introduction
This article aims to explore the development path and trend of NFT lending by sorting out the lending terms and liquidation mechanisms of various NFT lending protocols and important proposals that have been passed. The research objects include BendDAO, ParaSpace, JPEG'd, Blend, NFTfi, Arcade, Pine Protocol, and Sodium.
All parameters and proposals in this article come from the protocol white paper and governance platform. The data comes from Blur, OpenSea, LooksRare, and X 2 Y 2. The caliber is the platform floor price data. The deadline is 2023/7/30, and the statistics are summarized by Dune.
Overview of liquidation mechanism
This article divides lending protocols into two categories:
Peer-to-pool type: borrowers borrow from the collective fund pool;
Peer-to-peer type: lenders and borrowers are matched through matching.
Among peer-to-pool lending protocols, common features include:
All use decentralized oracles to feed prices. The basic algorithm is the time-weighted average price algorithm (TWAP) to avoid abnormal instantaneous fluctuations. The specific algorithm is not disclosed to avoid floor price attacks.
The loanable ratios of BAYC, CryptoPunks, MAYC, and Azuki are significantly higher than other NFTs, and the liquidation thresholds are generally better than other series.
In the peer-to-pool protocol, because borrowers can borrow money immediately, and the overall market has not had a clear upward trend since the NFT bull market in April 2022, in order to control risks, each lending protocol only opens lending functions to some blue-chip NFTs and sets more stringent control parameters.
For example, in BendDAO, if you borrow funds with an LTV of 30% and a liquidation threshold of 65%, a drop of 62.5% is required to trigger liquidation. In ParaSpace, with an LTV of 30% and a liquidation threshold of 65%, the liquidation rate is 53.8%.
Although subsequent market results showed that many series of blue chips experienced multiple declines of more than 50%, the following is a price curve chart of Moonbirds starting from 2022/4/18. The floor price on that day was 18.9 ETH, the highest point was 37.6 ETH on 2022/4/24, and the floor price was 1.7 ETH on 2023/7/30, with a maximum decline of 95.5%.
The peer-to-pool protocol improves the matching efficiency of blue-chip NFTs, without the need to match the consensus of borrowers and lenders on the market situation, and improves the turnover capacity of blue-chips. However, in order to ensure the safety of the overall capital pool, the economic efficiency is usually low. In addition, the peer-to-pool protocol cannot solve the problem of rapid deterioration of the market environment by simply relying on the protocol mechanism. For example, the rapid decline and liquidation after the issuance of Azuki Elementals were dealt with by temporary measures by the project party outside the protocol mechanism. If the auction liquidation mechanism is relied on alone, bad debts may occur.
Reference report: "ParaSpace: Due to the sharp price fluctuations of Azuki, the Azuki mining pool has been suspended, including recharge, withdrawal, forced equalization and other functions"
Among peer-to-peer lending protocols, common features include:
Usually, there is no floor price involved, and the liquidation trigger is whether the loan can be repaid on time;
Usually makes an offer for the lender (i.e. sets the parameters for the loan terms), representing the lender’s dominant market position;
It is usually possible to extend the term and delay liquidation.
The peer-to-peer protocol solves the lending problem of long-tail assets through matching. Because the non-blue chip NFT market is relatively niche, lenders have an advantage, so the main offer is made by lenders. Only in Sodium, because many-to-one and multi-tiered lending is possible, the offer is made by the borrower. Liquidation is based on the repayment of the loan at maturity, avoiding the liquidation problem that the peer-to-pool protocol may face after a rapid decline, but it also brings the risk that if the price continues to decline and no longer rises, the borrower may not consider repayment directly. For this reason, Pine Protocol has set up the function of lenders initiating liquidation, but it needs to charge an additional 5% liquidation fee.
In addition, peer-to-peer protocols usually support extensions, but only Blend and NFTfi support re-setting loan conditions, which can prevent the market situation from being too different from the initial loan conditions. Pine Protocol has made targeted settings to limit the number of loan days to only 7 or 14 days, reducing the possibility of large fluctuations. Compared with the traditional bond market, changes in market interest rates are balanced by reverse changes in bond prices, but the NFT loan protocol does not have sufficient depth of secondary market support and does not support balancing through this channel for the time being, but as the market size increases, it is also a potential development direction. Pine Protocol V 3 has made initial attempts to NFTize loan positions and transfer them between accounts. Therefore, for protocols that support lending for more than a quarter, the function of resetting loan conditions is indispensable.
Proposal on loan terms and liquidation mechanism
The initial versions of major lending protocols were relatively strict on lending terms and parameters, and lacked flexibility. During the development process, restrictions were gradually relaxed to deal with the liquidation crisis caused by the decline, or to improve economic efficiency and promote the development of the protocol. This section lists the proposals for important changes to the lending terms and liquidation mechanisms in the lending protocols described in the previous section.
The proposals mainly focus on two directions: improving economic efficiency and improving liquidation.
Ways to improve economic efficiency include: increasing the loan ratio of top blue-chip NFTs, or increasing the loan ratio of rare items in a blue-chip series. For example, in BendDAO, BAYC's LTV was only 10% higher than other NFTs in the initial version, and the gap widened to 30% in BIP#15. In ParaSpace V 1.4, the gold skin BAYC and Koda increased their LTV by 6 times.
Ways to improve liquidation include: reducing liquidation, such as JPEG'd PIP-61 allows partial repayment and delays the time of liquidation. Another way to ensure successful liquidation and prevent unsold items is to remove the reserve price limit of the auction in BendDAO's BIP#9, which greatly increases the profit margin of liquidation. All major protocols are shortening the auction time. According to JPEG'd statistics, most auctions take place in the last few hours or minutes. It is only necessary to ensure that users have enough reaction time to participate in the auction.
In order to study the relationship with market conditions, the following times are based on the time when voting on the proposal begins.
BendDAO
Improved Liquidation: BI#9(2022/8/22)
Remove the restriction that the liquidation Bid price must be greater than 95% of the floor price;
The liquidation threshold is adjusted to 70%, which will be completed in three steps;
Adjust auction period to 4 hours: “The 48 hour window is designed to protect NFT holders from liquidation and waking up to lose their PFP. But now we have on-chain oracles protected by TWAP, which means floor price attacks will be very difficult. So we hope to reduce the time from 48 hours to 4 hours to improve the liquidity of the auction.”
Improve economic efficiency and improve clearing: BI#10(2022/8/23)
Liquidation threshold adjusted to 80%;
Adjust auction period to 24 hours.
Improving economic efficiency: BIP#15, BIP#15-1 (2022/11/11)
ParaSpace
Improving economic efficiency: ParaSpace v 1.4 (2023/1/28)
Increase the collateral value of rare NFTs, such as Koda collateral is six times that of regular Otherdeed;
Otherdeed LTV increased from 30% to 35%-40%.
JPEG’d
Improving Liquidation: PIP-51 (2023/4/29)
The repayment time after liquidation is reduced from 72 hours to 48 hours.
Improving Economic Efficiency: PIP-58 (2023/6/11)
Increase the LTV of each collateral, minimum 5% and maximum 25% (BAYC);
Add staking tokens to improve LTV function.
Improved Liquidation: PIP-61 (2023/6/15)
Partial repayment is allowed to avoid liquidation.
Improved Liquidation: PIP-71 (2023/7/17)
Auction time reduced from 24 hours to 12 hours.
NFTfi
Improved liquidation: Loan Renegotiations (2022/8/30)
NFTfi borrowers and lenders can renegotiate loan terms at any time before the loan is foreclosed (i.e., liquidation of NFTfi).
Pine Protocol
Improved Liquidation: PIP-8 (2023/4/28)
A liquidation fee is levied, payable by the lender when the lender initiates liquidation, and is 5% of the loan amount.
Improving Economic Efficiency: PIP-12 (2023/7/12)
Limiting loan terms to only 7 or 14 days will improve market predictability and reduce decision-making difficulty.
Improving economic efficiency: Pine V 3 (2023/1/13)
In V 1 and V 2 of the Pine protocol, the addresses of lenders and borrowers were written directly into the loan smart contract. This could not be changed as long as the loan position existed. To make it more decentralized and flexible, lending positions were tokenized as NFTs in the Pine V 3 smart contract design. Any blockchain address holding these NFTs will become the lender and borrower of the corresponding loan position.
NFT Blue Chip Index and Major Change Time Series
Based on the 2022/4/18 BAYC, MAYC, Azuki, Pudgy Penguins, CloneX, Doodles, Moonbirds and other 7 blue chip prices, the daily price relative percentages are averaged to obtain the NFT blue chip index as follows. CryptoPunks is not included because the series has not been traded for many days, which is easy to cause distortion.
The following conclusions can be drawn from the relationship between the time when each proposal was initiated and the index:
Proposals for improvements to liquidation are usually made when prices are at lows. For example, in 2022, BendDAO had four loan interest rates exceeding 100%. When this happened for the second time in August, BendDAO made major changes to the liquidation mechanism and removed the floor price requirement for Bid.
However, measures to improve economic efficiency have no obvious relationship with NFT prices. Measures to improve LTV, such as BendDAO BI#15and JPEG’d PIP-58, were proposed when prices were low, or were related to the development needs of the protocol itself. Another potential factor is the health of the NFTs that have been loaned on the platform. Since the fourth loan interest rate of BendDAO exceeded 100% in September 2022, the loan interest rates for the remaining three months have been at the low point of the year, that is, the loan health coefficient is relatively high, which has become a window period for improving LTV.
As the crisis brought by Azuki Elementals is resolved, various lending protocols have also gained the opportunity to re-improve the protocol mechanisms and parameters. It remains to be seen whether the lending protocols can become a booster for the recovery of NFTs or whether a liquidity crisis will occur again.