Author: Jiawei (Twitter: @Elegy4TheArctic)
1. Background
Since DeFi summer in 2020, Fungible Token (FT) lending is becoming more and more common and popular as an infrastructure in DeFi, represented by Aave and Compound.
At the same time, according to Bloomberg, NFT market size surpassed $40 billion in 2021. From the chart above, we can also see the continuous growth of the largest NFT marketplace OpenSea. However, compared to FT lending, NFT lending market is highly undeveloped.
For FT lending, mortgage obviously entails a certain liquidity cost. When tokens are pumping, borrowers are unable to sell them to take the profit. When tokens are dumping, borrowers are unable to sell them for stop-loss. In addition, the more volatile the tokens’ price, or the longer the collateral period, the higher the liquidity cost.
In terms of NFT lending, for institutional holders or top NFT collectors, there may be no intention to sell their valuable NFTs, so lending is an option worth considering when they need liquidity.
This report provides a thorough introduction to the NFT lending platform Arcade, analyzes its competing products, and promotes some personal thoughts on NFT lending.
2. Project Overview
Arcade (formerly Pawn.fi) is a Web 3.0 platform which enables liquid lending markets for NFT. It focusses on building primitives, infrastructure, and applications to enable the growth of NFT as an asset class.
Arcade facilitates trustless off-chain order matching using structured digital signatures to validate loan term attestations from borrowers and lenders. Loans are settled on-chain and held in decentralized escrow, co-opting cryptographic security guarantees offered by Ethereum.
The first product released by Arcade is a P2P lending marketplace on Ethereum. It has three features in total.
2.1 Asset Wrapping
Arcade provides a smart contract for NFT wrapping. Users can deposit hybrid assets (ERC20, ERC721, ERC1155) to mint an NFT which represents the whole basket.
2.2 Borrowing
Borrowers can make loan requests setting terms such as funding amount, duration, interest amount, for loans of at least one day in duration, collateralized by their wNFT. Once the loan requests were created, borrowers should wait for any lenders to accept it. When a borrower creates a loan request on Arcade, the 'open to offers' option can be set, meaning that lenders can submit loan proposals against this collateral.
Borrowers can request for any ERC20 token, including wETH, USDC and DAI. For paying off the loan, currently only payment in full is supported. Periodic payments will be supported in Arcade v2.
2.3 Lending
Lenders can explore new loan requests that require funding on Arcade. Funding takes place in the form of ERC20 tokens, typically wETH or stablecoins like USDC.
In terms of liquidation, note that there are no auto-liquidation or margining capabilities in Arcade currently. When the loan goes into default, borrowers can still pay off so long as the lender has not claimed the collateral.
2.4 Pros and Cons
Pros
- Low risk. As P2P lending platform, Arcade only acts as a middleman. The risk is greatly reduced because loan request of P2P lending can be filled depends entirely on the will of the borrower and the lender. Arcade just charges a small percentage fee for each transaction.
- Flexible. Since the funding amount is mutually agreed by both the borrower and the lender, this allows the value of the high rarity NFT to be reflected. Whenever there is supply and demand, loan requests can be completed.
Cons
- Low efficiency. Intuitively, P2P lending might not be efficient enough. The borrowers cannot receive funding if no lenders would like to accept the requests. Therefore, lowering the average waiting period of loan match is important to optimize user experience.
2.5 Team Background
Arcade has 13 team members currently, and it’s hiring for various roles across product, business development, marketing, and engineering functions.
Arcade’s co-founder and CEO Gabe Frank graduated from The University of Texas at EI Paso, he was previously institutional sales at BitGo and Director of Sales in Curv.
Arcade’s co-founder and COO Robert Masiello graduated from New Jersey Institute of Technology. Before founding Arcade, he served as strategic advisor in Industry Capital. He is experienced in crypto-economics, distributed systems, and big data analytics. Mr. Masiello has been an active member of the blockchain community since late 2015 having co-founded RiverblockAI, a blockchain and crypto-focused software company.
2.6 Business Model
Arcade’s business model is simple. For every user who borrows against their assets, Arcade charges 2% fee. Arcade currently does not have its native token yet, but it’s evaluating to launch one.
2.7 Technical Resources
Arcade’s smart contracts include AssetWrapper, BorrowerNote, LenderNote, LoanCore, OriginationController, PunkRouter, and RepaymentController, which can be reviewed here. These contracts have been audited by Least Authority and Quantstamp.
2.8 Development Status
So far (as of March 14, 2022), Arcade has $10 million loan volume in 29 loans with 24.78% weighted APR and supports 50+ NFT collections.
3. Competitive Analysis
3.1 P2P Mode
NFTfi allows NFT owners to use the assets they own to access the liquidity they need by receiving secured wETH and DAI loans from liquidity providers peer-to-peer in a completely trustless manner. NFT liquidity providers use NFTfi to earn attractive yields or — in the case of loan defaults — to have a chance at obtaining NFTs at a steep discount to their market value.
The NFTfi service fee for lenders is 5% of the interest only earned by lenders on successful loans (while Arcade charges 2% from borrowers). In the case of a loan default, there is no service fee.
Compared to NFTfi, Arcade's competitive edge is that it allows multiple NFTs to be included in a bundle to acquire a single loan through wNFT. This helps with lower gas fees since there is a single loan transaction instead of multiple ones.
According to the chart from Dune Analytics, NFTfi has shown good growth and development. So far (as of March 14, 2022), NFTfi has accumulated a huge total loan volume with 23,026 wETH and 21,884,193 DAI. In January and February 2022, its monthly loan volume even surpassed $20 million.
Similarly, as a P2P mode platform, NFTfi should be the major competitor of Arcade.
3.2 Centralized Mode
Nexo is a centralized cryptocurrency lending platform. Recently, it announced the launch of a new NFT lending desk collaborating with Three Arrows Capital as its first client.
Nexo offers an NFT lending OTC service, requiring a simple KYC and application form for each loan. Currently, only BAYC and CryptoPunks are supported as collateral, and the value of the NFT must exceed $500,000, with an APR about 15% and a loan-to-value ratio varies from 10% to 20%.
The centralized NFT lending mode is suitable for institutional customers. Compared to decentralized mode, Nexo is less risky, although it may seem less native to Crypto OG.
3.3 Pool Mode
Drops DAO provides loans for NFT and DeFi assets, supplying them with much-needed utility. The protocol uses lending pools that enable any type of NFT asset to be used as collateral – from collectibles and metaverse items, to financial NFTs. Users can leverage their idle NFTs and DeFi tokens to obtain loans and earn extra yield.
In this mode, the loan has no maturity date, and the interest rate is calculated based on the utilization of the NFT pool. The real-time price of NFT is quoted using an oracle. So far, only CryptoPunks have enough liquidity to be used with the oracle.
In my opinion, pool mode of NFT lending has the following problems:
- Unfair offer. Obviously, this kind of pool mode is suitable for FT lending since they’re all the same. However, NFT is “non-fungible”. For NFTs with high rarity, the values in the pool are diluted, making the loan-to-value ratio for this portion of NFTs unfair.
- High risk. Generally, the pool mode is relatively complicated in smart contracts logic, also with the possibilities of malicious price manipulation and serial liquidation. With the current low liquidity of the NFT market, there is a high systemic risk.
4. Fundraising
In December 2021, Arcade raised $15 million in a Series A funding round led by Pantera Capital, with Castle Island Ventures, Franklin Templeton Blockchain Fund, Golden Tree Asset Management, Eniac Ventures, Protofund, Probably Nothing Capital, Lemniscap and angel investors such as BlockFi CEO Zac Prince and Quantstamp CEO Richard Ma also participating.
The fundraise was an equity funding round and will help Arcade expand its team, launch the platform publicly, and reach more users. It brings Arcade's total funding to date to $17.75 million. In May 2021, it raised $2.75 million as Pawn.fi and that was also an equity round.
5. Personal Perspective
5.1 Traditional Artwork Lending
Looking at the traditional artwork market by analogy, global artwork transaction amount in 2020 fell 22% from the previous year due to COVID-19, but still exceeded $50 billion. It seems that there’s a promising market for artwork lending.
However, there’re still some problems remained unsolved.
-
Difficult to Verify
The appraisal of traditional artworks (including antiques in this case) itself varies widely, lacks authoritative guarantees and is difficult to value. -
Lack of Liquidity
Because of the lack of liquidity, it is uncertain whether the collateral can be sold even after liquidation. To compensate for this risk, traditional pawnbrokers often offer only very small loan-to-value ratios.
Because of these two problems, most of the banks and pawnbrokers do not accept artwork as collateral. Back to NFT, compared to traditional artwork, NFT’s authentication only requires checking the contract address, and its valuation has the same collection’s floor price as a reference.
Also, the form of online trading makes it relatively easy to sell the collateral. In a word, in terms of technical aspects, NFT lending faces fewer problems because of its technical features.
5.2 Target Customers and Collateral
Generally, for retail investors, their NFTs may be less valuable and have frequent turnover. And those NFT loans accepted are always with high value and about 30 to 90 days duration. As a result, retail investors are not supposed to be main target customers of NFT lending in a short time. Therefore, main target customers of NFT lending in the early stage should be institutions, high-net-worth individuals, DAOs, and companies with NFTs on their balance sheets.
In terms of target collateral, blue chip NFTs such as BAYC and CryptoPunks are highly recognized, relatively liquid, and have high trading volume, making them suitable as collateral for NFT lending.
5.3 Summary
Based on the above analysis of advantages and disadvantages, I believe that the P2P model is more appropriate and relatively risk-controlled in the early stage of development of NFT lending. The success of NFTfi kind of proves that the NFT lending is feasible.
Recently, Azuki soon became the 8th highest traded OpenSea NFT collections, and I think similar blue chips may emerge with greater numbers in the future. Top NFTs represented by CryptoPunks and BAYC, blue chips represented by Doodles and Azuki, and lands from Sandbox and Decentraland, or other in-game assets will take the lead in the future as the main targets for NFT lending.
With the continuous development of NFT, there may be a good market size for NFT lending in the future. However, for now, that is, at the early stage of development, the customers and collateral oriented should be mainly institutions or high net-worth players and blue chip NFTs.
References
Arcade Developer Hub. Arcade.
Nexo Partners with Three Arrows Capital on NFT Lending Services. CryptoPotato.
Arcade Raises $15M to Offer NFT-Backed Loans. CoinDesk.
NFT lending platform Arcade raises $15 million in Series A funding. The Block.
OpenSea Dashboard. Dune Analytics.
NFTfi Dashboard. Dune Analytics.