Understanding NFTs and semi-fungible tokens: From asset characteristics to market applications

The development of blockchain technology has dramatically transformed the landscape of the financial world. Following cryptocurrencies and blockchain, non-fungible tokens (NFTs) have rapidly risen to prominence, and now another asset class—semi-fungible tokens—is gradually gaining mainstream attention. If you are unfamiliar with semi-fungible tokens or confused about the differences between NFTs and semi-fungible tokens, this article will provide a comprehensive explanation of these two concepts and their application scenarios.

Two Asset Characteristics: Fungibility and Uniqueness

To understand NFTs and semi-fungible tokens, first grasp the two fundamental properties of assets.

Fungible assets refer to asset classes that can be exchanged on a 1:1 basis. For example, one US dollar bill is equivalent in value to another US dollar bill; regardless of their condition, they can be exchanged directly. Cryptocurrencies and fiat currencies are examples of fungible assets.

Non-fungible assets are entirely different. When two assets cannot be exchanged at equal value, they are considered non-fungible. Each non-fungible token (NFT) has a unique digital identity representing proof of ownership by the creator. Due to differences in rarity, features, value, and popularity, two non-fungible tokens cannot be exchanged with each other.

In short: fungible assets are easy to circulate, while unique assets each have their own value.

Overview of Non-Fungible Tokens

NFTs are blockchain assets with a unique digital signature used to prove the originality and ownership of digital assets. These assets are diverse, including artworks, music files, images, videos, virtual land, and items within blockchain games.

The core characteristic of NFTs is their non-interchangeability—even if two NFTs are created by the same artist or share similar features, they remain unique. On open NFT marketplaces, even if priced the same, each asset is different.

NFTs aim to protect digital creators’ copyrights, ensuring they can earn fair revenue from their creative labor and prevent piracy. This concept gained widespread attention starting in 2020, and by the end of 2020 and into 2021, trading volumes had reached billions of dollars.

Development and Evolution of NFTs

Many consider NFTs a recent innovation, but the concept of non-fungible tokens predates their boom in 2021.

NFTs trace back to 2012 when Meni Rosenfield first proposed the idea of using “colored coins” on the Bitcoin blockchain to manage and represent ownership of real-world assets, turning them into unique tokens. Although limited by Bitcoin’s space constraints and original design, this idea laid the groundwork for later NFTs.

Key milestones in NFT development include:

• 2014: “Quantum” becomes the first NFT—a pixelated octagon with rhythmic scaling and color changes—created by artist Kevin McCoy on the Namecoin blockchain.

• 2016: Internet memes begin to be minted as NFTs, bringing new creative forms to the space.

• 2017-2020: The Ethereum smart contract standards become widely adopted, shifting NFT development focus to the Ethereum blockchain, with rapid growth in projects and trading volume.

• The Cryptopunks and Cryptokitties era: Inspired by the success of Rare Pepes NFTs, Cryptopunks by John Watkinson and Matt Hall launched on Ethereum. Subsequently, Cryptokitties gained massive popularity during Ethereum’s largest hackathon, igniting the NFT craze.

• 2021 breakthrough: NFT artworks start selling at major auction houses; Beeple’s NFT piece sets sales records, marking explosive growth in the market.

• Multi-chain expansion: As NFT sales surge, other blockchains like Cardano, Solana, Tezos, and Flow begin participating.

• Metaverse era: NFTs become especially popular in virtual worlds, such as virtual real estate. Facebook rebranded as Meta, focusing on the metaverse, further propelling NFT development.

Application Fields of Non-Fungible Tokens

NFTs are mainly adopted in gaming, art, and music industries. Although these three sectors currently dominate, NFTs are applicable to nearly any industry—any real-world asset can be tokenized into a rare collectible. Use cases include identity verification, proof of ownership, and digital goods trading, with applications continuously expanding.

How Semi-Fungible Tokens Work

Semi-fungible tokens (SFTs) are a unique asset class that can flexibly transition between fungible and non-fungible states, combining features of both asset types to offer greater flexibility and functionality.

Unlike traditional NFTs, semi-fungible tokens initially exist as fungible tokens that can be exchanged with similar tokens. They only transform into non-fungible tokens with unique value after being used or under specific conditions.

A simple example is a concert ticket. When purchased, the ticket is a fungible asset—any ticket in the same row can be exchanged. After the concert, the ticket’s fungibility ends; it can no longer be exchanged for a new valid ticket. It becomes a collectible, a memento of a memorable event. At this point, the ticket turns into a non-fungible asset, unique to the owner, with value depending on the rarity and popularity of the event.

Semi-fungible tokens are based on the ERC-1155 standard on the Ethereum blockchain. This standard allows a single smart contract to support multiple semi-fungible tokens, complementing the ERC-20 (fungible tokens) and ERC-721 (NFTs) standards.

Technical Architecture: Comparing Token Standards

Understanding the differences among the three main token standards is crucial for grasping the technical foundation of NFTs and semi-fungible tokens.

ERC-721: The Core of NFTs

ERC-721 is the most widely used standard for NFTs on Ethereum. It defines a protocol for token functionality and capabilities, enabling NFTs to be traded and created. Creating non-fungible tokens on Ethereum requires strict adherence to ERC-721 rules and specifications.

ERC-721’s advantage lies in allowing developers to add advanced features, such as verifying authenticity sources, fulfilling the unique needs of non-fungible items. However, it also has notable drawbacks—particularly the issue of multiple transactions. Each transfer can only handle one NFT at a time; sending 50 NFTs requires 50 separate transactions. This is time-consuming and can congest the Ethereum network, significantly increasing transaction fees.

ERC-1155: A Flexible Multi-Token Standard

ERC-1155, also known as the multi-token standard, is an optimized fusion of ERC-721 and ERC-20. It provides flexibility and multiple functions for created tokens. Semi-fungible tokens sit between fungible and non-fungible assets, addressing limitations of both and enhancing their advantages.

For example, with fungible tokens, a key limitation is irreversible transactions—sending tokens to the wrong address cannot be undone. Semi-fungible tokens allow for reversible transactions in case of human error.

For non-fungible tokens, the problem is transaction limitation—each smart contract can only send one NFT at a time. Semi-fungible tokens enable multiple transfers within a single transaction, reducing costs and network congestion.

ERC-404: An Innovative Hybrid Standard

ERC-404 is an innovative token standard in the Ethereum ecosystem designed to merge the functionalities of ERC-20 (fungible tokens) and ERC-721 (NFTs). Unlike ERC-721, which is tailored solely for NFTs, or ERC-1155, which manages multiple token types within one contract, ERC-404 introduces a new concept.

It allows tokens to operate as fungible under certain conditions and as non-fungible under others—effectively combining the two. This dual functionality fosters new digital assets that are both flexible like fungible tokens and unique like NFTs, expanding application scenarios and improving liquidity options.

Developed by anonymous creators “ctrl” and “Acme,” ERC-404 aims to enhance NFT liquidity and enable fractional ownership trading, addressing liquidity challenges faced in traditional auctions.

However, ERC-404 has not yet undergone formal Ethereum Improvement Proposal (EIP) review, lacking the usual rigorous review process. This informal introduction raises concerns about security and potential misuse, including rug pulls and smart contract signature risks. Nonetheless, projects like Pandora, DeFrogs, and Rug are exploring ERC-404’s potential, indicating growing interest in hybrid token models.

Practical Applications and Market Trends

Currently, semi-fungible tokens are mainly used in blockchain gaming, covering in-game items that can serve as both fungible and non-fungible assets. As awareness of SFTs deepens, industries are exploring their potential beyond gaming.

In gaming, players might encounter tokens that start as NFTs but can be exchanged for in-game currency, such as tokens that can be traded for game coins. These coins can then be used to buy items or weapons, which can be converted back into NFTs on the marketplace. As players level up, items may appreciate in value. Smart contracts embedded in the game drive these state changes, and the ability to easily swap tokens makes them suitable for multiplayer online games. Developers can better track assets and cash flow, gaining more control compared to uncontrolled inflation seen in early MMOs.

Enjin and Horizon Games developed the ERC-1155 standard and The Sandbox platform for managing and regulating semi-fungible tokens within games using a single smart contract.

Combining Semi-Fungible Tokens with Real-World Asset Tokenization

Semi-fungible tokens offer a unique solution for tokenizing real-world assets (RWA), addressing challenges faced by fully fungible or non-fungible tokens. SFTs can represent the initial fungible portion of an asset (e.g., real estate shares) and, under certain conditions, convert into non-fungible tokens, enhancing liquidity and accessibility, and providing greater flexibility in ownership and trading.

They can also dynamically reflect changes in asset value, status, or conditions. SFTs facilitate efficient fractional ownership of indivisible assets, lowering investment barriers. By enabling trading on digital platforms, SFTs improve liquidity for traditionally illiquid assets.

These tokens can encode specific rights, returns, or obligations related to RWAs, with state transitions from fungible to non-fungible designed to meet regulatory requirements and enable asset tracking. Additionally, SFTs support innovative asset financing and investment structures, combining liquidity of fungible tokens with the uniqueness of NFTs to create new investment products and opportunities.

Key Takeaways

Asset tokenization is rapidly becoming a market hotspot due to its vast potential driven by market demand. The NFT ecosystem is transforming industries and gaining wider adoption, enabled by blockchain technology to realize ownership and data protection in new ways.

NFTs and semi-fungible tokens are ushering in a wave of change, redefining profit models for digital content creators, artists, enterprises, blockchain game developers, and players, while increasing accessibility for customers and fans.

Although semi-fungible tokens are currently mainly used for in-game assets, as technology matures and understanding deepens, they are expected to find applications across various industries beyond gaming, becoming a significant force in the evolution of asset tokenization.