What is NFTfi and how does it work?

Narcisse Luci
Narcisse / Luci

NFT Finance, also known as NFTfi, is one of the latest innovations in the realm of non-fungible tokens. By exploring different avenues to leverage ownership, this emerging concept could transform they way we view and interact with the NFT market and economy

Introduction: defining NFTFi

NFTFis, the fusion of DeFi (decentralized finance) and NFTs (non-fungible tokens), represent a new frontier in the web3 space. This umbrella term encompasses the various ways of using NFTs to finance transactions by accessing more liquid assets. It holds tremendous potential for innovation and opens up exciting new opportunities.

This novel concept can be divided into four main sectors:

  • NFT fractionalization
  • NFT renting
  • NFT derivatives
  • Lending and borrowing NFTs

NFT fractionalization involves breaking down an NFT into smaller chunks, making it easier for investors to invest. However, in order to remain competitive, the sector has a few challenges to solve.

NFT renting allows people to use NFTs without owning them, with over-collateralized and under-collateralized options existing side-by-side with one another.

NFT derivatives are akin to derivatives in traditional finance, providing tradable contracts for betting on the future prices of NFT collections. Much like in non-NFT markets, this sector also has great potential for trading. However, offering derivatives on illiquid assets like this remains one of the most difficult challenges.

Finally, lending and borrowing NFTs provide a new way to use these illiquid assets as collateral for loans. Here, establishing a fair price for NFT collateral is the main challenge.

There are three main types of loans to consider: peer-to-peer NFT lending, lending/CDPs, and lending pools.

In this article, we'll explore the proposed solutions for various applications of the NFTfi options. These options are gaining significant traction in the web3 market, as depicted in the graph below:

NFT Fractionalization (F-NFTs)

F-NFTs are a solution to the high cost of owning an entire NFT. They allow for the division of an NFT into fractions, enabling multiple people to own a small piece simultaneously. This is achieved by locking the NFT in a smart contract and dividing it into multiple ERC-20 tokens, with each token representing partial ownership. These tokens can then be individually sold at a fixed price, either for a specific period or until they are sold out.

The potential use cases for F-NFTs are vast, ranging from managing in-game assets to facilitating real estate transactions— all the while speeding up the buying process by replacing intermediaries with smart contracts.

While still a relatively new concept, fractional NFTs are gaining traction quickly and are being seen as a transformative move in the space by allowing more people to invest and showcasing a potential to democratize ownership of digital assets, opening up new, smaller-case investment opportunities.

NFT renting

If you own an NFT with utility, you can either use it yourself or rent it out to someone else for a fee. For renters, this provides the benefits of owning an NFT without the financial commitment of investing in it, making it an essential advantage for mass adoption, especially in the GameFi space.

When an NFT owner lists their asset on a rental marketplace, a renter can initiate the renting process. The NFT is then placed in a smart contract that includes the terms and conditions agreed upon by both the owner and renter. This ensures secure transactions.

Once the contract expires or the renter decides they no longer want the NFT, it's returned, along with the collateral, to its original owners. This process guarantees a fair and seamless experience for all parties involved.

These transactions can be categorized as either collateralized or collateral-less renting.

  • Collateralized renting occurs when prospective renters are required to post collateral valued higher than the amount they wish to borrow.
  • Collateral-less renting allows lenders to deposit their NFT and generate a wrapped version of it. When a user rents the NFT and pays the rental fee, they receive the wrapped NFT with the same functionality as the original. Once the contract expires, the wrapped NFT is destroyed, and the rental fee is sent to the lender without any collateral being involved.

NFT renting allows owners to earn passive income from their NFT on their terms, without having to worry about fractionalization problems, while also adding asset liquidity to their collection. However, as with any emerging technology, there are still some operational security risks related to the contract.

What is the IQ protocol, and how does it work?

This technology enables the creation of rentable copies of the original NFTs, known as warped assets, which can be seamlessly integrated into any service. The warper has control over the rental business logic.

The IQVerse represents the service in the IQ protocol and comes with an associated IQVerse NFT that allows the owner to modify its parameters. The renting process is trustless and riskless: renters do not need to provide collateral, and the asset automatically returns once it expires, without requiring a blockchain transaction. When a user rents an asset, the payment is divided between the original asset’s owner, IQVerse, and IQ Protocol in equal fashion.

To use the warper technology, a service provider creates an IQVerse account and either creates or uses an existing original asset. They then prepare a warper for the asset and configure their platform to extend various benefits and perks associated with it.

NFT derivatives

NFT derivatives are one of the hottest new trends in the NFTFi space. They’re similar to traditional derivatives, as they represent contracts that allow people to bet on the future prices of NFT collections. Derivatives trading is a well-established practice in the traditional finance industry, and the same concept applies to NFTs.

NFT derivatives provide a platform for retail users and traders to take long or short positions on the value of NFTs. This opens up numerous possibilities for NFT liquidity and enables more robust trading strategies to maximize users' profit opportunities while hedging risk and exposure.

In traditional finance, the derivatives market is significantly larger than the spot markets. Although it’s a part of a complex and high-risk financial product, it presents as a significant growth opportunity in the NFT space as well. Currently, only a handful of top NFT collections are available for derivatives trading, limiting users’ options.

Over-speculation on a collection’s value can also create a negative image of the NFT community. It's crucial to approach derivatives trading with caution and consider its potential risks. However, with proper risk management and a focus on responsible trading practices, NFT derivatives can be a powerful tool for expanding the market and improving liquidity.

What is nftperp and how does it work?

A perpetual futures exchange for NFTs that tracks the floor price of NFT collections, nftperp allows traders to go long or short on the floor price of NFT collections like Bored Apes or CryptoPunks with any amount in $ETH. Traders do not need real NFTs as collateral as perpetual futures contracts simply track the floor price of the underlying NFT collection.

The true floor price is a tamper-proof NFT price oracle with robust statistics, backed by sales between real buyers and sellers of a given NFT collection. The exchange uses a vAMM (virtual automated market maker) under the hood, and funding is used to ensure that the derivatives’ prices stay close to the real floor price in the spot market. Interested parties can participate in the beta version by joining the project’s Discord channel.

NFT lending

The world of web3 has embraced NFTs as a vital component, with the market projected to reach $147.24 billion from 2021 to 2026. But let's dive deeper into the lesser-known benefits of NFTs and uncover strategies for tapping into liquidity.

Consumer lending is backed by some of the most sophisticated financial technology products, yet its fundamental concept is relatively simple. At its core, an NFT loan uses a non-fungible token as collateral for a loan, making use of an asset with otherwise little liquidity in its original form.

The concept is straightforward: deposit your NFTs into a smart contract and receive an agreed amount of crypto assets in return. The borrower can then access cash for other investments while the lender earns interest on the exchange. If the borrower cannot repay the loan as per the agreed terms, the lender retains the NFT collateral. If the borrower repays the NFT-backed loan with interest, they get back their collateral.

There are four main methods of making such loans:

Peer-to-peer NFT lending

Operating similarly to DeFi lending, using on-chain smart contracts which house the assets, loan liquidity, and loan terms and conditions, peer-to-peer NFT lending platforms serve as intermediaries that facilitate trustless loans between prospective borrowers and lenders, utilizing NFTs as collateral.

Blur, a non-fungible tokens (NFT) marketplace, has launched Blend, a peer-to-peer lending platform that aims to boost liquidity for these digital assets. It allows borrowers with NFTs on their platform to obtain loans by leveraging their assets. Simultaneously, lenders can earn interest by funding these secured loans.

Peer-to-pool NFT lending

A novel approach where NFT owners borrow funds from a liquidity pool instead of an individual lender. Although still in its infancy, this lending model has the potential to be highly efficient in matching lending and borrowing demand, with immediate liquidity made available without the need to wait for specific bids or offers.

There are various design approaches in peer-to-pool lending, with differences in how the liquidity pool operates. Some designs use algorithms to adjust loan parameters, optimizing outcomes for both borrowers and lenders, while others are set by the pool owners.

What is BenDAO and how does it work?

BendDAO is an NFT liquidity protocol that offers instant NFT-backed loans, collateral listing, and NFT down payment. As of now, BendDAO has the most significant liquidity for NFT peer-to-pool lending.

Holders can borrow ETH through the lending pool using their NFTs as collateral, while depositors provide liquidity to earn interest. The protocol also allows NFT holders and sellers to receive up to 40% of the floor value of the listing before the sale, with the instant liquidity provided by the NFT-backed loan. Existing borrowers can also list their collateral directly on BendDAO, with the balance transferred to the seller after deducting the debt with interest.

Non-fungible debt position

In most cases, NFT owners need to sell their tokens to realize their value. JPEG'd, a decentralized lending protocol on the Ethereum blockchain, enables NFT holders to open collateralized debt positions as a solution to this issue. These non-fungible debt positions allow users to deposit their NFTs as collateral and take out a loan for a portion of its total value. These trustless and permissionless collateralized debt positions allow users to access the value of their NFTs by using them as capital collateral.

NFT rentals

NFT rentals also provide owners with an opportunity to access liquidity and leverage their NFTs, earning interest on their loan.

Two main approaches have emerged to add capital efficiency to NFT owners in this manner. Rental solutions can be directly integrated into specific games via smart contracts, like in the case of Cometh. Alternatively, external agents can develop their own centralized solutions to offer to several games at the same time.

In closing

Embracing the world of NFTfi comes with its fair share of challenges and risks, much like any groundbreaking technology. However, it is crucial to acknowledge and tackle these hurdles head-on.

From establishing fair prices to prioritizing operational security, the sector must take responsible and cautious approaches to mitigate the dangers of over-speculation. In doing so, sustainable growth and development can flourish, paving the way for a future where NFTfi seamlessly blends digital ownership and limitless financial opportunities.

To truly harness the transformative power of NFTs, we must continuously innovate, addressing challenges as they arise and promoting responsible practices every step of the way. By prioritizing integrity and stability, we can unlock the true potential of NFTfi, ushering in a new era of unparalleled possibilities.