At the MVP Workshop, we had a chance to organize an internal NFT hackathon within our research and development department called 3327. The topic was NFT liquidity as one of the hot challenges in the blockchain ecosystem nowadays.
We split into smaller teams and chose our subtopic. As lending is one of the main assets’ liquidity boosters, our team decided to tackle it and research NFT lending solutions’ current state.
Today, you can find a couple of solutions that provide NFT owners with an option to borrow funds by lending their NFT(s) as collateral: Starter, UniLend, Lendroid, and NFTfi.
However, most of them are early-stage protocols. The Starter and NFTX are the ones who went furthest as the Starter has the Rinkeby version and NFTX is the only one that is on the mainnet.
NFTfi is a simple place for NFT collateralized loans. There are two main use cases, depending on the nature of your need – whether you want to borrow or lend crypto:
- If you need a loan, put any ERC-721 token up for collateralization and wait for the best loan offer.
- On the other hand, if you want to lend the crypto to someone, find acceptable NFT, and submit your proposal (loan value, repayment value, and duration).
It is a pretty straightforward and useful solution. Right?
Besides previously mentioned, there are no other solutions that are actively working on NFT based lending. Still, there are two initiatives worth mentioning that tried to contribute to this topic.
At the beginning of last year (2020), an initiative gained a lot of publicity. It was a project called Rocket, initiated by Alex Masmej. Unfortunately, Rocket hasn’t been released to production yet. More precisely, the team that stands behind this idea offered to transfer the ownership of the project (and in the meantime created DAO) to the highest bidder.
Also, an early-stage idea was shared by Dragos I. Musan. Dragos took comprehensive research and proposed theoretical solutions on how to bridge some of the current gaps in the market of NFTs by applying adequate DeFi principles. However, based on the ideas he listed, only PoC solution have been developed. Since it has similar functionalities as NFTfi we didn’t take it into further consideration.
The lack of options for loans collateralized by NFTs is the consequence of the larger challenge of NFT liquidity and defining the NFT assets’ price. The same problem fungible (ERC-20) tokens faced before AMMs (automated market makers) were introduced. Once it is solved and an efficient price discovery mechanism is created, NFTs backed loans will experience a boom.
Many different projects are trying to create efficient price discovery mechanisms. Most of them use auction and sale models, but it seems that they are insufficient as we still don’t have an appropriate price discovery mechanism.
On the other hand, some projects use a model that creates fungible (ERC-20) fractions of non-fungible tokens. This is the one that we bet on!
Projects such as NFTX, NIFTEX, and NFT20 are mainnet solutions. Some of them even have pools of ERC-20 tokens (created via their protocols) on Uniswap and Sushiswap with considerable liquidity.
Finally, the last model (project) is UpShot One. It is based on the idea of combining the benefits of peer-to-peer networks, DMI-Mechanism, and the historically proven fact that appraisals are one of the best means of non-fungible, low-velocity asset price definition.
We are fascinated by the UpShot One approach. Still, as we believe that the best solutions are the simplest ones, we bet on the NFT20, NFTX, and other projects trying to boost NFT liquidity by creating fungible versions of non-fungible tokens.
Future of NFT Lending
As it is a matter of day when we will have acceptable solutions capable of defining non-fungible assets’ value, we wanted to take a step further and predict how lending protocols that accept NFTs as collateral will look in the future.
We see two main types of NFT lending solutions. The difference between them is the type of collateral they accept.
First is one that accepts fungible (ERC-20) representations of the non-fungible tokens. It assumes that the approach of creating ERC-20 versions of NFTs will effectively determine their price.
There is no significant difference between this kind of lending protocol and those currently offering loans backed by fungible assets as they both accept ERC-20 tokens as collateral. This approach is simple and already proven, but once again, it assumes that the price of the NFT can be reliably defined through a mechanism that NFTX promotes.
This option’s pros are that lenders can use collateral (ERC-20 token) to gain more profit (e.g., providing liquidity into some ERC-20 pool). Also, it is essential for the borrower that he can easily add more assets and prevent liquidation in case of a margin call.
The downside is that the lender can not use the underlying NFT token’s functionality, as he only possesses an ERC-20 representation of it, not an actual NFT token. E.g., the NFT token can represent ownership of some virtual real estate, domain name, etc… In that case, a lender can not benefit from it, as he does not wield that specific NFT.
The second type of solution is lending protocols that will accept NFT itself (e.g., ERC-721 tokens) as collateral. Until the effective price oracles, such as UpShot One aim to become, are developed, this kind of solution can not be fully automated/decentralized. The reason is that each NFT is different. Until we have an effective price oracle or other price discovery mechanism, there has to be some central authority that will decide whether a specific NFT is accepted as collateral or not and also how much it worths.
Compared to the previous solutions, the pros are that lenders can utilize NFT’s functionalities (e.g., use it in the game). Also, a lender can earn additional funds by leasing that NFT to some third party or gathering profit that NFT generates (e.g., rent if it represents ownership of some virtual estate).
However, besides depending on the effective price oracle, the downside of this solution is the challenge of preventing the liquidation in case of the margin call. Since the NFT is non-fungible, the user can not add more of that same NFT as collateral. Hence, he has to add another acceptable NFT, which is not always practical since it is hard to find an NFT that matches the missing value he wants to add.
Finally, there is a joint agreement. All of us would bet that the first approach will see the light of the day earlier. The main reasons are the similarities to current lending protocols and the fact that at the end of the day, you are collateralizing ERC-20 tokens. From a protocol perspective, as long as you have an effective price discovery mechanism that allows you to track asset price and trigger margin calls and liquidation if needed, it doesn’t matter whether that is a standard ERC-20 token or it is a fungible (again ERC-20) version of NFT token.
What do you think about the NFT lending platforms? Do you see any other type of protocol that will arise soon? Are there any other problems besides price discovery that are significant impediments? Please share your thoughts in the comments or contact us at…
PS: Thanks to our 3327 community members for the initial feedback and efforts that helped us research the topic of NFT liquidity.
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