Non-fungible tokens (NFTs) are unique units of data stored on blockchains that represent physical assets.
The key to understanding the term non-fungible token (NFT) is twofold: tokens and their non-fungibility.
Tokens
First, NFTs are tokens, or units of data, stored on blockchains. They are a digital record of the historical and present ownership of physical assets in the real world, such as a painting, or digital media, such as a photo, a video, or a music file, following the events of sale or resale, on blockchains. Additionally, a non-fungible token’s underlying smart contract also operates on the blockchain where the non-fungible token exists. (See Dufoe v. DraftKings Inc., Hermes Int'l v. Rothschild, and XMOD Indus. v. Kennedy)
While a NFT is linked to a physical asset or digital media, such a linkage can only serve as the digital record of the ownership of the physical asset or digital media. Owning “the digital record of that ownership” does not necessarily indicate the actual ownership of the physical asset or digital media. It merely represents the ownership of the digital record itself. Therefore, the owner of a non-fungible token could differ from the owner of the linked physical asset or digital media. Accordingly, owning a non-fungible token does not necessarily grant the intellectual property right of the physical asset or digital media from which it is derived. (See Hermes Int'l v. Rothschild)
Non-Fungibility
Second, non-fungible tokens are unique. Each non-fungible token represents a different physical asset or digital media. In this context, non-fungibility refers to the fact that each non-fungible token uniquely differs from one another. They also cannot be copied, divided, or substituted. (See Dufoe v. DraftKings Inc.) Therefore, while the value of each cryptocurrency within the same category remains identical, the value of each non-fungible token could differ.
The process of creating a new non-fungible token is called minting. When a new non-fungible token is created or minted, it will have a unique identifier, which links directly to an address of a blockchain. Each minted non-fungible token can be listed in an online platform, often referred to as a marketplace. In a marketplace, interested buyers can purchase or trade a variety of non-fungible tokens based on the rules established by the underlying smart contracts that govern non-fungible tokens ownership transfer. (See Hermes Int'l v. Rothschild)
There are also money laundering issues stemming from non-fungible token trading. Those trading could use their pseudonymous identities to evade regulatory detection and scrutiny when selling and/or purchasing non-fungible tokens. Additionally, bad actors could manipulate the market price and liquidity of a non-fungible token by creating a number of pseudonymous identities and conducting multiple trades in a short period of time by acting on both sides of each trade, a technique called wash trading that harms the legitimate non-fungible token market.
For more details see this Government Accountability Office (GAO) publication on NFTs and this United States Patent and Trademark Office (“USPTO”) and the United States Copyright Office Report to Congress.
[Written in October of 2024 by Kai Wang with the Wex Definitions Team]