Since the first iteration back in 2014 called Quantum, cryptocurrency enthusiasts have been experimenting with non-fungible tokens (NFT). The introduction of a universal standard for NFTs based on the original CryptoPunk smart contracts, dubbed ERC-721, has helped speed up development. As the popularity of NFTs grew, it became clear a new sub-sector within the space was necessary to add leverage. This was the birth of NFT Finance which started flourishing in 2022 as there was a rush of companies fundraising and issuing tokens. Let’s dive into the major types of sub-categories within this niche, and explore why following developments in NFT Finance is important!
Kevin McCoy’s Quantum, the first NFT from 2014
The Types of NFT Finance Categories
NFT Finance can be broken down into four sub-categories:
- Appraisal / Valuation
- Derivatives / Hedging
- NFT Loans
- Fractionalization
There are plenty more sub-categories, but for this article, we’ll keep it to these four. Below, we’ll go through each category and cover some examples of companies working on a solution.
Appraising and Valuing NFTs
NFTs are an illiquid asset as it stands today. While there are lots of marketplaces working on solving this issue, the next best solution is to know what the market price is. For illiquid assets in the real world, guides usually exist. A few examples are Hagerty for classic cars and PSA Price Guide for trading cards. Having an idea of valuation for any specific NFT keeps the guesswork out.
Many companies are working on a product to automatically provide appraisals. One serious player is NFTBank, a company that started early in building algorithms for pricing NFTs. They provide a user-friendly interface to show historical price movements, pricing, and estimations. Upshot is another service built before the explosion of NFT popularity, though it is geared more toward developers through its powerful API.
For Metaverse land, Parcel is the leader in building an appraisal service based on various metrics unique to this asset class. Characteristics desired in real estate also carry over to Metaverse land, leading to intrinsic value. Proximity to major plots of land owned by brands, or high foot traffic leads to advertising dollars. Parcel is at the forefront of becoming the Zillow for the Metaverse and doubles as a marketplace for all Metaverse land.
Another approach to appraisal is through crowd-sourcing. Markets are the best crowd-sourced pricing as there is a monetary benefit to knowing the ‘right’ price. Lithium Finance is a service that provides a monetary incentive for pricing NFTs, without the need to trade the underlying NFT. Participants stake $LITH tokens to provide an estimated value for a requested NFT, and those closest to the adjusted mean are rewarded with more $LITH.
New projects looking to appraise NFTs through innovative and proprietary models come up almost every week. This is one exciting area to keep an eye on!
Derivatives and Hedging Instruments
One of the main utilities of NFTs is community building, which leads to speculation. While there are countless NFT collections, each one usually has around 10,000 pieces (some are more or less, but in general this is the magical number). For established collections, you can expect around 15% of the NFTs to be available on a marketplace for trading. Out of the 15% available, 20% are realistically priced while the others are so high in the offer queue that it becomes pointless. It becomes inefficient to trade in and out of collections in meaningful sizes for speculative purposes.
Options and futures add a key benefit to speculating in NFTs, as it doesn’t require the purchase of an NFT. This added leverage lowers the barrier for traders and thus adds an added level of liquidity to NFTs. Derivative instruments also provide the ability to hedge the collection vs. the individual NFT itself. It can also hedge market conditions without the need to sell assets. In traditional finance, derivatives exist for a myriad of commodities and securities, so an extension into NFTs is natural.
Hook is a service available on mainnet now for NFT options. Both put and call options are available for individual NFTs within collections. Cally Finance is another options platform, looking to streamline the process for users by offering call overwriting (selling calls against an underlying NFT). This service is similar to Ribbon Finance. It is being built by the team behind Putty Finance, another NFT options platform.
Futures are an easier entry point to NFT speculation. NFTperp is at the forefront here with a platform designed to lever up to 5x in either long or short directions on NFT collections. This is particularly useful for hedging against price movements in a collection or tracking the floor price without having to short an NFT.
Mimicry Finance is another platform in which participants can take a position on the future price of a collection through a pool. The powerful feature of Mimicry is the ability to freely short NFTs without the hassle and friction of high collateral. Metastreet and Reservoir have created ‘Power Sweep’ which provides the ability to speculate NFTs on leverage, but no ownership of the NFT until full payment. While leverage is limited, the user can perpetually extend the loan with careful monitoring every 30 days. This is a synthetic way to go long NFT perpetual futures.
As an early entry to derivatives, companies are working on credit default swaps against loans on NFTs. Abacus is one such platform designed to crowd-source a method of appraising an NFT, while simultaneously providing a way for the appraisal requester to post the pool as collateral against a loan. This provides a lender with a claim against the NFT loan with the ability to sell the NFT back to appraisers at the crowd-sourced price. Put simply, it is a way to insure against someone not paying you back for an NFT loan! Ranch Finance is another example of this type of product.
While NFT derivatives are still quite nascent, expect to see this category grow fast as users are always on the hunt for the most capital-efficient method for trading.
NFT Loans
This is a category first pioneered by NFTfi through their pawn service. Given the illiquid nature of NFTs, it is hard to trade in and out of NFTs when needed. Leverage doesn’t exist efficiently yet, so borrowing funds against an NFT makes sense. With well-established collections such as CryptoPunks or Bored Ape Yacht Club, market participants are willing to make loans against the NFT as collateral. This alleviates the need to sell the NFT for funds, which many collectors value as rare items may be hard to come by. However, the key drawback of this model is the need to have the NFT in the first place. There are a growing number of platforms working on a solution to provide a way to buy an NFT with a loan as well!
To deep dive into NFT pawning a bit more, the best place to start is NFTfi. They’ve been around since 2020 and have paved the way to create a liquid market for NFT collateralization. Willing lenders match with NFT holders looking for liquidity through a bidding process. NFT holders will post their NFT to seek a loan, and lenders will send in bids for various terms and rates. A loan is made once the NFT holder accepts a loan bid, which then locks their NFT in exchange for cryptocurrency for the duration of the loan. This is the peer-to-peer model. So far, NFTfi has serviced over 2000 borrowers and has processed about $300 million in loans.
A peer-to-protocol model exists as well. BendDAO is the largest example of this, popping up in late 2021 and making headlines in mid-2022. The protocol adds leverage for a handful of projects, pooling capital for each collection that is available for loans. NFT holders can post their NFTs as collateral to receive cryptocurrency (usually Ethereum) in the form of a loan. These loans don’t have an expiry date but do require a certain margin rate to stay solvent. If the underlying NFT price drops, then the borrower must post increased collateral or pay back the loan to get back their NFT. The risk here is the reliance on BendDAO’s oracle pricer and the volatility of NFT prices, thus increasing the likelihood of defaults. This happened a few months back and is still an ongoing concern for the space. The platform has processed over $100 million in loans and has about 1000 unique borrowers.
Cyan provides a peer-to-protocol method of pawning an NFT but eliminates the need for margining. It is a new kind of pawn system where NFTs are appraised on the spot with an interest rate for a fixed-term loan. When the loan starts, all terms lock for the duration of the loan. This means the borrower must only make monthly payments to keep the liquidity. The benefit is the ability to get instant loans without the hassle of keeping track of NFT prices. Cyan also provides a 24-hour pawn window for 50% of the value of the NFT. This is useful for quick liquidity for a high amount of the appraised value, thus eliminating the need to sell at the floor price now.
As mentioned above, pawning NFTs only provides servicing once a user owns an NFT. Before ownership, leverage is accessible through Cyan in the form of a Buy Now Pay Later (BNPL) service. BNPL is a popular method of purchasing goods in e-commerce from the likes of Klarna and Affirm. Cyan works similarly, with the user only required to make a 25% down payment for the NFT, and three more monthly payments until maturity. This feature allows the user to enjoy the benefits of the NFT today without the burden of making the full-price commitment upfront. During the loan, users have ownership utility such as community rewards, airdrops, and staking.
There are other services in this category providing a flavor of peer-to-peer and peer-to-protocol solutions for NFT leverage. Arcade is a similar platform to NFTfi in the form of a modernized user interface. Pine is also similar, with the added benefit of NFT collection pools, making it easy for lenders to choose which they’d like to extend credit to. As NFTs continue to grow in popularity, this category will be one of the first entry points for new users to access leverage!
Fractionalization
This sub-category may seem counterintuitive as the point of NFTs is to keep assets non-fungible. It’s the definition! The purpose is to keep a single asset non-fungible so it is authentic. Similar to how we treat a Monet painting or a Vacheron Constantin mechanical watch. This feature is also a limitation of NFTs, as fewer people can afford to experience the exclusivity of a non-fungible asset. Especially on the higher end.
Fractionalization is the idea that a non-fungible asset can be broken up into an infinite amount of pieces and distributed to more people. In simpler terms, it is partial ownership of an authentic asset. An example would be an apartment complex. A single investor may first acquire the building, but individual apartments are sold off to others. The building is non-fungible, but the individual apartments are dispersed ownership with everyone having a percentage claim to the underlying land (this is a very simplified example!).
A non-crypto product that is similar is Masterworks. The problem they are solving is the lack of access to art investments by the general public. Masterworks handles the purchase and safekeeping of art, all within a legal structure to provide shares in a particular piece. For example, you can buy shares in various Banksy paintings to create a portfolio of art investments, without having to buy each whole painting. Masterworks is taking a non-fungible asset and making it fungible through shares.
The model in cryptocurrency would be to take an ERC-721 NFT and hold it in escrow, and issue ERC-20 tokens against the NFT for the general public to consume. Tessera (formerly Fractional.art) is a platform providing this exact service. They have done so with the PleaserDAO’s fractionalization of the original dog picture of the ubiquitous DOGE meme. The 1/1 dog picture is chopped up into 17 billion pieces, with over 10,000 owners. Unicly is a similar project working on the fractionalization of NFTs.
According to DappRadar, the total market size for fractionalized NFTs sits at $32 million today. As the utility for NFTs increases, the fractionalization of NFTs provides a lower barrier to entry so more users can enjoy the benefit!
TL;DR
NFT Finance is an important sector to add liquidity and price discovery for NFTs. As more and more web2 companies migrate over, user numbers will continue to grow. Adding leverage to the space is a key ingredient for the next bull run. This article only covers the current major sub-categories, but more exist such as Rental, Custody, and Analytics. In this article, we didn’t cover JPEG’d, Charged Particles, Solv Finance, FloorDAO, and countless others as the space is growing. There are over 100 companies today, with more added almost every week!
Be sure to visit Cyan often to get the latest developments in the space and follow us on Twitter to keep up to date!
Projects covered:
NFTBank: https://nftbank.ai/
Upshot: https://upshot.xyz/
Parcel: https://parcel.so/
Lithium Finance: https://lith.finance/
Hook: https://www.hook.xyz/
Cally Finance: https://www.cally.finance/
Putty Finance: https://www.putty.finance/
NFTPerp: https://nftperp.xyz/
Mimicry Finance: https://www.mimicry.finance/
Metastreet: https://metastreet.xyz/
Reservoir: https://reservoir.tools/
Abacus: https://abacus.wtf/
Ranch Finance: https://ranch.finance/
NFTfi: https://www.nftfi.com/
BendDAO: https://www.benddao.xyz/en/
Cyan: https://www.usecyan.com/
Arcade: https://www.arcade.xyz/
Pine Loans: https://pine.loans/
Tessera: https://tessera.co/
Unicly: https://www.unic.ly/
Useful Links:
NFT market data: https://cryptoslam.io/
Fractionalized NFT size: https://dappradar.com/nft/fractionalized
NFTfi Dune Dashboard: https://dune.com/rchen8/NFTfi
BendDAO Dune Dashboard: https://dune.com/janetalcott/benddao-nft