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NFT lending is the act of pledging your NFT as collateral to secure a loan funded by a lender seeking to earn returns from their investment.
Like traditional arts and collectibles, NFTs have been experiencing low liquidity and cash flow generation.
NFT lending changes this old narrative by injecting more liquidity into the space.
Gone are the days when Non-Fungible Tokens (NFTs) were simply JPEGs used as profile images – nowadays, they mean business! The latest trend, NFT lending, which enables collectors to use their collections as collateral to secure crypto loans, is booming. Most NFTs lack adequate liquidity, and various decentralized finance (DeFi) projects have responded to the need to boost NFT liquidity through lending.
Though NFT floor prices have tumbled along with the entire cryptocurrency market, NFTs’ utility is exploding – from fantasy gaming to social clubs. The increase in utility has led to the demand and popularity of NFT lending. After all, since NFTs are blockchain tokens, they can be loaned out and borrowed against.
This article takes you through the NFT lending trend. Follow along to the end to learn what NFT lending is, how to lend an NFT, types of NFT lending, and NFT lending platforms.
What is NFT Lending?
NFT lending involves pledging NFTs as collateral for a loan on a platform like NFTfi.com. The loan is provided by an investor or lender looking to generate interest on their investment. Generally, lenders engage in NFT-based loans to generate higher returns than standard crypto-based and traditional loans. Like cryptocurrency lending, NFT lending leverages digital currencies as collateral. However, in NFT lending, borrowers lock their NFT assets as collateral to receive loans.
NFT lending is rarely available in centralized finance (CeFi) applications, such as Nexo, which act as traditional lenders by determining the lending terms and rates. Instead, most NFT loans are offered by DeFi applications, which leverage smart contracts to govern the terms and rates. NFT lending is a new trend, implying it will evolve as more people and money gets involved and regulation steps in.
The Demand for NFT Lending
NFTs are unique blockchain tokens that represent ownership of virtual and physical items, such as real estate, collectible cards, music, artwork, in-game avatars, tickets, domain names, etc. The main selling point for NFTs is their non-fungibility feature – they are not easily divisible, nor can they be replicated. NFTs have exclusive digital identifiers that make them indivisible and unreplaceable. Besides, you can easily verify them by tracking their origin on the blockchain.
On the contrary, cryptocurrencies are highly divisible, meaning you can purchase fractions of a bitcoin if you can’t afford to buy a full bitcoin.
EVERYDAYS: THE FIRST 5000 DAYS NFT. Source: Christie’s
The most famous example of an NFT sale that hit the headlines in 2021 was Beeple’s EVERYDAYS: THE FIRST 5000 DAYS. The collection sold for a whopping $69,346,250 at a Christie’s auction, causing an NFT craze in March 2021. Other notable sales include former Twitter CEO Jack Dorsey’s first-ever tweet, which sold for $2.9 million and a legendary dunk by LeBron James with a sale price of $208,000 in February 2021. The NBA Top Shot is the official platform for minting and trading NBA-based trading cards featuring NBA stars. NBA fans can own these trading cards or trade them for a profit.
Source: NBA Top Shot
NFTs’ lack of fungibility is key to crafting their uniqueness. It has led to a diverse asset class for digital collections, which shares some similarities with standard artwork and other physical collectibles, such as Pokémon cards. Nevertheless, non-fungibile tokens also have their weaknesses. For example, NFTs tend to be illiquid when compared against conventional crypto tokens and coins. Instead of trading it instantly on an exchange, you have to list it on an NFT marketplace and wait for a buyer to come along.
Now, this is where DeFi lending comes into play. NFT-backed loans and fractionalized NFT ownership via DeFi applications are the latest solutions for unlocking the full financial utilities of NFTs. These faucets create platforms where NFT collectors can lock their assets as collateral for crypto loans.
After collecting or minting NFTs, it isn’t easy to use them productively without selling them. Unlike fungible assets, you cannot stake or farm yield with NFTs, meaning they will be lying idle until you sell them. But NFT lending allows you to secure loans by pledging your collections as collateral in a lending platform. You can then use the loan to acquire more NFTs (especially newly-minted NFTs with lower floor prices), buy tokens that you can cash out into fiat, or buy other tokens for DeFi staking and yield farming activities.
How Do You Lend an NFT?
NFT lending platforms let NFT investors borrow crypto and set the lending terms and rates without a third party. As a borrower, you can secure a loan of up to 50% of the value of your NFT, with rates of between 20-80%, based on the valuation of the asset. NFT lending protocols are more straightforward, transparent, and faster than real world lending platforms. There is no intermediary to evaluate your creditworthiness, verify your identity and take several days to weeks to consider whether to approve or reject your application.
DeFi apps leverage smart contracts, allowing users to enjoy total control of their assets. Essentially, the collateral is locked in a smart contract, which is automated. Lenders choose ”the fair value” of the collateral by evaluating the NFT’s past transactions and the floor prices of similar collections. After the lender and borrower agree on the terms, the borrower transfers the NFT from their wallet to an escrow system, and the protocol handles the rest. If the borrower fails to repay the loan and interest within the specified period, this results in forfeiture of the NFT.
Lending protocols, like NFTfi.com and Arcade, have fixed-period, fixed-rate loans. They don’t have access to the collateral or funds involved, nor do they liquidate the collateral when its price shrinks. However, other protocols like JPEG’d will liquidate the collateral if the loan-to-value ratio reaches 33% or more.
Types of NFT Lending
Peer-to-Peer NFT Lending
Peer-to-Peer NFT lending functions like regular crypto loans – the transactions happen directly between parties. For instance, a borrower lists an NFT as collateral on NFTfi with a loan offer. The borrower will receive wrapped Ether (WETH) or DAI, and the collateral will be locked in a digital vault under specific terms and conditions. When the borrower clears their loan and interest within the stipulated time, they receive their NFT, as the lender receives his investment plus interest. NFTfi is an example of a peer-to-peer NFT lending platform.
Peer-to-Protocol NFT Lending
Peer-to-Protocol NFT lending resembles DeFi lending protocols, where native assets are borrowed directly from lenders. Peer-to-Protocol platforms require liquidity providers (LPs) to deposit tokens into pools. The borrowers can access the liquidity by transferring their NFTs into the available vaults.
Non-Fungible Debt Positions
MakerDAO has been leveraging collateralized debt position lending to offer crypto loans – borrowers lock ETH collateral to qualify for DAI loans. In non-fungible debt positions, borrowers lock their NFT assets to qualify for synthetic stablecoin loans like in MakerDAO. On the other hand, lenders can offer PUSD liquidity or exchange PUSD for other tokens to generate yield on DeFi protocols.
reNFT is one of the NFT lending platforms that provide non-fungible debt positions.
NFT Lending Platforms
NFTfi leverages the peer-to-peer and peer-to-protocol models to offer NFT loans. Borrowers can access liquidity and receive WETH or DAI tokens by locking their NFTs in vaults. On the other hand, the LPs receive rewards for providing liquidity. The platform employs three lending strategies:
Lending – It involves offering liquidity to another person, the borrower. As a lender, you loan out wETH to a borrower who locks their NFT in a vault.
Lending for profit – You lend to other crypto users in return for financial incentives in the form of interest rates.
Lending to acquire – This strategy is commonly used by users who double up as extensive NFT collectors. Besides, it’s ideal for users that want to acquire a broad collection of NFTs cost-effectively over time.
Arcade, formerly Pawn.fi, is a web3 solution that provides NFT lending services. It focuses on creating primitives, systems, and apps that facilitate the growth of NFTs. It provides trustless off-chain order matching through structured digital signatures to confirm lending terms between parties. Loans are processed on-chain and kept in a decentralized escrow, secured by Ethereum cryptographic guarantees. Besides lending NFTs, users can also swap them for other NFTs or crypto.
Unlike NFTfi and Arcade, Drops supports loans for NFTs and DeFi assets, enabling them to gain extra value. Lenders can use any asset to fund liquidity pools through the Drops DAO. Borrowers can utilize their idle DeFi assets and NFTs to obtain trustless loans and generate extra yield through leverage. Generally, the community-based protocol allows a wide range of assets – from metaverse items to NFTs to DeFi assets – to act as collateral.
NFT lending bridges the NFT and DeFi spaces. It injects much-needed liquidity into NFT assets by offering NFT holders funds to use in other endeavors. This prevents collectors from selling their assets at throw-away prices because of an urgent need for funds. NFT lending also allows lenders to put their assets to work and generate interest. Though nobody can safely predict the next NFT trend, it’s safe to say NFT lending will continue to create alternative investment opportunities in 2022 and beyond by offering liquidity options to a notiously illiquid market.