This episode is all about NFTs. It seems like nothing has caught on and spread into mainstream interest like NFTs, where one hears everything from “I’ve never seen anything like this before” to “is this like ICOs all over again” to “it’s just a jpg I don’t get it” to “but what about the energy use!”

So, in this special deep-dive episode from the a16z Podcast network, we break down everything you need or want to know about NFTs — while cutting through the noise for what’s hype/ what’s real, as well as where are on the long arc (and sometimes seemingly sudden tipping point!) of innovation (apparently, Google trends data showed that interest in NFTs recently surpassed interest in cryptocurrency). Editor in chief Sonal Chokshi interviews friends of a16z crypto Linda Xie, co-founder of Scalar Capital and former Product Manager at Coinbase; and Jesse Walden, founder at Variant Fund and former co-founder of Mediachain Labs (which was acquired by Spotify, where he was then an R&D lead).

This episode is posted on both the a16z Podcast show and 16 Minutes as one of our “2-3x explainer episodes” of topics that keep coming up over and over again in the news (past such episodes have covered everything from Section 230 and Tiktok to GPT-3 and the opioid crisis).

Show Notes

  • What NFTs (non-fungible tokens) are — as well as the properties of crypto that enable them, just to set some big-picture context [2:07]
  • What forms they take, and what is and ISN’T an NFT — including where “social tokens” and the creator economy do and don’t come in [11:18]
  • Common myths and misconceptions — from ‘just a jpg’ to the frequent question of energy use & NFTs [18:23]
  • How they work — as well as the broader ecosystem around NFTs [29:35]
  • Discussion of different ecosystem players [35:08], including DAOs [44:02]
  • Various applications, now and next — touching briefly on how to think about NFTs, whether you’re an artist/creator, developer, or institution [49:32]

Transcript

Sonal: Hi, everyone. Welcome to the a16z Podcast network. I’m Sonal, and this episode is ALL about NFTs. And, as with our other special deep-dives, we cover everything you need or want to know about NFTs, while cutting through for what’s hype, what’s real, as well as where are on the long arc (and sometimes seemingly sudden tipping point!) of innovation.

We start for the first 10 minutes by discussing what NFTs are and how crypto enables them, just to set some big-picture context. The next 10 minutes, we cover what forms they take and what is and ISN’T an NFT — including where “social tokens” and the creator economy do and don’t come in. Then for the next 10 minutes we cover common myths and misconceptions, from “just a jpg” to later going into the frequent question around energy use and NFTs. But about 30 mins in, we quickly share how they work, as well as the different players in the ecosystem.

Throughout, we of course cover various applications, now and next. And finally we touch briefly on how to think about NFTs. Whether you’re an artist/creator, developer, or institution, this episode is for everyone.

And, as with past such 2-3x explainer episodes (as I call them), it’s being posted on both the a16z Podcast and 16 Minutes feed, our show where we talk about tech trends in the news, including topics that keep coming up over again [ICYMI: past episodes include explaining Section 230; Tiktok; GPT-3; and the opioid crisis – you can find all of those at a16z.com/16Minutes. We also covered the historic auction at Christies this month, where an NFT by the artist Beeple sold for $69 million; and I mention that only since we reference that event in this episode.]

Finally, since our podcasts bring you insights directly from the experts, the guests I’m interviewing today are two close friends of a16z crypto: Linda Xie, co-founder of Scalar Capital and former Product Manager at Coinbase; and Jesse Walden, founder at Variant Fund and former co-founder of Mediachain Labs, which was acquired by Spotify, where he was then an R&D lead.

To be clear: NONE of the following should be taken as investment advice. For more important information please see a16z.com/disclosures.

Terminology & foundations

Sonal: So. Let’s just start with a quick set of definitions: What IS an NFT?

Linda: So, NFT stands for “non-fungible token”, which is just a term used to describe a unique digital asset, whose ownership is tracked on a blockchain.

This can be a really broad set of assets from: digital goods, like virtual lands and artwork; to a claim on physical assets, like real estate or clothing items.

Sonal: What I heard you say there is not just digital, because it *can* cover something physical as well, that you can essentially represent as NFTs.

Linda: Yah. It’s a really really broad space; it’s exciting to see NFT art really take off, but this covers a lot of different industries as well.

Jesse: So, I like to focus on the digital side of things a little more, and, a metaphor that I would offer as a definition is NFTs are a way to make digital files ownable — instead of a financial asset, you can now own a digital media asset on the internet.

And that’s why the file metaphor is apt: You can now own a JPEG, own an MP3. And, what you’re essentially doing when you create an NFT, it’s sort of like metaphorically ‘uploading’ that file to the blockchain — such that anyone can track its provenance and attribution.

Sonal: So, Dixon described this in a recent blog post, very simply put, as: “NFTs are blockchain-based records, that uniquely represent pieces of media” — or in your words, Jesse, a file.

One more word to focus on is the “fungible” in the non-fungible token, which is that you can represent these items uniquely — I just want to really emphasize ‘cause, again when you think of $1, that’s fungible (or even a single bitcoin arguably is fungible) — but something fungible is interchangeable, replaceable; it doesn’t matter what dollar I have, as long as I have a $1.

But in this case, something is “non-fungible” means it’s super unique; and we can go into like what that means in a moment — but before we do, let’s talk now about the underlying crypto aspect of NFTs… not the specific crypto protocols, but maybe more broadly, what are the properties of crypto — ‘cause we don’t wanna make this conversation about crypto per se, but about how crypto enables NFTs.

When you think about the physical world: sometimes it involves a notary; like a third-party bank; it involves someone to (in the art world), like provenance-tracking through certificates… — this ability to own and track a digital file, without a third-party player intermediary, is key.

Jesse: That’s right, you depend on the bank to maintain the ledger; or the title to a property that you buy, there’s some property registry that the state or the city maintains. So you’re always dependent on a third party to track the attribution of ownership: how the title changes hands, how bank statements get updated.

And bitcoin changed the game because it enabled this public, decentralized ledger — where no one party is in control — and yet each individual owner of a bitcoin is able to verify their ownership using cryptography. As a result, you don’t have to depend on a single third party to verify ownership.

Linda: Yeah, middlemen are tracking ownership for people of all these different assets — and they’re taking fees for the service; they’re preventing some people from using the platform — and, what’s really powerful with crypto is you have all these open protocols that you can kind of plug into each other.

And so, when you have NFTs, you can plug them into decentralized systems and be able to trade these NFTs with anyone in the world, and have that be instantaneous. You can also imagine plugging into using your NFT as collateral; so let’s say you have video game items that’re worth a lot of money, you can actually imagine taking a loan out from them.

And so NFTs on the blockchain allow anyone to permissionlessly own, issue, trade them.

Sonal: And the other property of being able to track provenance; which has essentially a built-in secondary market to it — which is this idea that not only do you track the provenance, but you can actually track the financial benefits that accrue as a result of that built-in secondary market. This is particularly true in cases of digital artworks, etc.

Jesse: Yah, the secondary *resale* of an asset can be programmatically constructed, such that anytime the NFT changes hands, a portion of the resale value goes back to the original creator.

Sonal: And by when you say “programmatically”, automatically, that is a distinct property of crypto — specifically, smart contracts that you can do that type of programmability of a contract.

Jesse: Yeah, it can be totally automated, totally transparent — Contrast that with royalties in the music industry, which is like a completely opaque system with many layers of middlemen that are each taking a cut, right.

It’s a wildly more efficient architecture; that’s uniquely made possible by blockchains and smart contracts. The blockchain’s really good at tracking the history of things — Sonal, if you send me one bitcoin, everyone can see that you have one less and I have one more <Sonal: right> — and the history of that transaction is forever sort of enshrined on the blockchain. The same is true of non-fungible tokens in that, when they’re incepted or “minted”, they’re signed by the creator using their cryptographic keys — which now enables anyone to see okay this file was signed by this creator or this person — that message is constructed in the same way any other cryptocurrency transaction is constructed.

Thereafter, that NFT lives on the blockchain alongside all other transactions, and everyone can see it. And so if that NFT changes hands, and say Linda buys my NFT, everyone can see I transferred ownership to Linda. And as a result, we start to build this very rich history of the interactions people have with media on the internet. Whereas today, think about an image you see on Instagram: You could screenshot that; you know, crop it; and then paste it on another platform, say like repaste it on Facebook. And as soon as you do that, you break its entire history, its entire provenance — you no longer know who made it, what it’s about, where it originated… And, with this new sort of architecture, we can now sort of have a z-access into the entire history of any piece of media on the internet.

And: through that channel that information flows, value can also flow.

Sonal: Concretely for artists, this means an artist today who may have created a work 20 years ago — and that work completely appreciates in value, but the last owner is the only one who benefits from that — if the programmatic arrangement is that that artist continues to get value, they can always get paid on this built-in secondary market. Like, if it later becomes millions of dollars versus $500 for a painting, then you’re getting money back each time it is sold. Which is not possible before.

Jesse: And I think, important to note, that’s just *one* of the possible arrangements that can exist, when the rules around monetizing creativity can be expressed as code by any developer and any creator on the internet. 

Linda: The ownership history is really important — the ownership history is something that is really uniquely accessible on the blockchain, because everyone can see, and therefore some items might be more meaningful to certain people. Let’s say “Magic: The Gathering” has a tournament where this deck of cards actually won this tournament, you might want to buy these set of cards because they’re historical, and the winner of these games actually used this deck to play.

From the art perspective, just imagine your favorite musician or creator owning a piece of art. And, now that ownership is just tracked in the blockchain, that piece of art might become more valuable to you because of who’s owned it in the past.

We also have a lot of projects that are working on fractionalizing NFT art: So, splitting up these NFTs into multiple pieces; and these individual pieces are also tracked on the blockchain, and you can trade them through decentralized exchanges.

So, it’s really powerful when you can plug these NFTs into all these different crypto protocols, because in a traditional system, these middlemen aren’t plugging themselves into all these other companies and middlemen. You can kind of freely do whatever you want with these NFTs, which I think is a really big difference.

Jesse: Yah, I think it’s important to contrast the way NFTs work to the way the traditional web works; so, with social media today, when you share a file or share a piece of media, you upload the file to the platform. And what’s actually happening under the hood is you’re “copy-pasting ownership” of the file to the platform: What I mean is that somewhere along the way you signed the terms of service that allows for the platform to monetize that piece of content as they see fit, and maybe they give you a cut of the revenue, maybe not — but the platform gets to make that call. And, they also get to make the call on how that content is consumed, and there’s not a whole lot of innovation going on there because any developer who plugs in to try to innovate has been shut down in the past.

Now, contrast that to NFTs — and I’m going to run with this metaphor of uploading a file to the blockchain —

Sonal: Keep goin’, I love someone who owns a metaphor… <chuckles> <Jesse chuckles> do it! <laughs>

Jesse: Okay, so, with this metaphor if you’re uploading files to the blockchain, and then those files become NFTs and they behave in the way that other crypto assets behave, that means that they’re permissionlessly accessible to anyone, anywhere with an internet connection. The implications are that any third-party developer can then innovate on the way that media is consumed: Like how the audience sees it, how people can interact with it or program it.

So, one way to think about what’s happening with NFTs is we’re building this universal,  open media library — on top of which any developer can build the next Spotify, or build the next Instagram, or build the next Facebook — and when there’s a lot more competition, there’s gonna be a lot of benefit to consumers… and likely to creators as well — because as Linda mentioned, all of this can happen without the traditional middlemen taking a cut of the value that’s flowing between the creators and consumers.

Sonal: That’s great.

What an NFT is and isn’t

Let’s get a little specific, though — let’s actually talk about the forms NFTs are taking, specifically. I think this is a great place to help tease apart what’s hype/ what’s real, as is the premise of the show. And so far, I’m actually having a hard time — and I’m someone who’s been covering this space: I mean bitcoin since very early on, Ethereum since very early on, NFTs since very early on — and I am honestly confused myself! So, maybe you guys can just help break it down.

Just to quickly recap, Jesse, you’re saying any media file; Linda’s saying any good, digital or physical — that leaves pretty much anything… So specific examples include things like:

  • art;
  • it can be in games;
  • in music — there are audio NFTs (this has been really interesting to me lately);
  • there are blog posts, like I see people on our friend Denis’s site talking about making NFTs of blog posts;
  • Brian Flynn wrote about token-gated newsletters
  • And another interesting example recently (it was a self-proclaimed first, but likely true): Someone wrote about how they created the “first ever tokenized crowd-funded equity research report”.

…Can you guys just quickly help tease apart what *is* and *isn’t* an NFT? It seems like everything is!

Linda: I really think that anything <chuckles> in the world can be an NFT… as in, anyone creates something that is unique, that can be owned.

The problem with physical goods is that you do have to have someone custody it, so there is a process behind that of having to make sure that you can audit that in the real world: And maybe multiple people own it, and it can’t be moved just by one person; so, there are pieces to that — but otherwise I find it to be an extremely broad category.

We’ve seen really cool things come about, where we’ve had the token-gated newsletters, which you mentioned — basically needing to have a certain number of tokens in order to access this newsletter. And people are doing like token-commissioned permission chats where these tokens are required to enter the chatroom and start talking so, you know everyone has like a level of skin on the game. You have to own like a certain amount of tokens in order to enter these groups: it proves that you have some sort of ownership into this community that can be adjusted over time. (The idea is that even one day that there could be DAOs formed where token holders can vote on how many tokens are required to enter this newsletter or chat group or something.)

And that piece, it’s kind of tangential to NFTs — I don’t necessarily think that social tokens themselves are NFTs, because sometimes people are creating these tokens that they’ve minted like a million of them; but if the creator of this group is issuing individual badges or unique items within that, then that can be an NFT.

Sonal: Can you say more on what you mean by “social tokens”?

Linda: Yeah; social tokens are just a really broad category of tokens that are issued by individuals or communities. So sometimes it’s- other terms are used like personal token, community token, creator token — but social token’s kind of the term that encompasses all of it.

And there’s just a bunch of different experiments happening in the space: So we’ve seen people tokenize their time; so one of these tokens equals one hour of their time, and that becomes freely traded. We’ve also seen someone like R.A.C (he’s a Grammy Award-winning recording artist) tokenize his social token, and his token holders get access to this private Discord group, and then they receive like all these additional benefits… and he retroactively distributed to his supporters — so this is a way that creators can interact with, and reward, their early supporters.

So it’s a really broad category and it can really be anything associated with an individual or community.

Sonal: And how is social tokens similar and adjacent to NFTs — and then when is it *not* NFTs? Can you help distinguish there, just to help the understanding of what is / isn’t an NFT.

Linda: Yah, sometimes social tokens can be NFTs in that a creator is issuing some unique piece of artwork directly to their fans — but in a lot of cases, social tokens can also just be fungible tokens. So like R.A.C. token, they’re all fungible so you can basically hold like a certain level of them, and that can always be traded and bought back and it doesn’t really matter which R.A.C. token you’re purchasing. So those are kind of more adjacent.

And I think the reason why social tokens and NFTs get lumped together a lot of times is just because it enables the creator economy, it enables creators to engage with their fans directly… and so, these are often tied pretty closely together.

Sonal: Right, but basically the bottom-line is