The recent wave of liquidations has sparked concerns in the crypto market, from Three Arrows Capital to crypto institutions such as Celsius Network, Babel Finance, BlockFi, and Voyager Digital. The market has lost billions of dollars over the past few weeks as the price of digital assets plummeted.
Liquidity issues are not only fatal to the development of DeFi, but also to NFTs. In this report, we will focus on the liquidity problem of NFTs and their solutions, not only because it is seen as the main gateway to Web3, but also because it has lower barriers to entry and more diverse use cases.
This report will cover the following topics:
- Briefly describe the liquidity problems of current NFTs
- Why is the liquidity of NFTs insufficient?
- What are the existing solutions for NFT liquidity?
- Other Ideas for NFT Liquidity Solutions
What are the liquidity problems of NFTs?
While NFTs have been active in 2021 and early 2022, the level of NFT transaction activity can only be described as good compared to DeFi. The top 15 NFT markets account for the vast majority of the global NFT market, but their combined trading volume is less than 2% of that of decentralized cryptocurrency exchanges, not to mention centers with over $14 trillion in trading volume in 2021 exchange.
Data updated on July 6, 2022
The current volatility of the NFT financial market caused by whale centralization has also exacerbated liquidity problems. In most Ethereum-based NFT markets, 0.06% of whales (with over $1 million in NFT holding value) hold $5.7 billion worth of NFTs, out of $22.2 billion in global NFTs as of July 6, 2022 25.7% of the market capitalization.
Data updated on July 6, 2022
Why is NFT trading illiquid?
What separates NFTs from fungible tokens is their rarity and utility. NFT investors can easily trade tokens like Ethereum and Sol via DEX/AMM, but the buyer pool for each NFT sale is actually much smaller, so the volume shown above is also relatively small.
Difficult to price
While NFTs have huge imaginations in “moving” the current narrative of physical asset chains, they are still very novel to the mass market. The lack of historical data points and widely accepted valuation analysis is a key reason why it is difficult to hype and price. Even NFTs within the same series can have vastly different prices due to differences in rarity and subjective opinion. This leads to low liquidity and unsatisfactory capital efficiency.
Similar to real estate like real estate, even in a bear market, the average price range for blue-chip NFTs is between $11K-$120K. High barriers to entry have caused many investors to lose their interest, resulting in NFT sharding, which we will discuss in a later section.
Not to be sold
Many NFT investors invest in a diamond hand strategy (a strategy that intends to hold stocks or other assets firmly) and are reluctant to sell their NFTs in exchange for instant liquidity. Therefore, the development of NFT financialization is a hot topic to solve the NFT liquidity problem.
Existing NFT Liquidity Expansion Solutions
Category A: NFT transactions and value-added agreements
Facilitate NFT peer-to-peer transactions in a smoother and lower-cost way: 1) NFT market aggregators; 2) price discovery tools; 3) decentralized NFT trading protocols; 4) NFT sharding.
NFT Market Aggregator
NFT market aggregators are probably the most compelling NFT liquidity solutions out there. An aggregation platform integrates NFT listings in most NFT trading markets and provides NFT investors with an unprecedented “vision”. Additionally, by allowing users to buy in bulk, gas savings of up to 40% can be achieved. Currently, the top three aggregators are Gem (acquired by OpenSea), Genie (acquired by Uniswap Labs), and Flip.
The recent acquisitions of Gem and Genie show that aggregators are effective front-end tools for individual marketplaces/DeFi pools to capture user traffic. They also allow for lower gas fees through bulk purchases and less hassle for NFT transaction buyers. However, despite the hype this year for NFT aggregators, they are fundamentally similar to Deliveroo/Booking.com in web2 in that they only aggregate information like NFT listings and pricing without injecting additional liquidity into the NFT market.
price discovery tool
This type of tool can address the difficult and highly speculative problems of NFT pricing to aid users in their investment decisions. Furthermore, price discovery lays a crucial foundation for the development of the financialization of NFTs. Unlike fungible tokens, where market prices are easily synchronized, NFT pricing is much more complicated because bid, ask, and realized prices can be quite inconsistent due to their P2P transactional nature.
Currently, there are several methods of price discovery:
(a) As in the traditional world, auctions are particularly suitable for high-value NFTs. Contrary to the traditional British auction model, the Dutch auction uses a markdown method, in which the artist and auctioneer informs all potential collectors and collects all their bids before the auction to determine a ceiling price. The auction will then start with a ceiling price and drop by XX% for each predetermined period until all NFTs are sold out at the bid price specified by the bidder.
Auctions benefit NFT issuers, but accurate pricing results greatly sacrifice market capital efficiency because it locks up bidders’ capital, which in aggregate likely exceeds the value of the NFT transactions purchased by the bidders.
(b) NFT oracles like Chainlink can retrieve the lowest price of NFT collectibles from the blockchain and calculate their time-weighted average price (TWAP). This can provide investors with a reference price range by tracking the average price.
However, its limitation is that TWAP requires huge transaction amounts to be accurate, so it is also vulnerable to oracle attacks and market manipulation.
© Machine-learning-driven algorithms can serve NFT collections that are relatively rich in data points (such as rarity statistics and features) as it leverages quantitative analysis more effectively for price prediction.
For example, NFTBank, a comprehensive NFT asset management company, provides price discovery services for more than 1900 NFT projects. It is powered by a machine learning model whose data input includes NFT metadata, sales history, feature values, categories, time of sale, and more.
Another example is Upshot, which has developed specialized machine learning algorithms that collect historical sales data, secondary market data, and NFT metadata to generate reliable estimates. Using an algorithm, Upshot reprices 270K+ top NFT items per hour, including Bored Apes, Art Blocks, and CryptoPunks.
Since ML-driven algorithms require a large number of data points to arrive at computational results, it makes more sense for NFT collectibles with rich historical sales data, rare attributes and traits, and lower volatility.Investors may find it not very accurate for NFT projects that don’t have much comparability in the market.
(d) Peer-based evaluations include 1) human voting/recommendation; 2) behavioral analysis and prediction mechanisms. Like digital art, NFT pricing is more subjective, making it difficult to calculate quantitative results, so collective judgment may be the more reliable type for this type of assessment.
The Upshot project mentioned above also has its own NFT evaluation protocol, which builds a set of data by incentivizing users to provide honest feedback and suggestions for NFT projects. It builds APIs for developers to integrate their data into various projects.
Decentralized NFT Trading Protocol
OpenSea announced in mid-June that it would be migrating to Seaport Protocol, an open-source Web3 marketplace protocol designed to trade NFTs securely and efficiently. OpenSea is a step ahead of its centralized DeFi peers, launching protocols that reduce gas fees by 35%, transparently expose on-chain transactions, and allow other developers to fork.
This move lowers the barrier for developers to build their own NFT marketplaces and moves transaction data on-chain. It can remove the pain points of many existing NFT tool platforms as they can build their own marketplaces on top of Seaport Protocol, extracting value from their existing base of users who often come looking for alpha and then switch to other marketplaces /aggregator to execute.
However, given the novelty of the protocol, it remains to be tested whether it can actually generate liquidity network effects between NFT instrument platforms. But one thing is for sure, we expect to see more developments in the field of permissionless NFT transaction protocols.
NFT sharding refers to splitting a given NFT into multiple parts that can be traded individually on the market. The process involves a smart contract that divides ERC-721 tokens into several F-NFTs or fungible ERC-20 tokens. Since these ERC-20 tokens can be used in DeFi systems and can be valued by the market through liquidity mining of AMMs, it can greatly improve price discovery and liquidity. Another, more obvious reason is that it encourages decentralization as it gives ordinary investors exposure to high-value NFT projects.
Split a CryptoPunk NFT into 100 ERC-20 tokens
One of the most high profile projects in this area is fractional.art. You can connect your web3 wallet with fractional.art. Buy sharded NFTs in the form of ERC-20 tokens. As an NFT shard token holder, you can participate in voting on the NFT floor price. The platform also has a 7-day auction feature that can be triggered when an investor intends to buy all parts of an NFT, i.e. own the entire part, allowing everyone to participate in the bidding process.
Developed by PartyDAO, PartyBid is an NFT auction platform that supports NFTs on multiple marketplaces including OpenSea. Anyone can initiate a “Party” to contribute ETH to jointly bid for NFT shards. This is achieved through PartyBid’s MarketWrapper contract, which provides a common interface to aggregate all NFT bids. PartyBid builds on fractional.art and is used to shard successfully bid NFTs. A successful bid will be charged a fee of 2.5 ETH and 2.5% of the token value, which will be transferred to PartyDAO’s vault.
Sharding of NFTs may be the next big trend because of its positive impact on liquidity, but it is not without risk. F-NFTs could raise regulatory issues as they could be considered unauthorized ICOs. SEC Commissioner Hester Peirce warned in 2021 that F-NFTs could be considered securities. Furthermore, managing intellectual property and publicity rights can be tricky and complex, depending on the characteristics and types of NFTs.
Category B: Passive Income for Diamond Hand NFT Investors
As we mentioned at the beginning of this report, one of the key factors contributing to the liquidity problem of NFT assets is that investors prefer to hold NFT assets rather than realize their profits. In order to solve the liquidity problem stemming from this behavior, 3 main measures in the existing traditional financial world are designed to serve these long-term NFT investors: 1) NFT-backed loans/collateral loans; 2) NFT transaction flow 3) NFT transaction leasing/lending.
They both provide passive income streams and increase capital efficiency for NFT investors while providing additional liquidity to the market. It is worth noting that many platforms under this category have included solutions under Category A, as they serve both types of measures in various ways.
As of May 1, 2022, NFT debt penetration is only 0.5% (~$250m/$37bn) compared to the global art market with a debt penetration of ~35% ($24bn/$65bn) ), so expect liquidity to increase as the total market size grows.
There are two types of loan issuers: peer-to-peer (P2P) and peer-to-peer protocol (P2Protocol). Most of the loans are made through P2P lending platforms such as NFTFi, Arcade, etc. The rest are issued by P2Pool loan providers such as BendDAO, DropsDAO, PineDAO, Goblin Sax, etc.
The total market size of NFT-backed loans currently exceeds $250 million. Due to higher volatility, NFT lenders can earn higher expected returns than traditional cryptocurrency-backed loans.
a) P2P lending platform supported by NFT. The two largest players in this space are NFTFi and Arcade, with a total of about $240 million in loans issued to date. Currently, these P2P platforms only support blue-chip NFTs due to the high volatility and uncertainty of other long-tail NFT projects.
NFTFi is built on top of the NFT lending protocol MetaStreet. It allows NFT owners to borrow wETH or DAI using their NFTs as collateral, and lenders can earn interest by making these loans. NFTFi’s 90-day loans require an annual interest rate of up to 1,000%, while the average annual interest rate for longer-term loans is 90%. Since its inception in May 2020 (as of July 5, 2022), the company has processed 13,363 loans amounting to $217 million. NFTFi charges 5% interest income to lenders on successful loans (excluding defaulted loans). Some collateralized NFTs include packaged Crypto Punks (about 29% of loans) and BAYC (23%).
Arcade ($20 million) is built on the Pawn protocol and has facilitated about $20 million in loans since its inception in 2022. In addition to wETH and DAI, users can also borrow USDC by staking NFTs from selected lists. Unlike NFTFi, Arcade charges borrowers a 2% upfront payment at the beginning of the loan.
Neither of the two P2P lending platforms mentioned above take any risk and do not rely on algorithmic pricing to scale. However, scalability is limited by its bespoke loan terms, and potentially slow matching as borrowers have to wait for repayments.
b) Loans backed by P2Protocol NFTs
The size of the P2Protocol lending market is still small ($30M-$50M). Major players include BendDAO, Drops, Pine, Goblin Sax, JPEG ‘d and Defrag. Some lending platforms, such as BendDAO, employ voting escrow token economics to incentivize NFT holders to provide liquidity in various lending pools. Similar to DeFi liquidity pools, they boost lenders’ profits by issuing governance tokens.
To solve the problem of slow matching in the P2P lending market, the P2Protocol lending project allows instant liquidity as the matching process is handled by the protocol. But its downside is that automated loan terms require rich data points, such as real-time price and rarity statistics, thus limiting the liquidity of the quantitative properties that NFT options already have.
Even with NFT-backed loans that are over-collateralized (at least 50%), NFT-backed lenders still take on greater risk due to the higher probability of “voluntary” defaults. When the value of the NFT is less than the loan amount, the borrower abandons the loan repayment. To mitigate such risks, accurate price discovery, credit risk analysis, and insurance are all important value-added services that many lending platforms have integrated or are actively exploring.
Inspired by NFT market aggregators, NFT-backed loan aggregators and infrastructure could be the next trend, as the NFT lending market is still fragmented (especially in P2Protocol). In addition to the MetaStreet mentioned above, Spice Finance is a new project that aims to integrate existing P2Protocol loans into a single platform by integrating various NFT P2Protocol protocols. In addition to this, it has built a machine-learning NFT assessment tool and credit risk system to underpin a comprehensive lending platform.
The biggest risk with this type of aggregator comes from a high level of integration and composability, as the project inherits all the risks of the underlying application.
NFT liquidity pool
NFT liquidity pools can be divided into pledge liquidity pools and transaction liquidity pools, which are consistent with DeFi liquidity pools. The main difference is that users can create fungible tokens (e.g. ERC-20 tokens) by depositing NFTs with similar characteristics/floor prices into the same liquidity pool. A fungible token is a representation of any random asset in the pool and can be exchanged. By storing NFTs, generating corresponding fungible tokens, and easily swapping them through DeFi AMMs (such as Sushiswap using NFTX), liquidity providers can enjoy faster liquidity times. Besides NFTX, another key platform is NFT20. Since liquidity pools involve the minting of fungible tokens, this type of service is often powered by NFT sharding protocols.
As in DeFi, if NFTs are mispriced, users can conduct arbitrage, facilitating price discovery. Additionally, liquidity providers typically earn LP tokens and can stake them to boost returns. However, given the high volatility and speculative nature of NFTs, the downside risk could be a challenge for both platforms and investors.
Leasing provides another direction for NFT owners to earn passive income. Double Protocol’s ERC-4907 standard, which just became the 30th official ERC standard on Ethereum, takes an innovative approach by adding an “expires” feature that authorizes “users” to expire automatically. In this way, projects built on the ERC-4907 standard can easily separate users’ ownership from usage rights that automatically terminate at the end of the lease. This will drive the development of NFT leasing and spawn more derivatives built around NFT leasing.
NFT leasing can be adapted for a variety of use cases, including gaming, art, PFP, membership NFTs, and more. For example, an art exhibition, brand or event might lease specific digital art NFTs that match them. Or someone who wants to join a community for a while, they might rent out NFT memberships for a month (sounds like a subscription to paid content).
Given the scale of the Metaverse, the most promising use case for NFT leasing is gaming. Virtual land could spark a boom, as as games attract more users and brands, many owners invest in large amounts of land so they can rely on them to generate passive rental income from different types of uses. Additionally, in-game assets such as skins, gear, pets, characters and other props are either necessary for the player to play the game or give the player an advantage. If players can’t afford or don’t want to buy in-game NFTs for various reasons, they will choose to rent them, thereby further improving the liquidity of NFTs.
Other Ideas for NFT Liquidity Solutions
When it comes to NFT transactions, the factor that can further drive liquidity seems to come from the community, where users have a consistent taste and value of NFT projects developed by the community.Typically, the market is a vertical market determined by the theme/atmosphere of the community behind it.Such NFT marketplaces are ideal for NFT projects to leverage the influence and utility of tokens among community members. Project owners will also have this sense of belonging and ownership, as they can vote on the design of the marketplace to provide the user experience.
The DAO sounds like an organic place for such a market to grow, especially with the aforementioned Seaport Protocol lowering the barriers to development. In addition, centralized NFT marketplaces are actively exploring community features, such as Coinbase’s beta NFT marketplace focused on creating a social community for buyers and sellers.
All of the above liquidity solutions are based on the current NFT market size to solve the problem. In the long run, the fundamental factor driving NFT liquidity must come from the penetration of NFTs into various industries.
We’re embarking on an exciting journey into the future of NFTs, where we see big-name businesses and celebrities from sports, fashion brands, music streaming services, and education, working with Metaverse-like projects and blocks Chain technology has established a cooperative relationship. The ultimate way to improve NFT liquidity is mass adoption. In the process of financialization and further adoption of NFTs, NFT trading platforms may be subject to stricter regulation in terms of anti-money laundering and securities investment.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/nft-liquidity-analysis-existing-problems-and-solutions/
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