NFT Challenges

This article covers NFT challenges and is the sixth in our series of articles introducing NFTs from a technical point of view. A series of barriers still exist in nascent NFT technologies. Here we discuss potential challenges from both blockchain systems and human factors.

By Qin Wang (Swinburne University of Technology & CSIRO Data61 ) and Rujia Li (Southern University of Science and Technology & University of Birmingham)

NFTs are not friendly to newcomers

Learning cost – Most NFT schemes are built on top of matured blockchain platforms like Ethereum, WAX, and Flow. Meaning that users have to be familiar with the related knowledge and backgrounds. What’s worse, the applications built on the same platform might be totally different. Users need to read the guidances project by project. Some of them do not even provide formal documents, which greatly increases the learning costs.

Economic cost – High gas prices have become a major problem for NFT marketplaces, especially when minting the NFTs at a large scale that requires uploading the metadata to the blockchain network. Every NFT-related transaction is more expensive than a simple transfer transaction because smart contracts involve computational resources and storage to be processed. At the time of writing, my NFT token costs over USD 60 (equivalently in around 5 x 10^{2} wei – source calculated from https://coinmarketcap.com/ and https://ethereum.org/en/developers/docs/gas/). Completing a simple NFT trade can run between USD 60 and USD 100 for each transaction. Expensive fees caused by complex operations and high congestion result in high economic costs.

Time cost – NFT users usually send the transactions to the smart contract to achieve reliable and transparent management (such as mint, sell, exchange). However, current NFT systems are closely coupled with their underlying blockchain platforms, which makes them suffer from low performance (Bitcoin reaches merely 7 TPS (transactions per second) while Ethereum only 30 TPS). This results in an extremely slow confirmation of NFTs. Conquering this issue requires a redesign of the blockchain topology, optimization of its structure, or improvement of the consensus mechanisms. The existing blockchain systems cannot fulfil such requirements and users may wait for a long time in each NFT trading.

Data storage has risks

The security of user data poses the first priority of systems. However, the data (stored off-chain but relates to on-chain tags) confronts the risk of losing linkage or being misused by malicious parties.

In the mainstream NFT projects, a cryptographic “hash” as the identifier, instead of a copy of the file, will be tagged with the token and then recorded on the blockchain to save the gas consumption. This makes the user lose confidence in the NFT because the original file might be lost or damaged. Several NFT projects integrate their system with a specialized file storage system such as IPFS (InterPlanetary File System, a decentralized file storage system launched in 2018)  in which IPFS addresses allow users to find a piece of content so long as someone somewhere on the IPFS network is hosting it.

In rare cases, when the users upload NFT metadata to IPFS nodes, there is no guarantee that their data will be replicated among all the nodes. The data may become unavailable if the asset is stored on IPFS and the only node storing it is disconnected from the network. This issue has been reported by DECRYPT.IO and CHECKMYNFT.COM. Also, an NFT might point to an erroneous file address. If that is the case, a user cannot prove that they actually own the NFT.  Fortunately, NFT is still reliable and safe in most cases. Accidents occur only when the underpinned blockchain platform has some problems. But it is almost impossible in the current stage. 

NFTs are not interoperable

Existing NFT ecosystems are isolated from each other. Once users have selected one type of product, they can only sell/buy/trade them within the same ecosystem/blockchain network. This is due to its underlying blockchain platform. Interoperability and cross-chain communication are always the obstacle for the wide adoption of dApps (decentralised applications).

Cross-chain communications can only be implemented with the help of external trusted parties. The decentralization property, in this way, is lost to some extent. But fortunately, most of the NFT-related projects adopt Ethereum as their underlying platform. This indicates that they share a similar data structure and can exchange under the same rules. 

How to upgrade NFTs

Transitional blockchains update their protocols through soft forks (minor modifications that are compatible forwards) and hard forks (significant modifications that may conflict with previous protocols). 

Despite using the generic model, a new version still faces strict requirements such as staying online during the update process. NFT schemes closely rely on their underlying platforms and keep consistent with them.

Although the data is often stored in separate components (e.g. IPFS file systems), the most important information and token-ID, are still recorded on-chain. Properly updating the system with improvements will be a necessity.

Users may concern about their privacy

In the current stage, the anonymity and privacy of NFTs are still understudied. Most NFT transactions rely on their underlying Ethereum platform, which only provides pseudo-anonymity rather than strict anonymity or privacy. Users can partially hide their identities if the links between their real identities and corresponding addresses are unknown by the public. Otherwise, all the activities of users under the exposed address are observable. 

Current privacy-preserving solutions (e.g. homomorphic encryption, zero-knowledge proof, ring signature, multi-party computation) have not been yet applied to NFT-related schemes due to their complicated cryptographic primitives and security assumptions. How to decrease expensive computation costs becomes the key to implementing privacy-promised schemes.

Governance is still uncertain

Similar to most cryptocurrencies, NFTs confront legal and policy issues across a wide range of areas. Potential concerned areas cover commodities, cross-border transactions, KYC (Know Your Customer) data, etc. It is important to understand the related regulatory scrutiny and litigation before moving into the NFT tracks. 

In some countries, such as India and China, the legal situation is strict for cryptocurrencies, and also for NFT sales. Exchanging, trading, selling, or buying NFTs have to navigate the difficulties of governance. Legally, users can only trade derivatives through authorized exchanges such as stocks and commodities. If users want to trade cryptocurrencies, they have to exchange with someone person-to-person. 

Several countries, such as Malta and France, are trying to implement suitable laws with the aim to regulate the service of digital assets. Elsewhere, issues are resolved by using existing laws. They require buyers to follow complex or even contradictory terms. Therefore, undertaking due diligence is a necessity before investing serious tokens in NFTs.

Should NFT-based products be taxable?

Although few countries, such as the US (internal revenue service, IRS), tax cryptocurrencies as property, most areas worldwide have not yet considered it. This may greatly increase the financial crimes under cover of NFT trading. 

It could prove lucrative for governments worldwide to make the sale of NFTs reliable with tax consequences. Specifically, the individual participants could have the tax liability on any capital gains that are related to NFT properties. Also, NFT-for-NFT, NFT-for-IP, and Eth-for-NFT (or vice versa) exchanges should be taxed. Furthermore, for high-profit properties, or collectables, a higher tax bracket could be applied. 

Thus, NFT-related trades are suggested to seek more advice from professional tax departments.


Researchers

Qin Wang is a researcher focusing on blockchain technology, covering sub-fields of consensus protocols, security, and blockchain economies. More information refers to his homepage https://qinwang.tech/.

Rujia Li is a blockchain researcher with interests on privacy-preserving smart contracts and FinTech. More information can be found at https://rujia.uk/.


Photo by Fakurian Design on Unsplash

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