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NFT Security Concerns – Will Non-Fungible Tokens Survive the Hype?

Natalee

NFTs, or non-fungible tokens, are a form of digital collector item. They are designed to track ownership of a piece of digital content. Many collectors are scrambling for these digital collectibles, while others are wondering why anyone would pay for something that can be so easily copied.

To the layperson, NFTs exploded on the scene overnight. One minute nobody had heard of them, and the next people couldn’t get enough of them. And they are paying very large sums to show just how much they want these pieces of digital property. One NFT sold at Christie’s for the astonished sum of $69 million. That one was attached to a work by the artist known as Beeple. 

It isn’t just the art world raking in money from NFTs. The NBA is using them to bring trading cards into the digital world, and have made over $230 million since launching their platform, called NBA Top Shot. A single LeBron James highlight went for $200,000 on its own. Musician Grimes sold around $6 million worth of NFTs after merging artwork with original music.

Essentially anyone who created content that can be sold digitally is capable of earning extra money via NFTs. Sometimes a lot of extra money. But what exactly are NFTs, and how secure are they? Is it safe to spend the kind of sums we are seeing people spend on the technology? We asked people on Twitter and the responses showed a lot of skepticism around this new medium.  

In this article, we’ll break down what NFTs are, how they work, and ask experts from the art, music and sports worlds what they think about NFTs and their future fate. 

The state of the NFT market

So, there have been a few high dollar sales of NFTs, but what does the market as a whole look like? Much like recognition of the term, it’s expanding rapidly. The first quarter of this year saw sales climb to over $2 billion. The fourth quarter of last year saw sales of only $93 million, meaning an increase of 20 times the volume in just one quarter.  What’s more, the first-quarter figures do not include revenue from NBA’s Top Shots or the $69 million Beeple NFT. 

 

Joe Conyers, EVP, Global Head of NFTs for Crypto.com, believes the numbers may not even be really accurate. “There’s even more happening that is untracked,” says Conyers. “And there’s a lot of inaccurate reporting happening. I think you had a lot of excitement, a lot of big projects that finally came to fruition. Beyond just the people and the bigger names, there’s a lot of mid six figures projects that dropped in Q1 that drove that number alongside a lot of new platforms.”

 

Four of the top NFT marketplaces are presented below, in alphabetical order. 

 

 

Sandy Khaund, Founder of Macrodemic, Entrepreneur & Investor, agrees that buyers are finally taking NFTs seriously, which is part of what is fueling the massive growth in revenue attributed to them.  “I think it starts with [NBA] Top Shot and what Dapper Labs did at Top Shot,” Khaund adds. “The combination of the fact that they made it very accessible coupled with the fact that you have some of the most prominent athletes in the game, that started to create some momentum. And what that did was help other people who were afraid to jump in on anything like NFTs to be able to do it. I think with every successful deployment of NFT, you have more people excited to do it. And the more content that’s out there, the more people want to engage and are willing to overcome whatever obstacles it takes to be able to buy the NFT, which includes buying Ethereum to be able to actually transact in these scenarios.”

 

This year, there have been 73,000 buyers of NFT, but only 33,000 sellers. The disparity has created a seller’s market and allowed NFTs to become a boon to those who are creating them. Elena Zavelev, CEO and Founder of CADAF & Digital Art Month, explains this from the arts market perspective. “We have been working with NFTs even before they were even called NFTs – we used to just call them blockchain art – and this recent boom has been pretty fantastic for many artists. I think that last year, with the pandemic, everybody had to go online and so many new projects, so many new initiatives were happening that this really made a big impact on both the collector and the traditional art world.”

 

As the technology is very new, it’s unknown whether the power dynamic will remain the same. If it does, the NFT market might continue growing considerably for quite some time. 

How NFTs work

NFT tokens are cryptographic assets on blockchain with unique identification codes and metadata that distinguish them from each other, so in order to understand how they work, one must understand blockchain. Blockchain as a technology here provides the possibility to store data in a secure and anonymous way. From a high-level technical perspective that is a database where for all data changes generates a unique transaction which in turn is organized as a chain. Using sophisticated cryptography and a decentralized network, the blockchain can ensure that it is safe from counterfeiting and that each coin belongs to the correct person.

 

NFTs exist on blockchain networks such as Ethereum, and provide a certificate of authenticity as well as legal rights to the digital asset.

 

In general, that is a new generation of ICOs and cryptocurrency tokens which use standard ERC-20 and they are fungible.  Unlike them, NFT tokens have ERC-721 standards (developed by some of the same people responsible for the ERC-20 smart contract) and they cannot be traded or exchanged at equivalency, so they are non-fungible and immutable. Also, NFT could be based on ERC-1155 standard which allows to issue multiple tokens in one contract, tokens in one contract can be fungible and non-fungible at the same time.

 

From a non-technical perspective, NFTs extend the concept of a cryptocurrency by encoding information about a digital asset along with the other information. Now, rather than a bunch of otherwise identical coins, there are countless unique items on the blockchain that can be sold. Anyone who purchases an NFT will be the only one who can own that particular chunk of the blockchain. If it seems weird to purchase something digital that can be copied, think of NFTs as a digital certificate of authenticity. Other people may have copies, but only the purchaser has the original, insofar as digital content can be original. 

 

And there is additional value in the smart contract logic that powers the digital collectibles. “I remember there were studies a few years ago,” Maryna Rybakova, CEO at Artisfact Limited, points out, “on how resale royalty right in the US was a problem for living artists who could not receive royalties when their work went up on for auction or was resold on a secondary market. And while in Europe, there is the resale royalty right, in the US there isn’t one. And so NFTs or the blockchain smart contract logic that came about with crypto art was also aimed at solving that problem. So I think there are many possibilities that are created by the smart contract logic to improve the existing art market and the way businesses operate.”

Will NFTs repeat the fall of ICOs?

With the success of Bitcoin, many other developers wanted to get in on the action. This led to the rise of initial coin offerings, or ICOs. The first appeared around 2013, but ICOs hit their stride in 2018 and 2019. Dozens of new cryptocurrencies were popping up, asking for money from investors before the coin launched. The problem is, there were more people interested in creating their own coins than there were investors wanting to invest in yet another cryptocurrency. ICOs are still around, but the market is nowhere near what it was at the height of the phenomenon when investors were still willing to pay for the chance to get in on the next big thing.

 

Like NFTs, ICOs were built on the backs on blockchain platforms such as Bitcoin and Ethereum. Although the concepts aren’t identical, they are similar enough that one must be cautious when investing in them.

 

Let’s take a deeper look at how similar NFTs are to ICOs. Will the parallels be enough to predict a crash of NFTs similar to what ICOs experienced? Litecoin creator Charlie Lee seems to think so. He draws a list of five similarities that NFTs have with ICOs and the altcoins that inspired the ICO craze in the first place.

 

 

Lee’s strongest criticism comes from the first point. It costs almost nothing to create an NFT, and they are currently bringing in a lot of money. As more artists decide to cash in on this new craze, Lee argues, the supply will overtake the demand and the prices will crash. 

 

Defenders of NFT argue that they are no different than other digital purchase. Once a piece of software has been written, it’s only the cost of the bandwidth send it out to as many customers as are willing to pay for it. The two questions left to be answered are whether or not the market will suitably discourage artists from selling too many copies of the same artwork, and whether people will view having the ‘original’ piece of digital artwork the same way they view owning the original of a piece of physical art.

 

“I like to think that the NFTs will be more like the dot coms than they will be like ICOs,” Sandy Khaund reflects. “I think ultimately the ICOs that survived are the ones that truly had value. And I think the dot coms were like that too. There were a lot that went away, just like a lot of the NFTs will go away. But I think the big difference is that there’s also a fundamental change where the technology behind the NFTs has a lot of room to grow and evolve in interesting ways.” 

The legal concerns with NFT

While the theory of NFTs is that they function similar to a certificate of authenticity, the problem with that is that the ease of creating them from digital content doesn’t guarantee that an NFT was minted by the original creator. Digital artist Corbin Rainbolt found this out the hard way when art that he posted on his Twitter account got turned into an NFT without his consent. This means that when you purchase an NFT, it’s possible you are buying it from someone who doesn’t have the rights to sell it. 

 

While most of the major NFT markets have systems in place to report copyright infringing NFTs, it can be hard for an artist to prove that they are the original creator and the person who minted the NFT isn’t. Because NFTs are built on blockchain, and a big selling point of such technology is anonymity, it can also be hard to track down and hold accountable those who violate copyright law for a quick buck.

 

Andrea Steuer, CCO and Director of CADAF & Digital Art Month, shares some of the best practices in the market. “We need to be extremely careful,” says Steuer, “because we really want to put out the best content that we’ve vetted, that we really know who the artist is and we can prove who the artist is. So, at the CADAF side, how it works is that we have an application process where we look at each artist. We check the older material, we check their social media, we basically do a little background check on them, and then they sign an exhibitor agreement where they really tell us that this artwork was created by them, and that they can and they’re willing to stand behind that.”

 

Even beyond outright theft, there’s the question of who has the rights to sell NFTs. Game developer Jason Rohrer found himself in the middle of just such an argument. Rohrer commissioned artwork for his 2012 game The Castle Doctrine. When he put that artwork up for sale as a collection of NFTs, however, the original artists cried foul. They argued that they sold him the rights to use the art in a game, not to sell it as NFTs. 

 

Although largely unregulated, there are some ways that NFTs can run afoul of legal obligations. In 2018, the European Securities and Markets Authority created a report on crypto-assets. The report noted that if the seller of a particular NFT grants certain rights to the purchaser, such as a profit sharing arrangement, the NFT could be considered a security token. It then becomes liable under the regulations for financial markets in that jurisdiction. As the NFT market grows, other jurisdictions will likely come to the same conclusions, to avoid any loopholes in their financial regulations.

 

Sandy Khaund argues, “Much like every new medium – and NFTs almost make a new medium in terms of the transmission of media, transmission of content – there’s going to be some level of legislation that needs to come into play, some level of regulation. But you also don’t want to stifle the creator community either. You want to make sure that there are no unintended consequences that prevent people who are trying to do the right thing from doing the right thing. And that’s why these laws are very difficult because if you make them too onerous, you may have unintended consequences. You may have negative effects because you’re actually stifling the creativity. Because one thing that can be said about these NFTs – good or bad – is that they brought out a lot of very interesting creativity.”

How secure are NFTs?

Imagine someone has purchased an NFT that later turns out to have been based on stolen artwork. The market that sold the NFT is going to have to take it down, as they don’t have the rights to host the art. This means that the person who purchased the artwork will no longer be able to see it. Granted, it’s digital, so the buyer could have just downloaded it after they purchased and be able to view it anytime they want from the comfort of their computer. But what if they then want to sell it? They are largely out of luck.

 

There are two ways the artwork could be stored on the blockchain. The art itself could be put in there, if it’s small enough in size. Alternatively, a link to the artwork could be put into the blockchain. If you’ve ever went to a website and encountered the 404 file not found error, you can probably immediately see the problem with the latter example. When you buy a collectible, the general idea is to sell it at some point down the road when its value has increased. Some people may be content just looking at their collectible. With physical collectibles, this is rather easy. You keep them in a secure location, and they’ll always be there. With NFT, you need to worry that one day the URL will simply stop working. This requires a significant amount of trust in the person you are purchasing from.

 

Thankfully, there are ways to protect your investment. The InterPlanetary File System (IPFS) by Protocols Labs, allows users to ‘pin’ an NFT to their platform so it will be available even if the point of origin stops serving it. IPFS only stores the metadata though, so NFTs that point to a URL could still end up missing. Services like IPFS 2 Arweave will pin your NFT to the IPFS and go a step further, storing the data on the Arweave blockchain. Now one needn’t worry about the data going missing, as long as Arweave continues to operate. In that sense, it’s more of a contingency plan than a full solution.

 

And of course, keep a general checklist to protect yourself from attacks based on general cyber security threats:

 

“We’re very early in the technology, and there’re bound to be security issues if NFT platforms don’t maintain a basic level of security procedures,” Joe Conyers agrees. “There are higher-level security procedures you can implement. For example, you may allow a valid IP address after a seven-day holding period, and add 2FA, obviously. Or just really basic stuff that I think some platforms miss who are not there yet, like basic credentials and staffing validation. When we came to market, we knew these were going to be real issues. We took a lot of what we learned on Crypto.com, obviously heavily security focused to ensure the billions of dollars of values saved there.” 

Conclusion

While there are many who have concerns about NFTs, there are also people ready to spend millions of dollars on them. As more of our content becomes digital, it is inevitable that collectibles will become digital as well. Whether NFT becomes the permanent form of digital collectible depends on whether the industry can find ways to navigate the copyright and storage issues. However, all our experts agree that the technology behind the NFTs is definitely here to stay and we are yet to explore its full potential. 

 

By DataArt’s Andrea Steuer, Elena Zavelev, Joe Conyers III, Maryna Rybakova, and Sandy Khaund 

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