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While the first NFTs were created in 2017, NFTs as an asset class are largely a 2021 phenomenon. Global NFT transaction volume in 2021 was $17 billion, a healthy 527x from 2020 volume ($32 million) and 5,126x from 2019 volume ($3 million). Strong.
NFT Weekly Trading Volume (The Block)
What does this imply for total market cap? Considering a large swath of these purchases were entirely speculative in nature and the assets are today or will be in the future totally illiquid at any price, this is an impossible question to answer. We’re also fast approaching the point at which it no longer makes sense to broadly bucket “NFTs” as a single asset class when there are such distinct subtypes (collectibles/pfps, artwork, gaming assets, music rights, metaverse land, etc). Ok, now that we’ve gotten all of our caveats out the way, we do still love to be wrong, so we’ll approximate market cap by multiplying the current floor prices by the total supply of the top 101 NFT projects by floor price for a total market cap of $9 billion (excluding play-to-earn NFTs, namely Axie Infinity assets). Notably, if we just look at the NFTs in Bitwise’s recently announced “Blue Chip NFT Index Fund” (collectibles and art only), we get a “blue chip” market cap of $7 billion (across just 10 NFT groups). Let’s just say as a rough order of magnitude, the total market cap is likely more than the single digit billions, probably in the tens of billions factoring in play-to-earn, and unlikely to be in the hundreds of billions (yet).
This one is a bit easier. The primary source of NFT loans to-date has been through NFTfi, a peer-to-peer NFT lending platform launched in February 2020. Thus far, the marketplace has done about $45 million in ETH and DAI loan volume (assuming current ETH values for all ETH based loans ~10k ETH lent). We’ll call it approximately $50 million to account to include other emerging marketplaces (Arcade.xyz, Pwn.finance, Stater.finance, etc) that have had loan volume while in beta.
Putting it all together, historical loan volume of ~$50 million and historical sales volume of ~$17 billion equates to a penetration rate of less than 0.30%. Even if we only consider the Bitwise blue chips, the penetration rate is 0.71%. To put that number into a bit more context, US housing debt as a percentage of the US housing market (for houses with mortgages) is about 55% (with entry level housing typically obtaining 75% to 95% loan-to-value ratios).
Ok ok, so you think comparing NFTs to government subsidized, physical housing is a stretch. Fair (for now). How about the institutional art market? Physical, disparate assets that trade in an opaque fashion with an extremely limited list of users. Surely no one dares lend against these assets? Yet even institutional art has about a 10% debt penetration rate (on the addressable market), with loan-to-value ratios on individual pieces as high as 50%.
For reference, at housing debt penetration levels, NFT loan volume based on 2021’s transaction volume would be $9.4 billion, a 187x increase from current levels. Even at institutional art levels, it would be $1.7 billion, a 34x increase. Keep in mind that these numbers only consider the existing pie, not any future growth (including giving proper credit to the sleeping giant that is gaming).
NFT Lending Penetration Rate vs Institutional Art and US Housing
So why does this disconnect exist? Part of it could be attributed to the nascency of the space — debt markets and user knowledge of debt markets just haven’t caught up to the equity markets yet. However, going back to our tradfi analog, there is a critical, structural difference between NFT lending markets as they exist today, and nearly every other sophisticated credit market globally…
First — a quick finance lesson.
To make sure we’re all on the same page, we want to loosely define two words for our purposes — securitization and tranche. Securitization is the process of taking a group of assets (for the sake of this conversation, we will focus only on loan assets) and bundling them together, then selling shares of the bundle to different investors. A tranche is the type of share an investor is buying (not all shares are created equal). An investor can choose to buy a “senior tranche” which has a lower yield or a “junior tranche” which has a higher yield (note that modern securitization processes often have many tranches, but only need two to be operable). If all goes well and the underlying assets that have been bundled in the securitization process pay out, then both the senior and junior tranches earn their respective yields. If, however, some of the assets in the bundle end up defaulting and losing money, the junior tranche will absorb up to 100% of the loss before the senior tranche loses any money. Thus, the junior tranche holder can earn a higher yield than the senior tranche holder, but takes on more risk in the process. The senior tranche holder’s lower risk position is only possible through the introduction of the junior tranche.
Mortgage Securitization Process
Ok, so what does this process actually accomplish? The goal of securitization is to improve capital efficiency. By bundling loans together, investors get to buy shares in a diverse group of underlying assets, thereby diversifying exposure and reducing their risk. By tranching the shares of the bundle, investors get to choose a pareto optimal allocation based on their own perception of risk, thereby allowing all investors to maximize expected value across a spectrum of positions. In essence, the securitization and tranching process generates excess capital demand for an asset that would have otherwise been considered to be in market equilibrium.
Back to our analogs, how has this played out in traditional lending markets? Of the $12 trillion of outstanding mortgages in the US, $7.7 trillion, or 67% are securitized.
While the housing industry is the best example of the impact of securitization on a market, it isn’t the only one. Other asset backed securities (automobile, credit cards, student loans, etc) represent another ~$1.5 trillion industry with tremendous growth since inception (note that while data is sparse, the institutional art space also offers securitizations from groups such as Griffin Art Partners).
Asset Backed Securities Market Growth (SIFMA)
In our opinion, NFTs / metaverse assets generally will grow in relevance to the world in the coming years and the current market cap of the space today will be considered laughably small in the future. Further, with any great economy comes a vibrant credit market that fuels growth, and while there have been a number of pioneering entrepreneurs breaking down the first barrier to credit markets for metaverse assets, the adoption to-date has been paltry compared to the future potential. We believe that in order to scale NFT lending, the market infrastructure needs to improve to allow capital aggregation (ie, pooled liquidity) and risk tranching (ie, pareto optimal efficency for capital providers).
MetaStreet v1.0 aims to provide a new layer of infrastructure built on top of existing lending platforms that both pools and tranches capital. While v1.0 draws much of its inspiration from traditional securitization markets, the product will take advantage of previous defi innovations to allow for a living vehicle that can continuously compound sustainable yield.
Over the past three months, MetaStreet has been hard at work fleshing out the full blueprint for v1.0 as well as hiring an 8-person, all-star team to execute it. Without going into great detail on specific dates, the next steps for MetaStreet are to (1) complete our first audit, (2) release our technical whitepaper, (3) complete our second audit, (4) launch in beta, (5) complete our third audit, (6) launch to mainnet, and (7) introduce fully decentralized governance. We expect all of these milestones to occur in the first half of 2022.
Thanks for reading! We would welcome discussion on this or any other related topics on our Discord. Thank you for being a member of the MetaStreet community!
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