The Value Of This Article
The current valuation of NFT collateralized lending projects is mostly less than $100 million. At the same time, the market reached tens of billions of dollars in valuation. There is a huge gap between the project valuation and the market size, which is a huge opportunity.
I will discuss why the current P2P model doesn't work well for NFT collateralized lending and why the lending pool model will create a new paradigm instead of letting 99% of NFT sit in the wallet.
- Content of this article
- The market size of the NFT collateralized lending
- Why the current Peer-to-Peer model doesn’t work well
- Why lending pool is the future and how it work
- What are the exciting projects for both models
Market Size
NFT lending means NFT owners need to take their NFT as a collateral asset and lend money from the fund provider.
For NFT to qualify as a collateral asset, it must meet the following conditions:
- Adequate value consensus: the market has a consensus that the NFT series has value, and the price will not collapse with short-term fluctuations. At the same time, the fund provider is willing to receive the NFT if liquidated.
- Sufficient demand and trading volume: Lots of NFT have a high price tag but no demand. Lack of turnover makes it hard to liquidate NFT instantly, resulting in potential losses for fund providers.
There are seven series with more than 100,000 ETH volumes on Opeasea: CryptoPunks / BAYC / MAYC / Art Blocks / Clone X and Decentraland / SandBox lands. For the seven series alone, NFT is already a market of 10 billion dollars, which is also the market size for collateralized lending projects.
In 2022, there will be other top NFT projects, and Financial Voucher NFTs like Solv will also start to gain traction. I think that by 2022 the top NFT projects will easily reach a market cap of over $20 billion, and there will be multi-billion dollar market cap projects for NFT collateralized lending.
Why The Peer-to-Peer Model Doesn’t Work Well
How it work
The biggest problem with NFT as collateral is how to price it, as each NFT has a different scarcity resulting in different prices. Therefore, the current NFT collateralized lending is mostly a Peer-to-Peer model, allowing NFT owners and fund providers to agree on a price acceptable to both parties. The project acts as a platform to facilitate the transaction.
In the case of NFTfi.com, a mature P2P NFT lending platform, the process is for the NFT owner to pledge the NFT to the platform and fill in the amount and time length they want to borrow.
The fund provider can browse the platform for each NFT with the desired borrowing amount of the owner, and the fund provider submits the amount of loan he is willing to provide along with the required interest rate.
The whole process is like an auction, from which the NTF owner finally selects a plan he accepts to complete the transaction. The borrower needs to repay the principal and interest to retrieve the NFT in the smart contract when the loan is due, or the NFT will be transferred from the smart contract to the lender.
Advantages of P2P
- Obtain current market consensus prices
Due to the uniqueness of each NFT, the P2P mechanism can solve the price problem of any NFT by letting the lender identify and quote the price, with the return risk depending on the lender's judgment. Especially for NFTs with high scarcity, the high premium above the floor price, and the low volume, the P2P model is needed to give the market the right price at the moment.
- Applicable to all kinds of NFT
Whether it is mainstream or niche NFT, collectibles, or game props. As long as there is supply and demand, the transaction can complete through P2P. The P2P model can apply to all NFTs.
Disadvantages of P2P
- Long transaction process
Borrowers can only wait for others to quote after they pledge their NFT on the platform, with no idea when someone will submit a quote. Borrowers need to constantly go back to the platform and check for the quotations. Each borrower would ideally like to have multiple quotes to compare; thus, the transaction usually takes days to complete.
This uncertain experience is less friendly for borrowers with immediate needs and may force the borrowers to accept offers with poor terms.
- Low number of professional lenders and high-interest rates
The P2P model will dissuade most interested lenders but lack professional appraisal skills. The NFT P2P model requires lenders to have professional appraisal skills, which is a high level of competence requirement for lenders. The wrong offer will require them to risk losing money after liquidation. So besides BAYC / CryptoPunks / ArtBlock, other series have close to zero offers on the P2P platform.
Yet even BAYC / CryptoPunks only have single-digit offers, with fund providers typically demanding interest rates in the 30-40% range, and sometimes even 60%-100%. The high interest significantly affects the willingness to supply unless there is a way to ensure a higher return on borrowing for NFT owners.
P2P platform tries to advertise a very attractive APY on Twitter to attract more people to provide funding and reduce the transaction time, but that means NFT providers have to bear the high APY, thus a bad user experience.
- Low platform transactions volume and the inability to lock the fund in the protocols
P2P is not friendly to the fund provider because the amount of lending is limited by the number and value of NFT, and finally needs to compete with other auction bidders.
They don't know when the transaction will have the conclusion, so they need to keep coming back to the platform to review. If they are not finally selected, they need to bear the time cost of funds.
At the same time, the fund can not accrue any interest in the protocol. Fund providers must constantly come back to the platform to find borrowers. Thus, platforms can only retain heavy users.
Summary
P2P is the logical solution to the problem of varying NFT prices, but it has obvious disadvantages such as inefficient use of funds, long transaction times, and high-interest rates.
So I think the most suitable scenario for the P2P model is the high-value NFT, long-tail NFT, etc. Also, the borrower is not in a hurry and can afford a few days' wait. Another good scenario is B-to-B large loan services such as Kyoko offering peer-to-peer, DAO to DAO lending services and focusing on long-tail gaming props. There is still more room for improvement in the P2P model user experience for general scenarios and users, which is why I am optimistic about the lending pool model.
Why Lending Pool Is The Future And How It Work
In the NFT collateralized lending model, NFT owners can borrow money right after overcollateralizing NFTs. The whole process is just like AAVE & Compound.
On the other hand, lenders who want to earn interest can put their stablecoins or ETH into the pool to earn interest, and the interest paid by the borrower depends on the supply and demand of the pool. If the borrower can't pay back the money or the NFT price falls below the liquidation line, the NFT will be put on auction on Opeasea, and the money from the auction will be returned to the fund providers.
Oracle
The current solution to price NFT in the lending pool model is to do TWAP
(time-weighted average price) based on the data on-chain. It will eliminate the extremes data and average the series's floor prices over a period of time. The mechanism is a way to prevent price manipulation but also means no matter how rare your NFT is in the series, the floor price is used as its value.
Advantages of the pool model
- Fast transaction completion
Most of Crypto's lending is for trading, all about timing and knowing how much money can invest. The lending pool model allows Punks and BYAC users to get a precise loan amount to invest as soon as they need to borrow. They don't need to wait for lenders to confirm the terms.
- Low and stable interest rate, fund locked in protocol
The pool model frees up a lot of money on lenders. Many people can understand the value of BAYC and CryptoPunks, but probably less than 5% of people can tell the value of each NFT. The pool model allows anyone with a shared understanding of the series to provide unlimited money into the pool to earn interest.
Compared to the P2P model, the amount of funds available to the borrowers is significantly increased, allowing the interest rate to be steadily reduced to 10%-20% from the 30%-100% in the P2P model.
At the same time, funds are locked in protocols to accrue interests. Lenders do not need to keep coming back to find projects to bid on.
Disadvantages and risks of the pool model
The most obvious is that it is impossible to give NFTs above the floor price a fairer borrowing amount, making NFTs further away from the floor price more reluctant to use it.
That's why I don't think high rarity NFTs are the primary target for lending pools right now unless the borrower doesn't need to borrow too much money and doesn't want to pay high-interest rates.
Then again, the biggest risk is price manipulation or a sudden price drop in NFTs, which can divide into three scenarios:
-
Sudden Price drop in NFTs
If the price of the NFT series falls too fast, large quantities of NFTs are liquidated in the trading market, resulting in a short panic, and the price continues to fall. NFT will not be sold, which results in losses in the lender's fund. This is why the lending pool model is currently more suitable for the NFT series, with a strong consensus that they are in strong demand when they liquidate.
-
Protocol attack
Another common concern is that users keep selling to themselves well below the floor price, which might lead to a manipulation of the floor price to fall rapidly. Even there is no benefit to the hacker; this might hurt the lenders. TWAP calculates a composite floor price made using multiple time dimensions as the source of data sampling and excluding extreme values to prevent protocol attack.
-
Borrowing and deliberate liquidation after pulling up the price
- The big players sell NFTs to themselves in a period of time, dramatically pull up the floor price, and later go to the pool to borrow heavily and refuse to pay back. The platform will have to liquidate NFTs that are not worth that much money, and this is especially easy for the long-tail NFT series. So the lending pool model is indeed risky for non-mainstream NFT, predictably higher interest rates for borrowers of such projects, and investors need to be more cautious.
- As for mainstream projects such as BAYC and CryptoPunks, the collateral ratio is assumed to be 30%, and 50 ETH floor prices can lend out 15 ETH. If you want to profit by pulling up the floor price, you still need to pull up to 150 ETH or more to make money, even with collaboration between the big players. The profit is built on the premise that the intrinsic value of BAYC is 50 ETH and will not rise again, and the cost is much greater than the benefit.
Summary of lending pool and P2P models
Most NFTs today have no value in lending because no one wants them when they liquidate, and most NFTs will probably not be able to resale. P2P could theoretically serve all NFTs, but there are not enough lenders and valuable NFTS in the market. Only series like BAYC / CryptoPunks have offers, while others do not have enough professional appraisers. Compared to the P2P model, the lending pool model now serves a broader range of mainstream NFTs with fewer requirements on the fund providers than the P2P model.
So the key to the NFT collateralized lending project at this stage is who gets the most supply of mainstream projects and who can service most mainstream series. If you get one more BAYC in your protocol, another protocol will have one less supply in the supply market. The faster to get more mainstream NFT supply and lending funds, the lower interest rates would be. It can form a positive cycle and establish an advantage. This is why I am more optimistic that the lending pool model can create the NFT collateralized lending market based on the current market situation. The fundamental reason is to attract blue-chip NFT supply into the financial market.
What are the interesting projects for both models.
Lending Pool Model
The NFT collateralized lending pool product will launch in February and go live with the BAYC / CryptoPunks pool. The current fully diluted market cap is floating around $ 30 million.
Have original businesses, Ether investment tools, tokens have been issued, the market cap is unknown. Q1 will launch P2P lending, and there is a plan to do a lending pool model.
P2P model projects
Most have not issued tokens, and many projects have originally other businesses.
Pantera Capital investment, in internal testing.
The current P2P marketplace is live and most mature, with no token issued.
Has original business, centralized lending platform, Three Arrows invested. Launched centralized NFT collateral lending service, can borrow up to 20% of the offer, market cap $1.1 billion, FDV $2 billion.
Other Projects
Users can borrow money to buy NFT and pay fixed interest to lenders, with a market cap of $5.8 million and an FDV of $ 162 million.
After pledging NFT, you can get the PUSD provided by the protocol from the pool, collateral ratio at 32%, and no token has been issued.
An NFT flash loan program for programmers allows for flash lending.
Update stopped in October. Not sure of the progress.
Solana project, CB / Solana / Jump investment, the mechanism still unclear
How to verify the success of NFT collateral lending project
Lastly, I would like to discuss how to observe which project is more promising in the process. The current judgment is subjective and static, and however, the market changes are dynamic. Whether the judgment is correct, whether there are new influencing factors, whether the project can operate properly, these all need time to verify.
- If Avatar NFT collateral lending is a necessity.?
The current NFT collateral lending market is targeting profile picture NFTs. Still, there is a big question mark over whether these profile pictures and virtual land will have enough liquidity or good value in the long run. The P2P model is flat because the experience is not good, or most profile picture NFT buyers just do not have the demand, similar reason why rich people will not pledge their famous paintings.
- Mainstream NFT Supply Quantity
The most important data to observe is the number of mainstream NFT supplies. The current collateral lending market has only reasonable value on the mainstream NFTs, and the mainstream NFT flows mainly to those protocols that are the leading projects in the market.
- Mainstream NFT community discussion
Mainstream NFT projects are self-contained into a community, and if the product hits the community's pain points, there is bound to be enough discussion volume.
Future Outlook
Most NFT collateralized lending projects differentiate themselves from the solution's angle and operation. The lending pool model is currently the most suitable for the mainstream series. However, after we get enough borrowers and lenders for all NFTs, the P2P model can apply to many scenarios in any series, the extensibility is stronger.
So I think the future of the P2P model may also have a lending pool model; the lending pool model may include the P2P module as well.
NFT collateralized lending can help NFT projects stabilize their floor price and increase their value. Suppose the user holding the project token can guarantee to borrow money from the protocol while receiving the protocol's reward token. In that case, the user will have more incentive to participate and buy the NFT.
The lending protocol has a DAO and allows token holders to vote on which NFT series to add the token rewards based will be distributed based on the number of votes. Like Curve, the protocol can also let each NFT project owner compete for token voting rights.
Whether avatars and virtual land are the most suitable for lending will take time to verify. At least land NFT may be more suitable for NFT leasing offered by IQ Protocol than NFT collateralized lending.
I think in-game assets are also a good target market for collateral lending. However, this market still needs to wait for the GameFi industry to develop, so Kyoko is also a project I am interested in.
Risk Warning
NFT collateral lending is still covered under the NFT track and is influenced by the NFT market. The above views are purely personal and subjective and do not constitute investment advice. Any thoughts or even opposing views are very welcome to discuss on Twitter.