- Non-fungible tokens and smart contracts are the extended functionalities of blockchain technology encoded within a block.
- NFT is a unique digital asset, while a smart contract is an agreement between two parties that ensures secure transactions without involving a third party.
- When comparing NFTs and smart contracts, while there are certain similarities in their basic structure, there are vast functional differences in their utility.
Non-Fungible Tokens and smart contracts can be seen as two aspects of blockchain technology, both of which play a great role in expanding its services but in different ways. The two blockchain traits are quite different from each other in that NFTs are utilized as tokens that can be sold and purchased, while smart contracts enable the automated conditional execution of on-chain transactions, including those of NFTs.
Understanding Smart Contracts
Smart Contracts are one of the basic building blocks of advanced blockchains that act like applications and were first implemented by the Ethereum blockchain. They are transaction protocol programs that will carry out and control transactions between two parties as per the terms of the contract or agreement and will also document and store the events of the transaction.
One of the purposes is to decentralize the process by automating it and eliminating the requirement for a third party to secure it. It also ensures there is no contract breach or malicious action. It also eliminates the third party’s vulnerability to corruption and unintentional failures due to external attacks.
Notably, smart contracts are just virtual contracts in the form of programmable codes that execute certain activities on the blockchain in response to certain sets of actions and situations. They are not legal contracts or legally enforceable “real contracts”.
The most popular analogy for smart contracts is a vending machine. A vending machine will carry out the automatic delivery of a product in exchange for money as per the pre-written instructions, such as a specific item at a specific price. Likewise, a smart contract is self-executing and will verify if both parties meet the conditions of its code, and then execute and record the transaction automatically without an intermediary.
Once implemented, the smart contract will be updated and logged onto the blockchain, becoming immutable and tamper-proof.
Understanding Non-Fungible Tokens (NFTs)
Non-fungible tokens (NFTs) are digital assets minted on a blockchain that are unique, meaning no two NFTs are the same. For example, looking at a token or a coin such as BTC, one cannot tell the difference between the one recently mined and the one mined 10 years ago.
NFT has items in the form of virtual content material such as digital art, music, videos, movies, video games, photographs, digital real estate, real estate tokens, trademarks and patents. NFTs can also be used to represent real-world objects on a blockchain, tokenize them, establish their tamper-proof immutability, secure ownership and facilitate further transfers. Hence, they are very profitable for the artists and the overall art market.
The NFT technique of enabling digital collectibles on blockchain helps establish clean and highly secure ownership of the asset. Once the digital material is uploaded on the blockchain, it gets tokenized, meaning a token representing the item gets minted on the chain, which has a fixed price, mostly in cryptocurrency.
From there, it is available to be bought at that price and can be further sold in the secondary market. The complete trail of transactions, owners and other details will be recorded on-chain. This results in a distributed, decentralized and trustless ledger with details like transfers, royalty, revenue, holders, price history, etc. This enables a secure, transparent, easily accessible and proven record of each owner and the price of the digital item.
There are unique identification codes and metadata attached to an NFT, which are authenticated and verified on the blockchain. Unlike cryptocurrencies, NFTs cannot be exchanged at equivalency and are, therefore, non-fungible. They are only one of a kind, hence, very scarce in quantity, unlike fungible assets, and this scarcity of NFTs is what drives their value.
The Difference Between Non-Fungible Tokens and Smart Contracts
The basic structure of both NFTs and smart contracts is that they are codes on blocks of the blockchain. But smart contracts are software programs running in the nodes of the blockchain for use as tools for executing operations, while NFTs are tokens, an item that is used as an asset, like cryptocurrencies.
NFT codes are unique and represent the digital asset, while smart contract codes execute actions on the chain, which can be copied to be applied for the same action on subsequent blocks.
A vast majority of NFT collections are currently minted on the Ethereum blockchain, which was also the first implementer of smart contract functionality. But the emergence of new blockchains aiming to increase scalability and interoperability, and looking to market a wide range of DeFi activities has led to the adoption of both of them over other blockchains as well.
The cost of minting an NFT can be anywhere between $1 and $500, while a smart contract developer, on average, charges from $7,000 to $10,000. As they just represent an asset, NFT programs are fairly simple and limited to specific use cases. Smart contract programs, on the other hand, use complex logic and advanced programming languages to enable a vast array of on-chain as well as block operations such as dApps.
Notably, smart contracts eliminate the need for middlemen in a process, while NFTs are launched, bought and traded via third-party NFT marketplaces acting as mediators that have collections listed on them.
Also, almost all NFTs have an artistic attribute to them, while smart contracts are purely tech–software programs. Hence, an NFT can be created by anybody, any amateur person, while smart contracts can only be created by software developer experts.
Smart contract execution results in money transfers, data modification, ownership rights, implementing privacy protection, selective launch of data to meet a specific request, etc.
Examples of NFTs include Bored Apes collections, NYAN cats, LeBron James’ NBA shot, Jack Dorsey’s first original tweet and Injective Protocol’s Morons (White) NFT of the original painting of the same title by the renowned British street artist Banksy.
A Deeper Understanding of the Comparison of NFT and Smart Contracts
There are also major technical differences between NFTs and smart contracts. Both function based on program code but smart contracts are more fundamental to a blockchain. It is one of the building components. Any development of a block program needs to go through the smart contract for it to be executed.
For example, the Ethereum Request for Comment (ERC) standards are the protocols that allow the minting of any token on a block. These protocols will be incorporated into the smart contracts to enable the process of minting.
NFTs are minted according to the ERC-721 standard. Their trade using crypto coins and tokens is enabled by the ERC-20 standard. Further cross-chain acceptance and interoperability of NFTs are governed by the ERC-1155 standard.
Now, ERC-721 is used to represent the ownership of a non-fungible token in a smart contract. This is linked to an account that owns them. Now here’s the difference. Smart contracts are also codes linked to that account but they are not owned by those accounts or even the accounts that publish them. It’s because the codes of a smart contract are public. Anyone can inspect it, authenticate the smart contract, and use it to be implemented on another block.
Whenever an NFT is minted, a smart contract is created, which is stored on the blockchain. Now this NFT is owned as a contract, called an NFT contract, by the entity that minted it. Once this NFT is sold, its NFT contract is retained by the one who minted it, but the NFT itself will belong to the buyer. Hence, an NFT contract can be owned by someone, while the NFT itself can be owned by someone else.
The representation of ownership of the token is established by the buyer’s address written inside an array inside the contract. Now the block’s smart contract will enable the token’s further transfer and utility at that address only; not even the owner of the NFT contract can transfer the token or have any rights over it.
When the buyer further transfers the token to another address, it will be entered in the array of the contract and now the new buyer can utilize the NFT. This is done with the help of an approve function inside the contract, which can only be used by the address owning the NFT.
Another difference is that the smart contract lives on the blockchain, while the NFT does not. Here’s the thing, an NFT always has metadata attached to it, which contains information such as NFT file type, code type, language, other specifications of the digital item, etc. It is only the metadata that is stored on-chain inside the smart contract, while the NFT itself is stored on an Interplanetary File System (IPFS).
This is done because an NFT can have an infinite amount of data. Storing that much data on-chain will consume energy and space and reduce the blockchain’s scalability. Therefore, the smart contracts will contain a link to the digital item they represent that can only be accessed by the owner’s address.
Whenever a non-fungible token is minted, it will contain a link to the underlying digital asset, which will take the user to an IPFS where the digital asset exists. Therefore, only the NFT metadata is on-chain while the actual NFT is off-chain.
Hence, an NFT cannot exist without a smart contract. And the converse is not true. You need a smart contract to implement a sale agreement between the owner of the NFT and the buyer. Many NFTs also come with use-permission licenses, which are given in the form of smart contracts. Certain NFTs find applicability in other dApps as well. Smart contracts are also used to program this.
