The combination of smart contracts and NFTs provides a range of use cases and possibilities. To fully understand the potential of these technologies it is essential to understand NFTs and smart contracts in more detail.
What is a smart contract?
Non-fungible tokens known as NFTs have been trending hot recently. NFTs are basically crypto tokens managed on blockchains. On the other hand, the function of a NFT is based on underlying smart contracts. Therefore, smart contracts are central to the functioning of non-fungible tokens. They could primarily be considered as pieces of software code that allow the network to store the information in a transparent and immutable manner. In fact, these codes are developed and used to control the digital assets known as NFTs.
To be more precise, smart contract represents programming which works within the blockchain. Hence, networks are able to store the information indicated in an NFT transaction. Once the information is stored, it is accessible when needed. The smart contract also ensures that the information stored is not only transparent but also immutable.
As smart contracts run over NFTs, they can govern various actions such as:
- Verifying the ownership
- Handling the transferability
Although smart contracts are software applications, they make NFTs programmable to be able to go both beyond their basic functions and add on other functionalities, such as linking to other digital assets, handling royalty payments, etc. Smart contracts offer the opportunity to have permanent identification information and ensure that NFTs cannot be divided into smaller units to be sold. Furthermore, the smart contracts are there to make sure that the digital assets are one-of-a-kind and non-replicable, which makes the NFTs scarce, rare and, as the result, valuable. All these can be represented digitally on the blockchain.
There are a series of if/then and when statements written as a code into the blockchain in the very core of a smart contract. A network of computers executes all the agreed upon actions coded in the smart contract and each action is executed under the condition that the predetermined conditions are met and verified.
How Are Smart Contracts Created?
When you mint and NFT, you basically write the underlying smart contract code which in fact decides the qualities of the NFT and adds these qualities to the relevant blockchain the specific NFT coded in. Among many standards established for smart contracts, Ethereum is one of the very first.
Standards of smart contracts when creating NFTs
As already mentioned, Ethereum is the most used with NFTs and here we will look at the Ethereum standards: ERC 1155 Standard and ERC 721 Standard.
- ERC 721 Standard
ERC 721 Standard is an open standard that describes how to build non fungible tokens on the Ethereum blockchain. ERC 721 is unique and unlike most other tokens. ERC721 standard defines the workings of a smart contract. When a token is transferred you need 2 pieces of information: Address of the smart contract and the ID of the token. Notice that a single ERC721 has the ability to manage multiple tokens.
- ERC 1155 Standard
The ERC 1155 is a multi-token standard that allows each token ID to represent its own configurable token type with its own metadata attributes and supply. Besides Ethereum, there are other smart contract blockchains with NFT tools including TRON, EOS, TEZOS and Solarium. This standardization of NFTs will help in ensuring interoperability of the tokens.
Keep in mind that NFTs tokens may operate differently based on the blockchain platforms they are executed in.The series of capabilities with a blockchain may bring in variations in the operations of the NFTs. However, these variations are usually small and adjustments are made so that the smart contracts adapt to the blockchains environments they are executed in.
How Do Smart Contracts Verify Authenticity?
The main purpose of a smart contract is to verify authenticity the token and its ownership. They can also trace the unique history of the development and linking to a creative work using a public blockchain. You can also verify the wallet address and its linked metadata from the public blockchains. However, it cannot link to any person in the real world or verify if the creator has the rights to link the NFT to specific works. To your knowledge, the platforms that display and sell the NFTs will verify the identifies of the creators by collecting the name, email, and specific details of the art work or add in disclaimers that the buyers search before buying any NFT.
How Do Smart Contracts Prevent Counterfeiting?
When an NFT is traded, a unique token is issued which has the information and the details of the smart contract all of which registered on the blockchain. Now this information on the blockchain is public and includes the record of purchase and proof of ownership.
The owner may display the digital asset and sell it. When the image is reproduced (as it is definitely possible if you display the work to the public), the blockchain will prove the ownership and the reproduced images or assets would be worthless. The personal key of the owner is required to authorize the transfer of NFTs on the blockchain.
What is Oracle?
A blockchain oracle is a trusted third party service that provides smart contracts including authenticated external sources of data from the real world which are obtained using an API. Oracles connect smart contracts with events around the world, therefore they are often triggered by an outside event. Oracles are developed to provide a wide range of data to smart contracts. For example, an oracle could provide real world weather data, outcomes of events, outcomes of legal cases, financial statistics, economic data, interest rates, market data, etc. Since most smart contracts are meant to be executed when a condition is met in the real world, oracles basically are the sources of data that can provide authenticated data about real world events.
In the case of larger bets, smart contracts may compromise and add multiple oracles to ensure that multiple sources or oracles validate the same outcome. Therefore, a smart contract may require five oracles, for example, to signal the exact same outcome before the contract can be executed.
How do smart contracts and NFTs interact with each other?
Smart contract is useful in business transactions where the specific agreement has to be enforced. This removes any uncertainty of the outcome and third parties can be avoided completely. There are two primary ways in which smart contracts and NFTs can interact with each other: NFT’s can be embedded in smart contracts and NFT’s can be embedded within smart contracts. A smart contract can own an NFT within it which can be later transferred to a user or another contract based on the rules and events defined in the smart contract.
On the other hand, a smart contract can be embedded in an NFT to call and access assets within the NFT. For example, a user can access a song which is embedded in an NFT through a smart contract. They would agree upon the terms using the smart contract, pay the agreed upon amount and then get access to that song. This is a process that will most likely run in the background when users start playing on their applications.
Now it is clear that combining NFTs with smart contracts will give users the flexibility to take their hands on wide kinds of cases. Depending on the case, complex contractual structures and agreements can be created. Meanwhile, the underlying blockchain mechanism make the contracts transparent, tamper proof and auditable in real time, which simplify and speed up any probable process in the future.
Overall, smart contracts form the building blocks of any NFT. NFTs have several enterprise use cases and have massive implications for media and Digital Rights Management which all could be managed and observed using smart contracts dedicated to each single NFT.
