An overview of the next generation NFT

In addition to the global correction, one factor behind the drop in demand for NFT tokens was the lack of practical value of most digital assets in this class. In other words, they had no utility, unlike conventional cryptocurrencies such as Bitcoin and Ethereum, which are actively used in payments and as core assets in the decentralized finance market (DeFi).

The shortcomings found in the early NFT market led to a new phase of development in this sector, dubbed NFT 2.0.

Background

The first game, CryptoKitties, launched on the Ethereum blockchain in 2017, right before the first large-scale boom in the cryptocurrency market, created a real furor and even almost led to a network shutdown due to a large influx of transactions. Players bred virtual cats en masse and exchanged them with other users. At the peak of the game's popularity, prices for some "cryptocats" exceeded a hundred thousand dollars, and the volume of trades reached $1.3 million.

CryptoKitties was also the first decentralized application (DApp) and the first blockchain game to use non-fungible token (NFT) technology and the ERC-721 standard, which was specially created for this purpose on the Ethereum network.

In June of the same year, the first NFT collection, CryptoPunks, was released. It was a set of 10,000 randomly generated pixel images with busts of punks. The value of some of the NFTs in this collection reached millions of dollars. For example, in February 2022, CryptoPunk token #5822 was sold at auction for a record $23.7 million (8,000 ETH).

However, interest in NFT began to wane that same year amid a general correction in the cryptocurrency market. Over the 2022-2023 period, trading volumes and NFTs' value fell significantly.

If in January 2022, the trading volume of NFT tokens amounted to $5.8 billion per month, then by the beginning of 2023, this figure has fallen to $988 million, more than 5.8 times.

Also, according to the analytical services NFT Scan and CoinMarketCap, more than 95% of NFT tokens have practically lost their value. For example, NFT from the popular Bored Ape Yacht Club (BAYC) collection with the number #8585 lost about 80% of its value in just 11 months in 2023 — from 777 to 153 ETH. And the value of NFT CryptoPunk #5822 has roughly halved.

What is NFT 2.0, and how has the market for non-replaceable tokens changed?

Based on the ERC-721 and ERC-1155 standards in Ethereum, early NFTs were static, and their value was determined only by their rarity. All these NFTs had the same properties: uniqueness, indivisibility (NFTs cannot be split into fractions like Bitcoin, for example), and non-interchangeability, i.e., they cannot be converted into other tokens as it can be done with ordinary assets on the exchange.

However, after a significant upgrade to the Ethereum network called The Merge, the transition to the Proof-of-Stake (PoS) consensus mechanism, and the introduction of the new EIP-6551, two new token formats have emerged in the Ethereum ecosystem:

• ERC-6551, which allows for each NFT token in the ERC-721 format to create a separate account (Ethereum account) and even its smart contracts for each NFT token;
• ERC-404 allowed the creation of unique tokens that combine the ERC-721 and ERC-20 formats and, as a result, jointly own NFT assets.

With the introduction of the new ERC-6551 format, it became possible to create two new formats of non-interchangeable tokens on the Ethereum blockchain:

1. Dynamic NFTs or dNFTs are a type of non-interchangeable tokens that can have their own unique and changeable properties. For example, NFTs of game characters or avatars;
2. Interactive NFTs are non-interchangeable tokens that can interact with DeFi applications such as decentralized games or social networks. In the form of NFTs, it is possible to issue, for example, lootboxes in games or passes to a closed community.

In this way, NFT 2.0 has gained new properties that make non-interchangeable tokens utilitarian and thus increase their value:

• Dynamism and interactivity: the ability to change the properties of NFT tokens;
• Programmability: the ability to create smart contracts for NFT tokens with unique features;
• Tokenization: creating digital artifacts for physical assets.

Another feature of NFT 2.0, acquired with the introduction of EIP-6551, was the ability to create NFT tokens that are themselves crypto-wallets, i.e., they allow the storage of other assets such as ERC-20 and even ERC-721. Thus, an NFT asset can now be made not just as a unique picture, of which there are already countless, but as a full-fledged account with a history — this also creates additional value for the token. In addition, NFT can also become a smart account, i.e., a cryptocurrency wallet endowed with smart contracts capable of interacting with decentralized applications (DApps).

The ERC-404 format allows the creation of divisible NFT tokens that are "split" into parts. These tokens are called "semi-replaceable." This has further enhanced the functionality of NFT tokens. For example, users can burn split tokens to get a full NFT.

Where does NFT 2.0 apply?

New format tokens are actively integrated into many decentralized applications, especially in games and DAO projects. Here are a few areas where NFT 2.0 is being used:

• GameFi: some blockchain games, such as Illivium and Parallel, represent characters in the form of NFT tokens — these assets contain, for example, the progress achieved by players;
• DeFi: NFT tokens are used as a collateral asset to secure loans, e.g. in BendDAO;
• RWA (Real World Tokenized Assets): with the advent of new NFT formats, tokenizing physical assets such as real estate and collectibles has become possible. This practice is already underway in Web3 projects Propy and RealT;
• SocialFi: for example, the Lens Protocol platform uses NFT to identify profiles. In other words, only owners of special NFT tokens can start a profile in Lens Protocol, which protects the platform from spam and bots.

In the future, NFT 2.0 will cover other emerging areas, such as artificial intelligence (AI). NFTs are expected to become generative, i.e., created and modified using neural networks. Such tokens already exist and are called AI-NFTs. For example, the Alethea AI project allows you to create NFT characters that can communicate and interact with each other.

Experts also believe that in the near future, a whole separate market will be formed, which will be called NFT Finance or NFT-Fi. NFT Finance will become an ecosystem that will combine non-interchangeable tokens and decentralized finance (DeFi). Thus, crypto users will soon be able to see, for example, NFT futures and so-called "insurance" tokens.

While first-generation NFT tokens were just static and useless assets, NFT 2.0 has become a real financial instrument capable of solving many practical tasks, from trading and tokenization to intellectual property protection and insurance.