How to Create Non-Fungible Tokens Without Cryptocurrency

“Or How to Create NFTs on eBay That Confer Real Ownership”

This talk was presented at the COSM.technology conference, November 10, 2021, in Bellevue, Washington. The simultaneous slideshow presentation is available here.

[DISPLAY SLIDE 1]

1 The Buzz About NFTs

This summer I wrote an article titled “How Non-Fungible Tokens Work: NFTs Explained, Debunked, and Legitimized.” I wrote it for Expensivity.com, a money and business website aspiring to rival NerdWallet and Investopedia. The article received favorable notice from the organizers of this event, which accounts for my talk here this afternoon.

I want in this talk to summarize that article’s key contribution, which was to propose a protocol for creating, buying, and selling NFTs that can be run independently of cryptocurrencies and that instead can be made to work in ordinary marketplaces trading ordinary currencies. Cryptocurrencies are not just inessential to NFTs but in fact sabotage their full potential. NFTs, as currently practiced, confine ownership of an underlying digital asset to a cryptocurrency blockchain rather than to the actual market where legal ownership can and must be secured. NFTs, for now, confer fake ownership, not real ownership. Before detailing this protocol, however, I want first to review the current state of NFTs and explain why it is deeply flawed.

The first half of 2021 saw a remarkable buzz about non-fungible tokens as well as mounting praise of cryptocurrencies for making NFTs possible. Thus, we saw Jack Dorsey selling the first tweet he ever posted on Twitter for $2.9 million. [SLIDE 2] Thus, someone named Sillytuna put up at Sotheby’s the Larva Labs 24-by-24 pixelated image titled CryptoPunk #7523. It sold, over the Ethereum blockchain, to an anonymous buyer for $11.75 million, which comes to more than $20,000 per pixel. [SLIDE 3] And last but not least, in March of this year, artist Mike Winkelmann (aka Beeple) put up for sale at Christie’s a 5,000-image collage titled Everydays. It sold to Vignesh Sundaresan (aka Metakovan) for over $69.3 million, which comes to almost $14,000 per image in the collage. It remains the highest priced NFT ever sold. [SLIDE 4]

Exuberance and disbelief were the most common reactions to the wild prices paid for these and other NFTs. As of early November 2021, Wikipedia records 38 NFTs selling for $1 million or more. Of these, the top 35 were all transacted on the Ethereum blockchain, with the Solana and Cardano blockchains breaking in at spots 36 to 38. All of these NFTs were bought and sold as digital collectibles. Hence the reference to “non-fungible”: each digital collectible ought in some way to be unique and thus not interchangeable with another (unlike cryptocurrencies, where one coin of a given denomination on a given blockchain is fully interchangeable with another).

2 Buying and Selling NFTs on a Blockchain

But what does it even mean to buy or sell an NFT? Sure enough, when an NFT sells at Sotheby’s or Christie’s, these auction houses receive their commissions in ordinary currency. But that’s after the main transaction in terms of cryptocurrencies and their associated blockchains has taken place. Only then will cryptocurrency need to be exchanged into ordinary currency to pay the auction house (and possibly the seller, unless the seller is happy to be paid in cryptocurrency).

But what exactly does the buyer get in such a transaction? This is where it gets funky. Digital collectibles are just digital files, and digital files can be copied at will with full fidelity (unlike real physical art, where copies will always be distinguishable from the original). So buying a digital collectible can’t just mean gaining access to a digital file and copying it to your electronic storage. There has to be something more to it, and there is.

To understand what the buyer of an NFT is getting, let’s examine Jack Dorsey’s first tweet, which he turned into an NFT and sold for $2.9 million, placing it currently among the twenty most expensive NFTs ever sold. Dorsey’s first tweet is, like every other digital thing, a digital file. For convenience and ease of display (and without in any way compromising the generality of this discussion), let’s take his first tweet to be a jpeg image. [SLIDE 5]

A million-dollar question (literally) now confronts us: what is the magic alchemy that turns any old digital file like this into an NFT potentially worth millions of dollars? You’ve got the digital file in its full glory. Indeed, you’ll never find some hidden dimension to Dorsey’s first tweet by probing deeper and uncovering some unanticipated digital layer.

In answer then to the question what turns any old digital file into an NFT, it is this: namely, a digital signature applied within a digital marketplace, and specifically on a blockchain running a cryptocurrency. The blockchain functions as a digital marketplace in which ownership of digital items is transferred from one party (usually called “Alice”) to another party (usually called “Bob”) in the act of Alice applying a digital signature to the digital item and designating Bob as the recipient.

In a blockchain-based digital marketplace, Alice, Bob, and any other transacting agents each use a public/private cryptographic key. The public key serves as the address to which digital items are assigned, the private key as the way to sign these digital items, authorizing their transfer from one party (or address) to another.

Thus, if Alice wants to sign a digital item over to Bob, she takes the digital item, attaches to it Bob’s address (from his public key), and then signs the combined item plus address with her private key. By signing with her private key, she authorizes the change in ownership of the digital item from herself to Bob, making clear to all members of the blockchain-based digital market that Bob now owns the digital item. And because the digital market is a blockchain, it provides a secure, untamperable ledger that reliably records the transaction.

Here’s how all this played out with Jack Dorsey’s first tweet: Dorsey (acting as “Alice”) uploaded his first tweet onto the Valuables platform, which served as an auction house for it. Valuables then handed over Dorsey’s digitally signed tweet to the highest bidder, namely, the Malaysian businessman Sina Estavi (acting as “Bob”). The transaction was run over the Ethereum blockchain, with Estavi in early March 2021 paying 1630.5825601 ETH (about $2.9 million at the time), 5 percent going to the Valuables platform as a commission and the remaining 95 percent going to Dorsey, who in turn gave his portion to people in Africa impacted by COVID-19.

Anyone besides Dorsey could have taken his first tweet and likewise put it up for auction on the Valuables platform or one equivalent to it. Anyone can still do this. Dorsey can do it again, putting his first tweet up for sale a second time. What if he did? Would the second signed version sell for a lot less than the first time around? Probably. Would putting it up again devalue the version that Estavi bought? Probably.

While NFTs are new, the debasement of value by proliferating copies whose marginal value is close to zero has a long and ignominious history. This is especially a danger for NFTs (a danger that elite NFT exchanges, such as SuperRare, acknowledge by underscoring the need for scarcity and therefore accepting digital artists by invitation only). In fact, what ends up being non-fungible is not any digital item per se, but the signing of it from one party (such as Dorsey) to another (such as Estavi).

3 Real vs. Blockchain Ownership

In this account of how digital signatures help transact business within a digital marketplace, there’s a sharp disconnect between digital (or blockchain) ownership on the one hand and real ownership on the other. When I own a physical item, often it’s close by me, and transferring ownership simply means moving it from my hands into someone else’s hands. If it is particularly large, bulky, or valuable, such as a piece of real estate, transferring ownership will involve signing paperwork with an official recording office, thus ensuring that the transfer has the full endorsement and power of law behind it.

In a real marketplace, even if the property is intellectual property (such as a patent or copyright, whose form can be entirely digital), there will likewise need to be a contractual transfer of the rights for that intellectual property to a new party, with the transfer again having the full endorsement and power of law behind it. For instance, if, in making an intellectual property purchase, I acquire the copyright to a picture, even a digital picture, the real market that operates in our society ensures that the transfer is subject to its laws and strictures. Through my purchase, I will own the picture in a real sense and can take legal action against anyone who tries to infringe on my copyright (such as by posting it on a website without my permission).

By contrast, the concept of owning an NFT on a blockchain is specific to the blockchain with no legal force. Suppose I snap a digital photo. Because I’m the one who snapped the photo, U.S. law makes me its copyright owner. Within the real marketplace of our society, I can sell the photo, license it, or just keep it. But suppose I decide to take it, as a digital file, upload it onto a blockchain, and then “sell” it to another party as a cryptographic transfer in a cryptocurrency that runs on that blockchain. This party signs over to me a certain amount of the cryptocurrency and I sign over to that party the digital file, all on the cryptocurrency’s blockchain.

Let’s now pose another million-dollar question: in what sense did I “sell” the digital file? Within the marketplace of that blockchain, as a matter of convention, it would now be said that I no longer own the digital photo and that the other party now does. So, in that sense, I sold it. But such conventional reassignments of ownership within a blockchain ecosystem mean nothing as far as the real marketplace and real legal system of our society is concerned. I could, for instance, put that digital photo as an NFT on the Ethereum blockchain, get paid handsomely by you in ether, and then, when you use that photo on your website, sue you and try to collect damages for copyright infringement.

You think I’m kidding? Let’s try it right now. [SLIDE 6] You are looking at an NFT that I created at Rarible, an NFT exchange that operates on the Ethereum blockchain. This NFT is a collage of pictures taken by my wife during the 2007 Democratic primary in Iowa, most of the pictures having my 8-year old daughter cropped out, but originally standing with the politician or media personality depicted. I’ve listed this NFT for 0.1 ether, which at the moment, according to CoinMarketCap.com, comes to about $475. A bargain for this priceless piece of history.

But seriously, unless my signing over of this digital image on the Ethereum blockchain to you, whether directly or through an NFT exchange like Rarible, is combined with a parallel signing over of actual copyright in the real marketplace of our society at large, all you can do is reassign this image to other participants on the blockchain where it was uploaded and where I signed it over to you. In effect, you’re forever stuck on the blockchain where the NFT resides.

Try to go outside this blockchain and use my image? Compliance organizations employ software to track unauthorized uses of images on the web. Some bad actors even make a business of dangling tempting images in front of unsuspecting people on the web, and then suing those who inadvertently, but without permission, post the images online. It’s actually quite a racket. So if you download my collage image and post it anywhere online, even if you have paid for it with ether at Rarible, you will be liable and I can sue you. I wouldn’t, but I could.

4 Bogus Reasons for Tying NFTs to Blockchain

SuperRare, the most prestigious NFT exchange for digital artists, offers the following rationale for NFTs: “The creation of the internet made it nearly impossible for digital artists and creators to 1) prove they created a digital work and 2) monetize these digital creations because everything could be freely downloaded. Ethereum, and the non-fungible token standard (ERC-721) has made huge strides towards solving this problem. For the first time ever, digital creators now have the ability to tokenize their digital artworks as 1 of a kind assets that can be bought, sold and traded, with the provenance of ownership and previous sales/bids being forever recorded on the blockchain.”

This is the state-of-the-art argument for legitimating NFTs, and it is deeply flawed. First off, proving that one is the creator of work that exists only digitally is straightforward. Photographers do this all the time, and photo banks such as Getty Images would be out of business except for this fact. Proving creation of digital work these days usually requires having a clear web identity, such as with a blog, and then posting the digital work on it. This is what Mike Winkelmann did for years, and no one questioned that he was the creator and owner of the digital art that appeared on his website (Beeple-Collect.com).

Provenance is also straightforward and typically amounts to identifying a point of origin (usually the first place where a digital work appeared) and then tracking a digital item’s history across the web. Monetization (i.e., making money) from digital creations requires some technology, but nothing so state-of-the-art as blockchain. Digital data embedding technologies (such as watermarking and steganography) can claim title to a digital asset and encourage payment for it. So too, copyright laws and a digital artist’s willingness to enforce them, give legal teeth to one’s claim as creator of a digital asset and thus one’s ability to monetize it.

Two big problems exist with running NFTs on cryptocurrency blockchains. First, as already noted, ownership on the Ethereum blockchain is not ownership in the real world. Real world ownership is ownership with the force of law behind it. Ethereum blockchain-based ownership is purely conventional ownership. It applies only within the Ethereum ecosystem, and nowhere outside. Intellectual property law, for instance, remains in full force and will hold irrespective of NFT ownership. Hence, if you want to use or post online the digital art that is the basis for your NFT, you’ll need to get separate authorizations for it (ideally with the help of an intellectual property attorney).

The other problem is more radical, so let me state it baldly: NFTs shouldn’t even be on cryptocurrency-based token-standardized blockchains (such as Ethereum’s ERC-721). Blockchain makes sense for cryptocurrencies precisely because they transact fungible tokens. The most important reason for blockchain in cryptocurrencies is to avoid the double-spend problem, which is spending the same item of digital currency twice. This is a problem with fungible tokens because they are all interchangeable. But non-fungible tokens, precisely because they are non-fungible, and therefore distinguishable, do not face a double-spend problem, and thus need not be controlled with a blockchain in the same way as a fungible cryptocurrency.

But what about payment for NFTs? There’s no inherent need for such payments to be made with a cryptocurrency. In fact, NFTs can be created without the need of blockchains and paid for with ordinary currencies. With one slight adjustment, NFTs could be handled at eBay, the adjustment being that eBay would need to make its archive of past auctions available permanently rather than just for the past 90 days, as it does now. Moreover, it’s possible to roll into NFTs full authorization for real legal ownership of the underlying digital asset. I sketch out next such a radical reconceptualization of NFTs.

[SLIDE 7]

5 The DIY Protocol for Creating and Transacting NFTs on eBay

The best way to challenge a ruling idea is to replace it with a better one. I’m going to lay out a protocol for handling NFTs that dispenses with cryptocurrency-based blockchains and works in ordinary online marketplaces like eBay. As an added benefit, transfers of ownership of the underlying digital asset will have full legal force (none of this phony baloney “ownership” of the digital asset solely from the standpoint of the Ethereum blockchain but nowhere else). I call this a DIY (or Do It Yourself) protocol because its technological prerequisites are minimal, allowing you to create and trade NFTs without Vitalik Buterin’s blessing.

STEP 1: Establish a clear and true online identity. [SLIDE 8]

In contrast to cryptocurrencies, which historically have put a premium on anonymity, you need to have a clear and true identity that people can associate with the digital assets you create and trade.

Unlike cryptocurrencies and fungible tokens, where anonymity is a virtue, anonymity is a vice for creators of non-fungible tokens. For simplicity, let’s assume therefore that you have a blog where your identity is made manifest.

STEP 2: Create digital asset. [SLIDE 9]

Next, create a digital asset. As a matter of intellectual property law, because you are its creator, you own it, and you can transfer ownership or license to it on whatever terms you stipulate.

STEP 3: Assert effective ownership of digital asset. [SLIDE 10]

Make clear that this is your digital asset. You can do so by posting it online in a space clearly identified with you, perhaps only making it partially available (just enough to establish creative priority).

One powerful approach to partial availability is to post what I call an “anticipatory hash.” In other words, use a cryptographic hash function such as SHA-256 and apply it to your digital asset (which is just a digital file). Post the hash. Because hash functions are one-way functions, no one is going to be able to figure out from the hash what the digital asset is.

The moment the hash appears on your blog (or at whatever space on the web that you control) and once it is marked with a clear time and date stamp, your claim to the digital asset is in force because at whatever later date the digital asset is revealed, it will be clear that it was fully known to you at the point when the anticipatory hash was made public.

STEP 4: Get yourself a public/private cryptographic key. [SLIDE 11]

Go with a public-key cryptosystem that you like (such as RSA) and get yourself a public and private key that are secure along with a convenient way to implement these to encrypt and decrypt messages. The necessary cryptographic tools are readily available online.

STEP 5: Publicize the public key and tie it clearly to your identity. [SLIDE 12]

The public key will serve as your address where you can receive and send NFTs. Post the public key clearly on your blog or other controlled online space. And, as always, keep your private key private.

STEP 6: Offer your digital asset for sale on eBay. [SLIDE 13]

Provide a description of the asset on eBay along with the terms of payment (fixed price, auction, best offer, etc.). Indicate that the buyer will need to provide a public cryptographic key as an address to which the digital asset will be made out (i.e., digitally signed using your private key) once payment is made.

STEP 7: Receive payment in dollars via eBay. [SLIDE 14]

Simply use eBay’s PayPal or credit card payment system to receive payment for your digital asset in U.S. dollars or any other ordinary currency eBay may let you use.

STEP 8: Receive buyer’s public cryptographic key as address. [SLIDE 15]

Along with the payment, the buyer will provide you with the buyer’s public cryptographic key as the identity to which the NFT you are selling will be assigned.

STEP 9: Form an NFT consisting of the digital asset and a transfer of ownership agreement. [SLIDE 16]

The digital asset is yours, so in tokenizing it as an NFT, you can append legal documentation to it. Write up a transfer of ownership document that agrees to transfer ownership of the digital asset and incorporate it into the NFT.

This is where we depart radically from NFTs residing on cryptocurrency blockchains. A transfer of ownership document that identifies the seller and the buyer by their respective private keys and that identifies the digital asset by a hash can thereby be incorporated into the NFT.

The digital asset and the transfer of ownership document can then be collected together into a zip file (or some other single file), which can then be digitally signed by the seller’s private key. Here’s what the transfer of ownership document can look like (items in double-square brackets serve as placeholders):

[SLIDE 17]

TRANSFER OF OWNERSHIP AGREEMENT
[[Alice]], whose public cryptographic key is [[PubK1]], as the owner of digital asset [[DA]] whose identifying hash is [[hashDA]], agrees to transfer ownership of [[DA]] to [[Bob]], whose public cryptographic key is [[PubK2]]. In granting ownership of [[DA]] to [[Bob]], [[Alice]] warrants that she is the full and sole owner of [[DA]], and that in transferring ownership to [[Bob]], she does so unconditionally, granting him full and sole ownership of [[DA]].

Combining the digital asset with this transfer agreement and then signing this combination with your private key [[PriK1]] forms your NFT. Your digital signature ensures that it is really you who are selling the digital asset and the legal documentation folded into the NFT ensures that it is a legally binding transfer from you, the seller, to your designated buyer.

Note that double selling is not a danger here because it’s like trying to sell the same house or car to two separate buyers. The law will catch up with you. This is unlike crypto, where crypto transfers are entirely conventional and occur within a crypto blockchain, and thus operate outside the law (which, perhaps, is why the government of China has outlawed cryptocurrencies).

STEP 10: Buyer downloads NFT and assumes ownership of underlying digital asset. [SLIDE 18]

This can be done from your blog or preferably from a link at eBay, which can then maintain a time-stamped record of such NFT transactions

STEP 11: Record at eBay sale of digital asset embedded in this NFT . [SLIDE 19]

Crucial here is to keep track of the seller’s public address and the buyer’s public address and that the NFT incorporates the necessary legal instrument to transfer the digital asset with full real-world ownership rights moving from seller to buyer.

STEP 12: Repeat previous steps so that buyer becomes seller and in turn can sell NFT. [SLIDE 20]

This is straightforward, simply requiring that the former buyer now substitute a new transfer of ownership document in the previous NFT, digitally sign this new NFT, and thereby transfer ownership to a new buyer. All this can be done on eBay in a repetition of the previous steps. In this way, the NFT becomes a negotiable instrument free of any cryptocurrency blockchain.

Of course, eBay, if it implemented this protocol, might want to use a blockchain to ensure that time and date stamps on such NFT digital-asset transactions were accurate. But that would be a minimal use of blockchain. Moreover, payment would be at the discretion of buyer and seller, as it always should be, rather than being tied to a particular currency, crypto or otherwise.

Note that nothing in this protocol demands that the NFT reside forever at eBay. The protocol makes NFTs fully portable to other marketplaces. Since real legal ownership is being transferred at each step of the way, ownership of the underlying digital asset will hold universally, and thus can be transferred at other marketplaces.

[SLIDE 21]

6 The Big Takeaway

NFTs are legitimate to the extent that they reside outside self-serving cryptocurrency blockchains (such as Ethereum) and allow for real-world legal transfers of ownership for underlying digital assets. The DIY Protocol shows how NFTs can accomplish transfers of real, legally binding ownership.