Non-fungible tokens (NFTs) are a red-hot asset class in the crypto world, with billions of dollars worth traded every month. But NFTs aren't just for buying, selling and holding. Just like other assets, they can be part of more complex and lucrative financial arrangements.
The need for financial instruments in the NFT market stems from a significant problem. While you can sell Bitcoin pretty much instantly, the NFT market is far more illiquid. It can take months for someone to buy your NFT.
And when you sell your NFT, you have to sell the whole thing. Many people don't want to part with their NFTs forever - not even parts of them, as would be the case with NFT fractionalization.
These problems explain why NFT lending is the latest sector to develop. It solves the problem of low liquidity of NFTs while encouraging more people to invest in the NFT market by lowering the cost of entry.
The sector is divided into four models:
- Peer-to-peer NFT lending.
- Peer-to-protocol NFT loans.
- Non-fungible debt positions.
- NFT leasing.
Keep in mind that financial investments in NFTs and decentralized finance (DeFi) - or the overlap of both, as in this case - carry a variety of risks, including sudden downturns in the cryptocurrency market, exploitation of smart contracts, and regulatory actions. Although many of these platforms are audited, an audit does not guarantee security, but only points out flaws in a platform's code to the extent the auditor can detect them.
Peer-to-peer NFT lending
The first type of NFT lending corresponds to the classic model of a credit marketplace: bringing lenders and borrowers together.
NFTfi is a popular peer-to-peer platform for NFT lending. When you post your NFT as collateral on the platform, you receive loan offers from others. If you like one of the offers, you can accept it and immediately receive Wrapper Ether (WETH) or DAI (a stablecoin) from the borrowing user's wallet. As part of the loan agreement, the platform automatically transfers your NFT into a digital vault - an escrow smart contract - for the duration of the loan.
You will receive your NFT back in your wallet if you repay the loan before the end of the term. If you don't repay your loan, the lender receives your NFT at a large discount. Drastic changes to the base price of an NFT collection do not affect the terms of the loan; it is a peer-to-peer transaction with its own terms.
Here is a recent example of an NFTfi loan. Someone who bought Bored Ape Yacht Club #8646 a year ago for 0.55 ETH secured the NFT for 90 days. The lender made a 45 WETH loan to the NFT owner on May 7. By August 5, the lender received either 48.328767 WETH (equivalent to 30% APR) or, if the NFT owner defaulted, the secured NFT. At the time of writing, the NFT valuation platform Upshot values the secured Bored Ape NFT at 123.63564 ETH, and another valuation platform NFTBank values it at 147.29025 ETH.
NFTfi charges lenders a 5% fee on interest earned on successful loans (no fee in case of loan default). Borrowers use the platform without a service fee.
Arcade (formerly Pawn.fi) is another popular peer-to-peer platform for NFT loans.
Arcade allows users to package multiple NFTs - for example, multiple CryptoPunks - into a single NFT that can be collateralized as a single asset. The platform offers more flexibility in lending terms than NFTfi. For example, you can specify what you are willing to accept with ERC-20 tokens.
Peer-to-protocol NFT lending
While peer-to-peer NFT lending allows for customizable lending terms, peer-to-protocol NFT lending platforms allow you to borrow directly through the protocol.
Similar to DeFi lending protocols, these NFT lending platforms rely on liquidity providers to add cryptocurrency to a protocol pool. Borrowers can instantly access liquidity after collateralizing their NFTs and locking them in the protocol's smart-contract-driven digital vaults.
BendDAO is a popular platform that operates on the peer-to-protocol model. As of May 2022, there were approximately 1,000 NFTs collateralized on the protocol, including 273 NFTs from the Bored Ape Yacht Club.
The platform uses chainlink oracles - which are bridges that connect blockchains to data streams - to obtain floor price information from OpenSea, the most popular NFT trading platform. BendDAO liquidates collateralized NFTs when the floor price in the collection falls below a certain health factor that takes into account the market value of the NFT collateral and the amount borrowed. However, there is a 48-hour waiting period before liquidation occurs, giving the NFT owner a chance to save their beloved NFT from slipping.
Pine is another peer-to-protocol platform that allows borrowers to lend Ether (ETH), Solana (SOL) or Stablecoins against their NFT collateral. The platform allows for more NFT collections than BendDAO.
In the current form of the platform, users only lose their NFT if they don't pay it back by the expiration date. However, in the next version of Pine, users will be liquidated based on poor "health factors," similar to BendDAO. The platform also promises a "thorough borrower protection plan" in the future.
Non-fungible debt position
MakerDAO, one of the oldest platforms in the DeFi space, is known for its collateralized debt position (CDP) structure, which allows borrowers to take out the stablecoin DAI if they put up ETH as collateral.
Following a similar model, JPEG'd offers non-fungible debt positions. The platform, which had a total value of 4,846 ETH in its smart contracts as of May 2022, allows users to collateralize blue-chip NFTs like whitelisted CryptoPunks and borrow a synthetic stablecoin, $PUSd, pegged 1:1 to the U.S. dollar.
As a borrower, you can use $PUSd to provide liquidity on the log and earn interest, or you can exchange it for other cryptocurrencies to seek opportunities elsewhere. And when you pay back the loan, you can regain control of your NFT.
Similar to peer-to-pool lending platforms like BendDAO, JPEG'd uses Chainlink Oracle to keep track of the market price of its NFT collateral.
Leasing NFTs.
A final category is NFT leasing, with reNFT being a popular platform. It is a permit-free market for potential tenants and lessees with varying lease terms.
Rather than holding NFT collateral in a digital vault, the protocol enables peer-to-peer NFT rentals, where the asset is transferred from one wallet to another for the duration of the "lease." As a renter of a rented NFT, one gains full access to token-linked perks such as Discord servers or whitelist giveaways available to holders of certain NFTs.
Although the protocol provides NFT holders with access to liquidity, those purchasing a "rent" are not necessarily concerned with earning returns - rather, they are paying for the privilege of access and crypto credibility. In one case of a three-month CryptoPunk rental last year, for example, the tenant saw his "[social media] engagement skyrocket and he made a name for himself in the industry."