NFTFi is the intersection of decentralized finance (DeFi) and NFTs.
This new area unlocks a series of actions for collectors:
- Take out a loan with your NFT as collateral.
- Pay for NFTs in 3-month installments.
- Rent an NFT for a period of time to gain social impact.
- Use financial options to hedge the volatility of holders’ NFT assets.
- Assess the value of your NFTs while obtaining liquidity for them.
- As a community, divide an NFT and hold it together.
How can you do these things? How do these protocols actually work? Are they safe? What challenges do they face?
The NFTFi space is promising and thriving, and this article will introduce this ecosystem.
The ultimate guide to NFT-Fi
Image credit: Logan Craig
What is NFTFi?
Whether NFTs are an investment or a digital collectible – for those active in the space, this is one of my favorite questions to ask.
Builders tend to “not invest” because Gary Gensler is paying attention (note, Chairman of the U.S. Securities and Exchange Commission (SEC)). In addition, if the price of the floor does not rise, the builder is not liable for the profitability of its holder (this is not an investment, it is a community token!). ）。
However, we clearly explicitly view NFTs as investments in many ways. Crypto Twitter is full of questions and tutorials, such as “How much of my cryptocurrency portfolio should be NFTs?” Investopedia, on the other hand, published articles such as “The Pros and Cons of Investing in NFTs.” We rejoice when the value of our NFTs goes up, and when they don’t, most holders think it gives them the right to complain about the project’s founders.
But my question is becoming less and less important. A dynamic and innovative submarket has emerged around the financialization of NFTs called NFTFi (NFT Finance) – regardless of how builders classify the nature of their projects.
The emergence of such a market sprout is not surprising. The trading volume of the NFT market in 2021 is $17.6 billion. That’s a staggering 27 percent of the global traditional art market sales ($65 billion) that same year.
NFTFi essentially just applies DeFi to NFTs. It makes the form of transaction for NFTs more efficient – from exchange, hedging, fragmentation and evaluation to leasing. Let’s start with the largest sub-sector in NFTFi: Simple Lending/Borrowing.
Image credit: 0xminion
If you spent 100 ETH on a Cryptopunk, it’s good to show it off on Twitter, but maybe you also want to unlock some useless funds and use them for loans. Lending agreements like NFTfi, Arcade, and Metastreet allow you to do just that. Borrowers can use NFT assets as collateral instead of using fiat/ETH to borrow as they would on Aave or Compound.
“NFTfi” is a leading project in this area, far exceeding its competitors in terms of loan volume. It deploys a “peer-to-peer” model that functions exactly like order book trading.
From the point of view of the agreement, this is indeed risky, and the reason is obvious. The NFT market is speculative, and Rug Pulls happen very commonly. If someone asks for a 10 ETH loan with a bunch of jpegs as collateral, you’ll wonder if those jpegs are run by reliable projects involved in the game. For this reason, lending out NFTFi protocols attempts to reduce this risk by generally accepting only established “blue chip” NFTs (such as Bored Apes, CryptoPunks, Doodles, Art Blocks, etc.).
The downside of the peer-to-peer model is its capital inefficiency, as transactions rely on matching borrowers and lenders with dual fit needs. To address this, projects such as BendDAO and JPED have introduced a more liquidity-efficient “peer-to-peer pool” model that connects demand and supply in a customizable liquidity pool, eliminating the need to bid and wait for bids.
But the “peer-to-pool” model isn’t perfect either. They have the same drawback as pooled liquidity protocols in DeFi, where lenders collectively panic, causing liquidity to dry up.
What happens when an NFT’s reserve price is lower than the amount of loans it mortgages? Theoretically, once the NFT collateral exceeds the set threshold (loan-based), the protocol will liquidate the NFT collateral through auction to protect the lender. In practice, they may not do this so smoothly.
In the past year, the price of most NFT projects has fallen by about 60-70%, and in August, BendDAO saw a protocol-wide “bank run” (bank run) (a bank run in which a large number of bank customers simultaneously withdraw cash from banks). When the agreement began to initiate a liquidation auction, there was a lack of bidding because the liquidation threshold was too close to the reserve price. No one wants to buy an NFT that is so close to the liquidation threshold, which means that BendDAO underestimates the possibility of a market crash.
Lenders to BendDAO’s liquidity pool panicked as a result, and ETH deposits for the agreement plummeted from 15,000 ETH on August 19 to a minimum of 12.5 ETH. DAO then lowered the liquidation threshold to 70 percent through an emergency vote, reduced auction duration from 48 hours to 4 hours, and lifted the initial bid limit of 95 percent of the reserve price – nipping its bad debts in the bud.
(See William Peaster’s strategy yesterday on how to borrow NFTs.)
Buy before you pay
In the fintech space, one of the trends among tech-savvy millennials and Gen Z in recent years is “buy now, pay later” (BNPL). Web3 builders are bringing this trendy new wave of budget-friendly financing to the NFT market.
Cyan is the largest and best example of such a BNPL protocol. Here’s a brief description of how it works from the buyer’s perspective:
1. Bob wants a Pudgy Penguin. First, he launched a BNPL initiative on Cyan to buy any Penguin currently listed on Opensea, LooksRare, or X2Y2.
2. Cyan then offers Bob an installment plan that includes a pre-quoted interest rate that he needs to repay over a 3-month installment period. Installments do not change regardless of how the NFT price fluctuates and are fixed for three months.
3. If Bob accepts the program, he will receive an ETH from Cyan’s treasury for the purchase of NFTs and escrow them under a smart contract wrapped in Cyan.
As of September 2022, Cyan’s funding bank
4. When Bob completes all of his installments, the NFT is transferred to his wallet and he can take full ownership. (Tip: If the price of NFTs increases during this period, Bob can pay the BNPL plan in full in advance and sell the NFTs.) ）
5. In addition, late payments are considered default and NFT will remain in the corresponding Cyan Vault for liquidation.
So how does Cyan generate revenue?
Cyan offers a “pawning” service that allows users to temporarily publish their NFTs as collateral in exchange for loans. The loan is then repaid along with interest, which goes directly into Cyan’s bank. To prevent plan defaults, Cyan has adopted various risk management measures, such as raising interest rates to regulate lending and preventing an increase in holdings of high-risk NFT products.
Currently, Cyan is leading the NFT BNPL submarket, with various competitors in the space building similar things such as Teller Protocol’s “Ape Now, Pay Later”, Cedar, Halliday, and Pine Loans.
NFT lease agreements are an emerging NFTFi submarket that allows users to pay for access to NFTs over a period of time. Participants include reNFTs or Vera that offer mortgaged and unsecured leases.
- Mortgage leases require funds to keep the transaction safe.
- Unsecured leases involve creating a “wrapped NFT” for the renter that is burned once the contract ends. Unlike a mortgage lease, the hirer never receives the original NFT.
NFT Rental Services – Who will actually rent an NFT?
In this early stage, the market fit for NFT rental products seems to be most consistent with current utility-based gaming NFTs. Why? =
Blockchain games often require users to pay upfront fees by purchasing NFTs, a business model pioneered by Axie Infinitylast year. As the cost of Axie NFTs soared, GameFi DAO (such as Yield Guild Games and Merit Circle) emerged, democratizing the entry of millions of players through a profit-sharing model, where guilds will sponsor players’ upfront entry costs and receive a profit share from them.
Later games, such as Polygon’s Pegaxy, built an internal guild management system that allowed players to rent out the introductory NFT without incurring significant upfront costs. NFT leasing has a similar effect, allowing borrowers to use NFTs for a small fee, while allowing NFT owners to unlock profitability with their assets.
NFT leasing is naturally a complement to blockchain gaming, but there are other obvious use cases as well. For utility-based NFTs in particular, users need to have NFTs for some practical purpose, such as accessing the world of Metaverse-gated, or real-world events or services. Let’s say you need a Bored Ape for a party in New York. NFT rentals, then, will let you get NFTs and join the party in a short period of time without having to pay huge fees.
NFT derivatives work exactly the same way they work in TradFi. The most famous NFT derivative project, NiftyOption, allows users to purchase NFTs in the form of financial options, giving the buyer the right to execute the trade at a price and date specified in the future, but without obligation.
This allows NFT assets to be hedged in an interesting way, mitigating market volatility. Here is an example:
The price of the latest NFT project, Degentown, is rising, and you grab one for 10 ETH in the hope of selling it for a profit in the short term.
But this is a risky trade, and you tell yourself that if the trade fails, you are willing to suffer a 20% loss (2 ETH) from Degentown. To hedge against the worst-case scenario, you create an NFT option, deposit your NFT as a custodian, and set an incentive of 0.5 ETH.
3. Bob appears. Bob is a bigger Degen (an individual or gambler involved in high-risk trading) than you do, and he thinks Degentown’s price may continue to rise. He was also motivated by your $0.5 ETH fee bait and he took the bait.
4.Bob deposits 8 ETH (execution price) into the managed smart contract and pays a fee of 0.5 ETH.
5. From now on, you can choose to exercise the option at any time within six months by withdrawing the escrow amount of 8 ETH.
6. Your incentives: If Degentown appreciates by more than 10 ETH after 6 months, you should cancel the option contract and all you lose is the fee paid to Bob.
7. However, if your trade does not succeed and Degentown plummets below 8 ETH, you can choose to execute the contract because Bob has promised to buy it at 8 ETH and your losses will exceed 2 ETH.
(At NiftyOption, when an option contract is created, it is also cast into a new NFT.) When an NFT option is filled, the NFT is equal to the value of ETH in the option and is released to be used as collateral. ）
Other NFT spin-offs include Hooks and nftperp.
Due to the illiquid and low-speed nature of NFTs, it is very difficult to value them. NFT projects do their best to “predict” borrowings by adjusting a series of mechanisms such as borrowing rates, loan-to-value ratios (LTVs), and liquidation thresholds. But they are at best experimental attempts to prevent market volatility.
What if this centralized valuation process could be divorced from third-party intermediaries and decided by market speculators facing price incentives? Some NFT evaluation projects such as Abacus, NFTBank, and Upshot are experimenting with this.
For example, Abacus innovatively uses proof-of-stake technology to create a liquidity-backed valuation system. Appraisers act as validators, guessing the value of NFTs and investing their money in different valuation levels. In turn, NFT owners are supported by liquidity to use their NFTs as collateral.
Upshot, on the other hand, uses a “peer prediction” model, which consists of a large population answering subjective questions and then incentivizing them to answer questions honestly with tokens, similar to the way prediction markets utilize the wisdom of the masses. For more information about Upshot, see the Metaversal article.
NFTBank provides a proprietary machine learning-based tool to simulate NFT price assessments. The appeal of NFTBank and Upshot is that they can be easily integrated through APIs, but unlike Abacus, which directly controls the liquidity pool, their assessment may be seen as a lack of participation.
Fragmentation is ironic, perhaps because it seeks to make irreplaceable assets that investors claim to be fungible. But when your assets are worth thousands of dollars, it makes sense to be able to split them into more liquidity so that you can use them as collateral elsewhere, not to mention that it’s actually in line with Web3’s decentralized spirit.
Fractional (recently renamed Tessera) is a leader in this space, allowing users to fragment their beloved NFTs and democratize collective ownership. On Fractional, you can mint NFTs and break them down into tradable ERC20 tokens in a vault.
In mid-August, Tessera tweeted that after launching, we quickly learned that the ERC-1155 component was more ideal than the ERC-20s we originally deployed.
Un-fractionalizing NFTs are one of the toughest challenges facing builders in the field. In fractional, non-fragmentation is determined by token holders voting on the reserve price, which is the weighted average of all reserve price votes. When enough holders vote on the lowest price, a buyout is triggered and all holders can exchange their tokens for ETH (see here for more details).
The obvious problem here is that whales are able to give a bid that exceeds the entire community of token holders. Another fragmentation project, Unicly, tries to improve this by fragmenting multiple NFTs bundled in a vault, rather than a single NFT on fractional. This allows the user to hold fragmented assets for an NFT asset collection. While this doesn’t technically make it harder for whales to access the entire NFT, it retains some ownership by the average user.
The commodification of art is often seen as a bad thing. Philosophers and intellectuals have long believed that capitalism distorts the nature of the art form in pursuit of greed. If this is true, then the high financialization of NFTs by NFTFi is certainly a death knell for Web3 culture.
But contrary to this cultural pessimism, history shows that commercialization allowed art to flourish as a form of creative expression and mass communication. In a letter from Mozart, the musician wrote: “Believe me, my sole purpose is to make as much money as possible; Because it’s the best thing besides health. ”
Through immutable smart contracts, NFTFi opens up a world of financing possibilities for the ownership of NFTs, allowing the masses to no longer be limited to the passive bystander role of culture, but to acquire ownership and participate in its creation.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/the-ultimate-guide-to-nftfi-how-to-open-up-the-world-of-financialization-for-nft-owners/
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