A diagram to understand the NFT stack. What projects do you know about the current state of the NFT ecosystem?

Original: Messari

Compiled by: Kyle, 8btc

At its core, non-fungible tokens (NFTs) are just a primitive form of blockchain, similar to fungible ERC-20 tokens. However, the narrative around NFTs as a category has begun to refer to broader trends, and thus, similar to DeFi, the term "NFT" now encompasses its own ecosystem.

However, NFTs will leverage many of the same financial primitives as DeFi, so the stack layers of both will ultimately look very similar, but NFTs are more consumer-centric.

### Layer 1: Base Infrastructure

So far, the NFT space has been dominated by Ethereum, Flow, and the smaller Wax. Most NFT applications may need to transition from the Ethereum mainnet to Layer 2 solutions or sidechains, while relying on Ethereum as a settlement layer. The exception to this rule may be those requiring stronger censorship resistance, such as high-end digital art or blue-chip collectibles.

Other base layers (Layer 1), such as Solana, are actively building their NFT infrastructure, like Metaplex, which enables individuals to create their own NFT storefronts and publish NFT collections with customizable royalty distributions.

### Layer 2: Layer 2 Solutions and Sidechains

Most consumer-centric non-fungible token applications—games, sports, virtual worlds, utility assets, etc.—have experienced turbulence on Ethereum. After building CryptoKitties and CheeseWizards, Dapper Labs determined that Ethereum could never provide the robust scalability needed by game studios, leading them to choose to build Flow.

Similarly, even projects like Sorare—which correctly identified the direction of scalability—built on ultimately shut down sidechains like Loom, failing to attempt to scale their NFTs.

Axie Infinity, unwilling to rely on other third parties, took the path of building its own sidechain, Ronin, which has been very effective so far in reducing gas costs and increasing user adoption.

As a hybrid Layer 2 of Ethereum, Polygon's biggest advantage so far is its compatibility with Ethereum, which lowers the learning curve for users and developers. Additionally, Polygon's use of its token to incentivize bridging to its network has been very effective.

Notably, Polygon is setting up a new $100 million fund for gaming and non-fungible token projects, doubling down on NFTs.

Gods Unchained, developed by Immutable Labs, is about to launch its Ethereum Layer 2 scaling solution, ImmutableX. This Layer 2 is built using ZK-rollups, and the Immutable team claims it is better suited for NFT-based applications.

Check out Messari's article on Ethereum Scaling Solutions for a breakdown of ZK-rollups, sidechains, and state channels.

So far, this story should sound familiar—[insert crypto project] built a relatively successful NFT protocol but could not achieve the necessary scalability on the Ethereum mainnet and chose to build its own solution [insert new blockchain].

The latest notable NFT Layer 2 solution comes from Enjin—the first platform to offer token injections with a fixed stickiness curve per token. Recently, Enjin raised $18 million for its NFT scaling solution, Efinity, which is a new blockchain built as a Polkadot parachain.

As part of Efinity, Enjin, the company that first launched the ERC 1155 token standard, is developing a new token standard called "paratokens," which will interoperate across the Polkadot ecosystem and be used for issuing Efinity tokens (EFI).

While the smart contract war is the battle of DeFi applications on blockchain, the upcoming battlefield between Layer 2s will be for NFT supremacy.

### Layer 3: Vertical/Applications

While NFTs are created and transferred at Layer 1 or Layer 2 levels, the application layer serves as a potential interface for issuing these tokens. As individuals enter the worlds of meetings, art galleries, casinos, and upcoming use cases, virtual worlds like Decentraland and Cryptovoxels have slowly grown over time.

Other applications like fantasy sports have experienced wild speculation but continue to add new users. So far, crypto-based sports applications have achieved incredible success. NFT sports applications have generated over $800 million in secondary sales, and when considering primary sales, it could exceed $1 billion.

While blockchain-based gaming as a trend has yet to fully take off—partly due to scalability issues—the field continues to grow with the upcoming releases of several games, including Illuvium, EmberSword, and Aurory.

Additionally, Uniswap V3 is the first financial application to effectively utilize NFTs. The V3 protocol of Uniswap requires actively managed liquidity—LPs choose a custom price range within the asset market—creating individual price curves represented by NFTs in the process.

Each NFT is displayed as unique on-chain generated art based on your position attributes.

Moreover, DeFi protocols like Synthetix choose to use NFTs to manage members of the Spartan Council governing the Synthetix protocol. Each council NFT (SC-NFT) is unique to individuals and can be reclaimed from old members and then awarded to newly elected members of the council.

While providing the ability to create unique NFTs (i.e., SuperRare tokens or Zora's zNFT) may suit the application layer, the primary benefits of the market come from its liquidity, which is why I place these protocols in the financialization layer.

NFT issuance is a commodifiable layer that multiple layers of this stack can facilitate, including:

1. Layer 1 or Layer 2 blockchains and scaling solutions

2. White-label issuance protocols (e.g., Nameless used for Veefriends)

3. Marketplace protocols (e.g., Rarible)

4. Individual applications (i.e., Sandbox, Uniswap, etc.)

5. Front-end interfaces (e.g., Zapper)

Ultimately, these platforms will have to rely on the unique utility propositions they can offer to users. Virtual worlds can authorize content, while Top Shot cards will be used for the NBA Top Shot game Hardcourt.

### Layer 4: Auxiliary Applications

Composability ensures that other developers can build on top of existing applications and protocols.

Decentraland and other virtual worlds will undoubtedly host various applications within their ecosystems, such as online casinos like Decentral Games.

Additionally, Sorare has partnered with Ubisoft, which is leveraging existing Sorare cards to develop its own fantasy league, One Shot League. The composability of this layer means that applications or protocols facilitating third-party application development will have the opportunity to capture more value.

### Layer 5: NFT Financialization

Similar to assets in DeFi, NFTs require similar primitives such as lending, liquidity, and asset management. Furthermore, while the value proposition of NFTs lies in their uniqueness, fungibility is crucial for increasing liquidity and the financialization of NFTs.

So far, projects focused on NFT financialization are trying to make non-fungible tokens as fungible (and liquid) as possible.

Most protocols aimed at increasing NFT liquidity achieve this by creating liquidity pools where individuals can deposit similar NFTs or fractionalize individual NFTs to encourage greater speculation.

NFT Fractionalization Projects

1. Fractional - Collectors create a fraction of an NFT as a fungible token, which can be combined to redeem the token or purchased at a price above the reserve price for the underlying NFT.

2. Niftex - NFT owners create fractions of NFTs as fungible tokens. The underlying NFT can be reclaimed by obtaining 100% of the fractions or through special buyout terms.

NFT Liquidity Pool Projects

1. NFTX - Collectors can deposit NFTs into the NFTX vault and mint fungible tokens (vToken) that represent ownership of random assets within the vault or redeem specific tokens from the same vault.

2. NFT20 - A decentralized exchange where individuals can deposit NFTs into a pool in exchange for a fungible token representing one NFT from the pool (e.g., a fungible token for 100 Punks).

3. Unicly - Fractionalizes NFT collections into tradable uTokens. Specific collections (e.g., uPunks) are locked.

Yield-Generating NFT Assets

1. Charged Particles - A protocol that allows users to deposit fungible or non-fungible tokens into NFTs. Charged Particles NFTs can be programmed with yield-bearing aTokens.

2. Uniswap V3 LP positions - By providing liquidity, LPs earn fees based on three tiers per pool—0.05%, 0.30%, and 1%—corresponding to different price ranges.

Marketplaces

NFT issuance platforms and marketplaces currently constitute one of the largest categories of NFT protocols and represent one of the more obvious market opportunities considering business models.

In this regard, NFT issuance protocols and marketplaces will compete based on the following characteristics:

1. Brand value

2. Liquidity (depth and breadth of assets)

3. Unique features (i.e., unique token standards, royalties, collector fees, etc.)

4. Additional service products (e.g., partnerships)

While unique features like royalties and collector fees may one day be commodified and incorporated into token standards, they are currently non-standardized, making them key value propositions for many NFT creators and companies.

In the long run, marketplaces may aim to be closer to social networks to keep users anchored to their platforms. Ironically, this contrasts with social networks like Facebook and Instagram, which started as social networks and later developed marketplaces.

### Layer 6: Aggregators

Aggregators can take many forms. Some protocols aggregate supply, while others focus on the demand (consumer) side. In the NFT space, there are effectively only two major aggregators—OpenSea and Rarible.

Both marketplaces aggregate supply by integrating various smart contracts and ultimately the blockchain. OpenSea has been the de facto aggregator in the space, as Rarible only recently integrated the ability to buy and sell non-Rarible tokens on its platform.

While many view OpenSea simply as a marketplace, it also aggregates a wealth of NFT data and metadata—data about data—that can be accessed via its API and potentially used for other purposes.

OpenSea and Rarible continue to create full-featured platforms for projects and individuals to issue non-fungible assets. As aggregators compete for growth, they will continue to expand their asset offerings across multiple blockchains.

### Layer 7: Frontend and Interfaces

Many companies are vying for attention and building effective frontends for NFTs. With collectibles and crypto art as the first breakthrough use cases, entrepreneurs choose to build galleries or interfaces for collectors to showcase their non-fungible assets.

Wallets like Coinbase Wallet and Rainbow, as well as platforms like Zapper and Zerion, provide user-friendly interfaces to view NFT portfolios.

More robust NFT analytics platforms (like NFT Bank) offer returns on investment analysis, taxes, price estimates, and more. There are multiple analytics platforms, but they do not provide interfaces for viewing NFTs, including Nonfungible, Cryptoslam, and Nansen.

As NFTs gain wider recognition, even protocols that do not issue NFTs may build interfaces for users to view, share, and interact with NFTs. Audius is a decentralized music streaming platform that launched Audius Collectibles, where artists with silver-level accounts—those holding over $100 in AUDIO tokens—can showcase NFTs on their profile pages.

This type of model combines native platform tokens and provides artists with another way to showcase their artwork, albums, or any tokenized assets.

Similarly, applications like Showtime and Nifty are building social networks for users to share and like NFT collections and interact with other collectors. Ultimately, displaying NFTs on profiles or social networks may become cross-platform universal.

Finally, platforms like RabbitHole are rewarding users for utilizing applications like OpenSea and Uniswap (in the form of tokens and potential NFTs).

### Final Thoughts

In the past 12 months, the NFT landscape has evolved from a small ecosystem with sales in the hundreds of millions to a multi-chain ecosystem where individual projects like Axie Infinity have surpassed $1 billion in sales. OpenSea had $24 million in sales for the entire year of 2020, while by August 2021, sales exceeded $1 billion.

Unlike the DeFi ecosystem, NFTs are highly consumer-oriented and attention-grabbing. As DeFi continues to build the future of financial rails, NFTs will periodically enter the cultural zeitgeist.