Non-fungible Tokens (NFTs) vs. Semi-fungible Tokens (SFTs): Explained

The world of finance is getting more robust faster than some of us get out of bed every morning. The last we heard was blockchain and cryptocurrencies. NFTs soon followed the trend, and now, another tokenized asset class known as semi-fungible tokens (SFTs) is vying for mainstream attention and adoption.

 

You may already be familiar with the term non-fungible tokens (NFTs), while semi-fungible tokens sound entirely new. Whichever category you fall under, sit tight as we look deeper into these two concepts in this article.

 

We can properly navigate the concepts of non-fungible and semi-fungible assets only with a foundational understanding of fungibility and non-fungibility.

 

Fungibility refers to an asset class that can be exchanged on a 1-1 ratio. Let's understand this with an example. Say you have 1 dollar, and your friend has another dollar. Can you exchange your 1 dollar note and still have the same monetary value? The answer is yes. Whether straightened out or squeezed, they have the same monetary value and can be exchanged. Cryptocurrencies and fiat currencies fall under this class.

 

The case is, however, different when two similar assets cannot be exchanged on a 1-1 ratio. Non-fungibility refers to the uniqueness each digital asset possesses. We can see this in non-fungible tokens that act as unique digital stamps that prove ownership of whatever asset to the creator. You cannot swap two non-fungible tokens as they possess different rarity, characteristics, value, and popularity.

 

A quick summary is this: fungible assets are exchangeable, while non-fungible assets are unexchangeable. 

 

Non-fungible tokens are assets with unique digital stamps or identities on the blockchain that prove a digital asset's originality and ownership. The digital assets, in this case, could be art, music (MP3s), images (JPEGs), videos (MP4s), virtual lands, and blockchain in-game assets, among others.

 

Non-fungible means that they cannot be traded with each other despite similarities in characteristics or creator. Each asset is unique, even if they have the same price tag on an NFT open marketplace. 

 

NFTs were partly created to safeguard the works of digital creators and ensure that they can monetize their hard work without losing to piracy. The news about NFT started gaining momentum in 2020, raking billions of dollars in volume traded by the end of the year into 2021.

 

It will surprise you that the concept of non-fungible tokens exceeded its glorious year of 2021 when it established itself in mainstream media and the market after enjoying record-high trading volume. A detailed timeline of NFTs carries us to 2012, when the concept of NFTs first appeared on a paper by Meni Rosenfield, who introduced a "colored coins" concept for the Bitcoin blockchain. 

 

The concept centered on managing and representing real-world items on the Bitcoin blockchain that showed provenance and had tokens that regulated their usage, making them unique. The limitation of Bitcoin in space and its original purpose ensured the concept was never brought to life. But it became the foundation upon which NFTs would later stand.

 

• In 2014, "Quantum," the first NFT, was minted; a pixelated octagon that changes color and contracts rhythmically like an octopus. Kevin McCoy is the artist behind that mint, which happened on the Namecoin blockchain.

• In 2016, memes started getting minted as NFTs.

• From 2017 to 2020, Ethereum's smart contract standards gained popularity and caused the NFT momentum to shift its blockchain.

• John Watkinson and Matt Hall created Cryptopunks on the Ethereum blockchain following the success of the Rare Pepes NFT.

• Cryptokitties came on-screen during the world's largest hackathon for the Ethereum ecosystem and gained so much popularity that it blew up NFTs.

• NFT gaming and metaverse (Decentraland) came to life.

• In 2021, the sale of NFT art began at prestigious auction houses.

• A record price is paid for Beeple's NFT.

• As their NFT sales took off, additional blockchains began participating (Cardano, Solano, Tezos, Flow, etc.).

• NFTs are in high demand, particularly in metaverse environments in the form of virtual real estate.

• Facebook changes its name to Meta and prioritizes the metaverse.

A lot has happened since then, and there’s more to come.

 

On the KuCoin exchange, you can instantly buy, sell, and swap your fractional NFTs or store and manage them in the Halo Wallet. You can also launch NFTs directly on the Wonderland platform, which is accessed from the KuCoin homepage.

 

Accessing NFTs on the KuCoin Platform

 

NFTs have been adopted mainly by the gaming, art, and music industry. Although these three industries currently dominate the space, NFTs can be adopted in virtually any industry as any real-world asset can be tokenized into a rare collectible. 

 

Semi-fungible tokens are an asset class that can shuffle between being a fungible asset and a non-fungible asset. They are a combination of both asset classes and provide more flexibility and functionality. A semi-fungible token exists first as a fungible token, which can be exchanged with similar tokens in its class. They only change into non-fungible tokens with distinct values when used. 

 

If it doesn't make sense yet, let's consider this example. Say you buy concert tickets to see your favorite artist perform live. Your concert ticket is a fungible token because it can be easily traded with any other ticket on your seating row. 

 

The fungibility of that ticket ends immediately after the concert ends. Why? Because you can no longer trade the tickets for a live one once the token loses its fungibility. It becomes a collectible, a souvenir for a memorable day you had. It becomes a non-fungible asset, unique to you, and its value distinction can subsequently be placed based on the rarity and popularity of the concert.

 

Semi-fungible tokens are after the order of ERC-1155 token standards on the Ethereum blockchain. It is a unique standard that allows a single smart contract to enable multiple Semi-fungible tokens, unlike the ERC-20 standard for fungible tokens (cryptocurrencies) and the ERC-721 standard for non-fungible tokens.

 

SFTs are only minted on the Ethereum blockchain, using the ERC-1155 standard, a combination of Ethereum's ERC-20 and ERC-721 standards for fungible and non-fungible assets. 

 

Enjin, Horizon games created the ERC-1155 standard and The Sandbox to manage and regulate semi-fungible tokens in-game using a single smart contract.

 

For now, SFTs are only used in the blockchain gaming industry. It embodies every in-game asset that can double as a fungible and non-fungible asset. The rise in SFTs’ awareness also comes with a yearning to determine what other industries can adopt SFTs' functionality.

 

New Entrant: ERC-404 Token Standard 

The ERC-404 token standard represents an innovative approach within the Ethereum blockchain, aiming to blend the characteristics of fungible tokens (like ERC-20) with non-fungible tokens (NFTs, like ERC-721) to create what are known as semi-fungible tokens. 

 

Developed by pseudonymous creators "ctrl" and "Acme," this standard facilitates the creation of tokens that can function both as interchangeable units and as unique assets, depending on their use case. This hybrid nature allows for more flexible and efficient market dynamics, such as enhanced liquidity and the ability to trade fractions of an NFT, thus addressing some of the liquidity challenges that NFTs face in traditional auction-based trading environments​​​​.  

 

Despite its potential, the ERC-404 standard has not undergone the official Ethereum Improvement Proposal (EIP) process. It lacks the formal scrutiny and audits typically associated with officially recognized standards. 

 

This informal introduction to the market has raised concerns regarding the standard's security and the potential for misuse, such as the risk of rug pulls or the unintended consequences of its token signature mechanism in smart contracts. Nonetheless, projects like Pandora, DeFrogs, and Rug have already started exploring the possibilities of ERC-404, indicating a growing interest in hybrid token models that could bring innovative solutions to the digital asset space​​.

 

Learn more about ERC-404 tokens and how they work. 

 

 

This comparison will not be complete if we don't place their token standards side-by-side to understand how they enable the assets.

 

ERC-721 Standard

This Ethereum token standard hosts the largest share of NFTs in existence.  The ERC-721 standard is a protocol that defines the functionality and capability of the tokens. It also allows NFTs to be traded and created. To create a non-fungible token on Ethereum, it has to strictly obey all the rules and regulations set by the ERC-721 standard.

 

A significant advantage of the ERC-721 standard is that developers can add more features to the tokens, such as authenticity provenance that caters to the uniqueness of non-fungible items over fungible assets. That is good but has a significant disadvantage: multiple transactions.

 

The smart contract underneath can only send one NFT per transaction. To send 50 NFTs, you must make 50 separate transactions. It is time-consuming, congests the Ethereum network, and increases transaction and gas fees.

 

ERC-1155 Standard 

On the other hand, the ERC-1155 standard, also called a multi-token standard, is a mash-up of ERC-721 and ERC-20 standards, empowering the tokens created with flexibility and multiple functions. Semi-fungible tokens being in the middle of fungible and non-fungible tokens somehow solves the limitations of both asset classes and further strengthens them. 

 

For example, with a fungible token, the dominant restraint is irrevocable transactions. You cannot reverse a transaction, even to the wrong wallet address. Semi-fungible tokens make room for revocable transactions in the case of human error. 

 

For non-fungible tokens, there's the issue of limited transactions, where a smart contract can only send one NFT. Semi-fungible tokens bring a different offer with a single smart contract enabling multiple transactions. This, in turn, reduces transaction fees, gas fees, and network congestion.

 

How Is ERC-404 Different From ERC-721 and ERC-1155? 

The ERC-404 token standard is an innovative approach in the Ethereum blockchain ecosystem, aiming to bridge the functionalities of both ERC-20 (fungible tokens) and ERC-721 (non-fungible tokens, or NFTs) standards.

 

Unlike ERC-721, which is designed exclusively for non-fungible tokens (each representing a unique asset), and ERC-1155, which enhances upon ERC-721 by allowing a single contract to represent multiple token types (both fungible and non-fungible), ERC-404 introduces a novel concept. It allows for the creation of tokens that can operate as fungible tokens under certain conditions and as non-fungible tokens under others, essentially combining the best of both worlds. This dual functionality facilitates new forms of digital assets that possess the versatility of fungible tokens while retaining the uniqueness of NFTs, offering a broader range of use cases and improved liquidity options compared to its predecessors​​​​.

 

 

By now, you already have an idea of how they both work. But let's reiterate some points. NFTs work on blockchain, predominantly Ethereum's blockchain. They are unique digital representations of real-world assets.

 

They work as an authentication mechanism that proves data ownership and can exist in different forms. NFTs, once minted, cannot be duplicated. This way, artists, content creators, musicians, and business owners can get the correct monetary value for their efforts.

 

For SFTs, you might encounter a token in a game that starts as an NFT and can be collected to get ten game dollars, which serve as fungible currency. You can then exchange that money for goods from other players or spend it on a weapon to convert it back into NFT via NFT markets. 

 

The weapon may become more prominent as the player reaches a higher level. The SFT's built-in "smart contract," the developer programmed, drives these modifications rather than protocols from outside sources.

 

The ability of a token to become easily interchangeable makes it possible to "transform" previous games for an online multiplayer setting, where the game creator can keep track of assets and cash, giving them more control over the game's economy as opposed to the unchecked inflation observed in earlier MMO games. Depending on the game mechanics, the same token may have a varied worth to users, whether it is traded on an NFT market in money form or weapon form.

 

Semi-Fungible Tokens and RWA Tokenization 

Semi-Fungible Tokens (SFTs) offer a unique approach to real-world asset (RWA) tokenization, addressing challenges associated with fully fungible or non-fungible tokens. SFTs provide flexibility in ownership and trading by representing initially fungible parts of an asset, such as property shares, which can become non-fungible under certain conditions, thereby enhancing liquidity and accessibility. 

 

They can also dynamically represent changes in asset value, state, or condition. SFTs facilitate efficient fractional ownership of indivisible assets, lowering the entry barrier for investors. They enhance liquidity for traditionally illiquid assets by enabling trade on digital platforms. SFTs can encode specific rights, rewards, or obligations associated with RWAs, and their transition from fungible to non-fungible states can be designed for regulatory compliance and asset tracking. Finally, SFTs enable innovative asset financing and investment structures, combining fungible liquidity and non-fungible uniqueness, leading to novel investment products and opportunities.

 

Asset tokenization is fast becoming a bigger deal as it holds a lot of juicy in-demand possibilities. The NFT ecosystem is rapidly changing the scope of different industries and is gaining wider adoption. Blockchain technology makes it possible to implement and represent asset ownership and data protection in ways unknown before.

 

NFTs and SFTs come with a wave of evolution that redefines profitability for digital content creators, artists, businesses, blockchain game developers, and gamers and accessibility for customers and fan base. SFTs might be limited to in-game assets, but they will soon find applications outside gaming and in different industries.

 

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