It has been more than a year since the NFT boom in 2021. According to NFTGO, the market cap of NFTs peaked at $36.8 billion in March 2022. As the market later cooled, the trading volume and market cap of NFTs started to shrink. This crypto novelty expanded its influence beyond the crypto community and fostered a huge market, which also gave rise to the combination of NFTs and DeFi. The market has witnessed the appearance of NFT lending platforms, NFT aggregators, and NFT derivatives markets, which constitutes the second debut of DeFi Lego enabled by NFTs. However, one wonders whether these products were built to meet real market demands and if they have created a false proposition that lacks any value for market participation. Today, we will dive into whether NFT-fi is a feasible trend and if it will earn market recognition.
Figure 1: Market Cap & Volume of NFTs | Source: nftgo.com | As of June 1, 2022
There are many NFT liquidity solutions and NFT structured products in today’s market:
1. NFT fragmentation: FT tokens (such as ERC20 tokens) that are issued by dividing the ownership of valuable NFTs. NFT fragmentation projects include Fractional.art, NFTX, etc.
2. NFT lending markets: Holders can borrow short-term loans by collateralizing their NFTs without selling them. Prominent NFT lending markets include BendDAO, NFTfi, and Drops DAO.
3. NFT leasing: Holders earn rents by leasing NFTs to users in need. NFT leasing projects include Double, reNFT, etc.
4. NFT aggregators: These aggregators, such as Gem.xyz, bring together the transaction data of multiple NFT exchanges, obtain the best NFT transaction price in one stop, and provide users with increased liquidity and more options.
5. NFT derivatives: NFT derivatives include NFT options like Putty, as well as NFT perpetual futures contracts such as NFTprep.
These projects are early attempts to bring together NFTs and DeFi. In particular, NFT fragmentation projects and NFT aggregators address the problems of poor NFT liquidity and high market threshold. NFT lending markets and NFT leasing projects also focus on improving NFT liquidity and capital utilization. Meanwhile, NFT derivatives are more complex structured products built to improve capital utilization. However, these projects have not been able to achieve large-scale adoption because they face limitations in terms of the underlying NFT logic and the development space. Next, we will explore the real demands and false propositions of NFTs.
1. The capital utilization of NFTs needs to be improved, allowing holders to collateralize their NFTs for partial liquidity when running out of cash.
2. The liquidity problem of NFTs should be addressed, enabling holders to quickly buy/sell the NFTs they own.
Did the capital utilization of NFTs go higher?
The problem of NFTs’ capital utilization can be seen in two aspects: 1) Users need to quickly buy and sell NFTs, and the transaction frequency should not be affected by the poor liquidity of NFTs; 2) Users should be able to quickly exchange their NFTs for liquidity and obtain cash for other purposes. When it comes to FT tokens, capital utilization can be improved through staking, leverage, etc. However, in the NFT market, there are only a few ways through which users can improve their capital utilization. In addition, combining finance with NFT significantly increases the learning cost. Right now, most NFT holders still rely on the “buy low and sell high” strategy. Moreover, most such holders are not the target user of NFT lending projects because only blue-chip NFTs with sound liquidity and value consensus are accepted.
In terms of the overall market scale, most users are absorbed by secondary markets and aggregators with low operating thresholds, and they have not achieved any major improvement in capital utilization. As shown in Figure 2, the number of new addresses of Genie and Gem, two NFT aggregators, has been on a steady rise, with increasingly frequent daily transactions. However, as the trading volume and transaction frequency of the two have been hit by the sluggish market conditions of NFTs, Genie and Gem have yet to reach their maximum potential for improving the capital utilization of NFTs.
Figure 2: New Addresses and Transactions of NFT Aggregators | Source: Dune @sohwak
Let’s turn to the capital utilization of mainstream lending projects. BendDAO is a lending market based on the liquidity pool model where holders can borrow ETH from the pool after collateralizing their blue-chip NFTs. Due to recent market fluctuations, a large amount of ETH deposit in BendDAO’s liquidity pool has been withdrawn, which resulted in decreased ETH supply. Yet, the ETH loans have remained at around 19,000 ETH, while the MA14 supply stands at 46,000. As such, we can make the rough estimate that BendDAO’s capital utilization is about 41%.
Figure 3: Bend ETH Utilization | Source: Dune@cgq0123
Note: MA14 refers to the moving average in 14 days, while MA7 indicates the moving average in 7 days
NFTfi is a lending market following the P2P model. The amount, interest rate, and duration of loans on NFTfi are jointly determined by liquidity providers and NFT lenders, which is more flexible in terms of the loan rate. The number of monthly loans offered via NFTfi increased from 21 in May 2020 to 2,000+ in May 2022, and the maximum monthly loan amount reached $27.52 million (March 2022), but this figure only accounted for 1% of the market cap of blue-chip NFTs (as reported by NSN-BlueCHIP 10).
Figure 4: NFTfi Monthly Loan Volume by Count/Value | Source: Dune@gideontay
JPEG’d is also a P2P model lending protocol, and it now only provides collateralized lending for Cryptopunks, EtherRocks, BAYC, and MAYC. After staking NFT, holders will receive PUSD, a stablecoin, provided by the protocol from the pool. Additionally, JPEG’d also features a 32% capital utilization limit on lending.
Of course, there are also other early-stage NFT derivatives platforms, but they have not introduced any mature products, so we could not analyze their capital utilization. Despite that, it is foreseeable that such NFT derivatives will come with higher learning costs as they are products designed for professional traders with greater risk appetite. As such, their growth potential is limited in today’s NFT market.
Asset Pricing and Liquidation Risks？
The pricing of NFTs has been so frequently discussed that it has now become a cliché. People are concerned with the issue because the price swings of NFTs will expose NFT lending or derivatives to liquidation risks. As the NFT prices fell over the recent period, BendDAO has started several liquidation auctions.
Although most of the lending protocols out there have adopted over-collateralization, in the face of wild price swings, many NFTs would be liquidated and sold in marketplaces. This, coupled with the poor liquidity of NFTs, might lead to panic selling, which would create downward price spirals, ultimately turning the loans into bad debts.
The pricing of NFTs is subject to multiple factors. Plus, it is also easily manipulated. For example, big holders could maliciously raise the floor price and then liquidate the NFTs on purpose, and an NFT could take a price plunge due to hacking or smart contract loopholes. Moreover, NFT pricing could also be affected by many intangible factors. For instance, the price of an NFT could soar if a famous person suddenly buys it in large amounts or if it releases a new airdrop plan.
As most lenders cannot accurately estimate the intrinsic value of their NFTs, they are vulnerable to liquidation if they borrowed loans or applied leverage. This is also one of the reasons why NFT lending and derivatives have not gained mass adoption: Blue-chip NFT holders are worried that they might suffer losses in the above scenarios, which is why they are reluctant to collateralize their NFTs.
Do blue-chip NFT holders really need NFT loans?
All NFT lending markets focus on blue-chip NFTs, but most blue-chip NFT holders are not in great need of loans. To begin with, such holders care more about their ownership of the NFTs, just like billionaires would not use their collectibles as collateral for loans. Secondly, NFT loans come with unknown risks, and many blue-chip NFT holders refuse to apply for such loans after weighing the risks against the benefits. Thirdly, applying for NFT loans comes with high learning costs, and not every user can understand the principle behind such loans.
Let’s compare the user base of the major NFT lending projects. As of June 15, there are about 2.4 million holders in the NFT market, of which 27,833 hold blue-chip NFTs (a user will be regarded as a blue-chip NFT holder as long as he owns at least one such NFT), according to NFTGO. There are 771 borrowers on BendDAO, 1,038 on NFTfi, and 51 on Arcade. As users must first deposit/collateralize their NFTs before applying for a loan, we can regard all these borrowers as blue-chip NFT holders. It is therefore clear that most blue-chip NFT holders are not users of NFT lending markets.
Figure 5: Bend ETH Borrowers & Depositors | Source: Dune@cgq0123
Could NFT-fi projects retain users with the same old incentive?
Lending or derivatives projects also bear the task of improving the protocol’s liquidity. Most such projects offer native tokens as the incentive for recruiting NFT holders and depositors as they go live. In this regard, these projects resemble DeFi liquidity mining platforms that attract speculators with high APYs. However, the problem is that they would not be able to maintain such liquidity if the APYs went down. Attracting users with token incentives is still the same old approach. Though this strategy could create a large user base at the very beginning, no one knows whether the protocol could retain users.
For example, when the project was first launched, BendDAO airdropped BEND tokens to users who had deposited blue-chip NFTs and ETH. It also uses BEND as a subsidy when paying interests. However, the interest rate went down when the BEND price dropped, which slowed down the growth rate of new users.
As such, attracting users with high APYs is only the first step. To retain new users, they must further explore the lending mechanisms, address the oracle pricing issue, and mitigate the liquidation risks. Projects should develop more flexible products while expanding the scope of NFT lending. Last but not least, they could also provide risk reviews, lower the learning cost, and offer more satisfying user experiences.
The evolution from NFT to NFT-fi is a process in which a market grows from its infancy to a more mature stage. However, it is also inevitably a process that’s full of doubts, traps, and problems. As NFT-fi projects seek to meet real demands, they will also have to face doubts that they are stating false propositions. Today’s NFT market is like a newborn child who needs to grow up and stick through challenges. Although NFT-fi might be a great attempt, there is still a long way to go, and NFT-fi projects have to keep exploring their underlying logic to earn market recognition.