1. NFT lending is an NFT financial product that occurs during the holding stage. Its core mechanism is to allow holders to use idle NFTs as collateral to lend short-term funds without selling NFTs, obtain liquidity in exchange for cryptocurrency or legal currency, and gain income while enjoying the rights of holding NFTs, thereby improving the efficiency of fund utilization.
2. NFT lending agreements are mainly divided into two forms: secured lending and unsecured lending
1) Mortgage Agreement:
Peer-to-peer P2P is suitable for bear markets with scarce liquidity and is not afraid that extreme market conditions will affect the security of the platform.
Peer to Pool is suitable for a bull market with sufficient liquidity.
Hybrid, based on the standard point-to-pool mode, also has higher operational convenience.
Collateralized Debt Position (CDP) is a good option for those seeking to get some liquidity from blue-chip NFTs without paying high interest rates.
2) Uncollateralized Agreement:
Buy Now Pay Later (BNPL)
Flash loan (down payment purchase)
Suitable for NFT market users who have the willingness to purchase but temporarily lack the ability to pay in full.
3. The profit model of NFT lending business mainly comes from the loan interest paid by users for mortgage lending. If there are functional businesses such as flash loans, corresponding functional fees will also be brought.
4. The main risks of NFT lending:
NFT collateral valuation volatility risk (bad debt risk)
High concentration of business target users
The limited increase in high-quality asset targets has limited the potential growth space for the overall track business volume
5. It is estimated that within 3 years, based on the neutral assumption, the overall market value of NFT will reach about $60 Bils, the NFT lending TVL will reach about $18 Bils, and the lending demand that can be met is about $9 Bils. The operating income of the overall NFT lending industry is expected to reach $1.3 Bils.
1. Industry landscape
In the past few years, there have been two areas in the crypto industry that have developed rapidly. One is decentralized finance, which experienced the Defi Summer in 2020, and the other is the NFT Boom in 2021.
The overall market size of NFTs on Ethereum has grown from US$61 million at the beginning of 2021 to a peak of around US$32 billion in just over two years. Even though the overall market value has fallen sharply, the market size is still around US$7.5 billion, and the industry has grown more than 120 times.
NFT Lending Track Industry Research Report
Ethereum NFT market size and transaction volume Source: NFTGo.io (2023.5.31)
Today, NFT-Fi, as a track that combines NFT and Defi, has rapidly developed from a niche field to an indispensable part of the crypto world.
The significance of NFT financialization is to help users expand and enhance their consensus and demand for NFT through financial deepening. Its industrial structure can be vertically divided into three layers:
1) Direct trading: that is, through trading markets, aggregators, AMMs, etc., using cryptocurrencies for price exchange transactions.
Representative projects: Opensea, Blur
2) Indirect transactions: that is, providing services such as NFT mortgage lending, financing custody, etc.
Representative projects: BendDAO, ParaSpace
3) Financial derivatives: products that provide high leverage and trading risks, such as options, futures, and indices.
Representative project: Openland
NFT Lending Track Industry Research Report
Since direct transactions have developed relatively maturely, while financial derivatives are still in the early stages. As the middle layer, indirect transactions involving deposits, borrowing and loans have the most basic attributes of the financial system and are still in a rapid development stage. Therefore, this article will mainly focus on the current industry's focus in NFT indirect transactions - NFT lending.
2. Industry market value
First, let’s answer a question: Why is there a market demand for NFT lending?
As we all know, NFT, the full name of which is Non-Fungible Token, refers to non-homogeneous tokens, which are a type of cryptographic assets that cannot be copied or replaced. They are unique, indivisible and irreplaceable. Their pricing is mainly based on personal subjective judgment or group consensus.
It is precisely because of these characteristics of NFT that, although it has its own ornamental and collection value (as well as possible project empowerment), since it does not have a standard value benchmark to anchor it, it often leads to the audience group facing NFT being relatively limited compared to ordinary homogeneous crypto tokens. Therefore, the liquidity of NFT is relatively poor in the entire crypto market.
The way for general NFT investors to make profits on NFTs is usually to sell them when the price increases. This method is greatly affected by the current market environment. When the Web 3 environment is in a bear market, market confidence is insufficient, and trading activity is low, liquidity will further shrink, resulting in most cases where these NFT assets are idle and the utilization of funds is extremely inefficient. In the absence of lending services, users may be forced to sell their unique NFTs to obtain valuable liquidity.
NFT lending is an NFT financial product that occurs during the holding stage. Its core mechanism is to allow holders to use idle NFTs as collateral to lend short-term funds without selling NFTs, obtain liquidity in exchange for cryptocurrency or legal currency, and gain income while enjoying the rights of holding NFTs, thereby improving the efficiency of fund utilization.
As a solution to the NFT liquidity problem, the demand for this innovative market is becoming greater and greater. NFT liquidity solutions with smooth user experience and sustainable trading models will soon stand out throughout NFT-Fi.
3. Industry barriers
The industry barriers of NFT lending business are how to achieve the feasibility of the core business model, which mainly include:
1) How to effectively match the system mechanism of users with NFT lending needs
Since NFTs are unique by definition, users usually need to have expertise in specific assets and relevant financial knowledge to link NFT assets with lending businesses. How to design a reasonable business model that is attractive to both lenders and borrowers is the basis for ultimately being able to effectively match user needs.
2) Reasonable pricing mechanism for NFT assets
An important component of NFT lending business is pricing. How to effectively, quickly and relatively accurately provide a reasonable quote to the system during the estimation of NFT asset value, calculation of LTV (Loan To Value) and liquidation is the most important link in the operation of NFT lending business. Especially when the number of users in the agreement increases and the business demand in the same time period increases, the system quotation, traceability and update data mechanism and efficiency will directly affect the customer experience of the entire agreement.
4. Competition landscape
Currently, the NFT lending business is divided into two forms: secured lending and unsecured lending.
NFT Lending Track Industry Research Report
Among them, mortgage loans can be mainly divided into the following types according to their agreement types:
Peer to Peer / P2P
That is, users match with each other to reach a loan model. Lenders and borrowers match in terms of interest rate, term, type of NFT collateral, etc., and loan transactions are realized after the demand is matched. Representative projects: NFTfi, Arcade, Blur (Blend)
Peer to Pool
That is, a lending model is reached between users and the protocol pool. The lender mortgages NFT to the protocol pool to quickly obtain a loan, and the depositor provides funds to the protocol pool to earn interest income. Representative projects: BendDAO, DROPS
Hybrid
That is, it is a protocol that integrates the peer-to-peer and peer-to-pool modes. In this mode, the lender sets a series of parameters such as interest rate, term, loan amount, etc. When requesting a loan on the platform, it is equivalent to establishing a separate protocol pool. Multiple borrowers can deposit funds into the protocol pool to earn interest income. Representative project: ParaSpace
Collateralized Debt Position (CDP)
Pioneered by MakerDAO, it is the ultimate model for the NFT mortgage lending market. Representative project: JPEG’d
Unsecured loans can be divided into:
1) Buy Now Pay Later (BNPL), representative projects: CYAN, Paraspace, Blur (Blend)
2) Flash loan (down payment purchase), representative project: BendDAO
NFT Lending Track Industry Research Report
Source: Dune Analytics@goyem (2023.6.12)
NFT Lending Track Industry Research Report
Source: Dune Analytics@goyem (2023.6.12)
As can be seen from the two pictures above, peer-to-peer and peer-to-pool protocols absolutely dominate the entire NFT lending scale.
It is worth noting that after Blur launched Blend in May, thanks to Blur's leading position in the NFT trading market and its user base, Blend quickly took the top position in mainstream lending protocols, and for several consecutive weeks its transaction volume was far greater than the total of several other protocols. At present, its cumulative lending business volume has jumped to the top of the industry.
NFT Lending Track Industry Research Report
5. Technical implementation paths and their advantages and disadvantages
Based on the different protocol types of NFT lending business mentioned in the previous chapter, they have their own different characteristics.
NFT Lending Track Industry Research Report
5.1 Mortgage lending
5.1.1 Point-to-point
The user valuation method is mainly used in peer-to-peer lending. The pricing of NFT is based on the price estimate given by the user. The user gives a corresponding specific quote based on the particularity of each single NFT. It has the following characteristics:
Low efficiency: It may take a long time to match borrowers and lenders.
Valuation is relatively accurate: NFTs with different attributes in the same series have different values. Lenders and lenders can negotiate and determine the valuation based on the attributes of a single NFT, rather than using a unified floor price for the entire NFT series as the only valuation standard.
High security: When an individual defaults, it will only affect the borrower and lender of the loan, and will not expand the risk exposure to other users on the platform.
There are many NFT objects that support mortgage: Since it is a peer-to-peer quotation, in theory any NFT series can be used as the subject of loan mortgage.
Summary: The peer-to-peer model is more suitable for a bear market with scarce liquidity, and is not afraid that extreme market conditions will affect the security of the platform.
NFT Lending Track Industry Research Report
5.1.2 Peer-to-peer pool
Time-weighted average prices (TWAPs) are widely used in peer-to-pool lending protocols. Oracles like Chainlink can obtain and publish the time-weighted average price of the sale price and floor price to create such a hybrid price to evaluate the value of NFTs. Such a model can reduce the impact of abnormal events on prices by taking the average of multiple prices over a predetermined period of time, thereby increasing the difficulty of potential malicious price manipulation.
Its main features are:
High efficiency: Directly interact with the loan pool and borrow at any time.
The valuation is not accurate enough: the platform cannot make a detailed mortgage valuation for each NFT’s attributes and can only determine the valuation through the floor price of the NFT series. The loan amount that can be obtained by mortgaging NFTs of any attributes in the same series is the same.
There are security risks: every loan on the platform will affect the interests of all depositors on the platform. In extreme cases, large-scale liquidation of NFTs may trigger systemic risks.
There are few NFT objects that support collateral: For security reasons, only blue-chip NFTs with large trading volume, good liquidity and relatively stable prices are supported as collateral.
Summary: The peer-to-pool model is more suitable for a bull market with sufficient liquidity.
NFT Lending Track Industry Research Report
5.1.3 Hybrid
The lending business at the bottom of the hybrid protocol also adopts the Peer-to-Pool model. Users can act as borrowers to pledge NFTs for real-time lending, or as lenders to provide funds to earn interest paid by borrowers. Its innovation is to create a cross-margin credit system instead of using the isolated margin pool design adopted by existing platforms, which will allow users to provide loans for all collateral with one credit line.
Let me illustrate this with an example:
Suppose you have 61 BAYC, and you decide to pledge 5 to borrow, and then buy one. Using the existing lending protocol and its isolated margin model, you need to use these 5 BAYC to borrow ETH, and then go to the market to buy new BAYC.
This process has at least two disadvantages:
1. User experience: Users need to perform 5 different on-chain transactions and then manage these 5 separate lending positions.
2. If any of your loan positions are about to be liquidated, you must repay the loan immediately to avoid being liquidated by auction.
The hybrid protocol will generate a credit line for you by pledging your NFT assets, and a health factor for your entire pledged asset portfolio. As long as the health factor of your entire pledged asset portfolio remains above 1, none of your NFTs will ever trigger a liquidation auction. To reduce risk, you can always choose to deposit more collateral (NFT or ERC-20 Token) to maintain a high health factor.
This credit system is similar to a valuation system that assesses the value of all your collateral and automatically approves loans based on that assessment. As long as your collateral is a type of collateral supported by the credit system, you can borrow or lend based on their total value. This is the full-position leverage model with cross-margin.
It is easy to understand that this mode is more convenient to operate than the standard point-to-pool mode.