers, it’s like a Mr. Potato Head, but digital and with thousands of possibilities. For our younger readers, it’s like creating your character on a Wii; you select hair color, hair style, skin tone, eyes, eyebrows, nose, lips, ears, facial hair, shirt, pants, etc., but instead of you selecting them, every possible permutation will now be randomly generated. An example of a website that lets you do this without needing to know how to code is Nifty Generator.

Participatory

It simply allows the holder to demonstrate proof of participation. Instead of keeping a ticket stub from that World Series game or rock concert, you can now display your NFT to show where you have been and what you have done. An app like poap.xyz (which stands for Proof of Attendance Protocol) enables this functionality.

Token gating

The gating refers to possession of NFTs providing access to content, experiences, or governance authority (see the section “DAOs”). An app like mintgate.io enables a user with no coding ability to mint tokens that can be used as keys to open gates that allow access to content or events.

Dynamic

Traditional collectibles, like baseball cards, are static. Once they are printed, they can never change. A player may have a great season, and the card will increase in value, but the card itself will always be unchanged. With a dynamic NFT, the token has data or traits that can be constantly updated due to external events. For example, if a baseball player hits three home runs in a game (an off-chain event), his NFT will now be updated on-chain. Much like the ability to instantly see a stock price and its associated metrics online as they are updated instantaneously with each price change, as opposed to the old days of receiving financial reports in the mail or checking the newspaper end of the day, this improvement in the timeliness and accuracy of key information about an asset builds both confidence and liquidity in a marketplace. The Chainlink network is an example of a platform that can support dynamic NFT functionality.

Three Types of NFT Platforms

To access and store your NFT, you will need a wallet. The wallet that you choose must be compatible with the blockchain platform on which your NFT is minted. If you mint an NFT, choose the platform that best meets your project’s needs (see Table 4-2).²

Table 4-2. Types of NFT platforms

NFT platform	Description/rules	Examples
Open theme	Anyone can sign up to be a creator.	OpenSea, Rarible
Exclusive open theme	Requires application and approval to become a creator.	Nifty Gateway
Exclusive theme-specific	Creators are integrated with platform owners, and only pre-approved collections can be exchanged.	Dapper Labs for NBA Top Shot Larva Labs CryptoPunks

So, to close this section on NFTs, let’s return to the two biggest questions in blockchain:

1. Can this be an NFT?

2. Should this be an NFT?

This is much like the dot-conomy of the late 1990s where everything was going to be put on the internet (whether it made sense or not) or the initial coin offering (ICO) boom where everything was going to be a coin on the blockchain (whether there was any benefit or not). Now, the same issue is arising for NFTs. People are considering turning every noncoin digital asset into an NFT.

In summary, NFTs are generating considerable interest and excitement because of their ability to deliver short-term financial gain and long-term value. But as with the internet, the derivatives market for subprime mortgages, and the ICO craze that led to market crashes, recessions, and crypto winter of 2018—the same dangers after the bubbles burst are very real.

In the hope that past lessons have been learned and mistakes will be avoided in the future, let’s conclude this section with a visionary quote from 2018 still proving relevant today:

Although CryptoKitties is likely a short-lived fad, it suggests a diversity of uses of smart contracts. Digital assets that can be sold and transformed could have serious applications in finance and other business domains.

Kevin Werbach, Professor of Legal Studies & Business Ethics, The Wharton School

DAOs

A natural extension of blockchain with its decentralized nature, NFTs with their ability to allow access, and Web 3.0 with its spirit of equity, are DAOs.

DAO: A decentralized autonomous organization.

Think of DAOs as cooperatives. Because there is no central authority, decisions are made by a community. Over time, DAOs follow a pattern. Initially, they tend to be more social in nature, with much activity taking place off-chain. Over time as they mature, they tend to become less social and more financial, and more of the activity and decision making is moved on-chain, being governed by smart contracts and token gating (see Figure 4-3).

Within the community of your DAO, people will bring varying interests and skills. Some may want to be only passively involved, while others may want a more prominent role. As a result, it is important that participants have an appropriate level of access and authority. Token gating can be used to effectively manage this process.

Figure 4-3. The off-chain social to on-chain financial DAO progression.

According to Blockchain Council certified DAO and NFT expert Justice Conder, as stated in an article for Medium, there are three questions to ask when organizing your DAO:

1. Does it segment groups with defined availability, responsibility, and expectation levels?

2. Does it leverage tools and access rights that correspond to those segmentation levels?

3. Does the financial upside of each segment match the expected levels of commitment and responsibility?

If the answer to any of these questions is no, your DAO will never reach its full potential. To address these questions, Justice proposed a hierarchical structure of four membership levels and gates to address the varying needs of each segment:

Level 1: Users

This is the largest segment and consists of all members of your community. There are no gates or restrictions at this level. Everyone can own any amount of the community token, and the hope is that everyone will continue to participate as your user base grows.

Level 2: Community members

At this level, we introduce the first gate. Instead of merely using the products or services, community members actually influence key decisions about those products or services and strongly advocate for them publicly, helping to build and reinforce the community culture. A specified number of tokens may be required as a gate for participation.

Level 3: Contributors

Contributors are productive assets of the community. Governance occurs at this level. The key difference between contributors and community members is voting rights and the authority to make key decisions. Contributors are fully invested in the community.

Level 4: Teams

This is the group that is actually responsible for implementation of community goals, i.e., getting things done. It is essential to maintain stable membership and to find the optimal size. Having too many members or transitional members will be distracting and will divert time and energy away from executing the intended objectives of the DAO.

¹ John Hargrave and Evan Karnoupakis, Blockchain Success Stories (O’Reilly, 2021), p. 94.

² See the article “What Are Non-Fungible Tokens?” Penn Today, February 15, 2022.