New Assets in DeFi
Part 1 — NFTs
Written by Conflux Network’s Strategy Manager Karan Ambwani
In the coming years, we will see DeFi becoming the underlying layer for most of our digital lives, whether investing in markets, playing online games, interacting and exchanging on new social media platforms, collecting art, or even purchasing real-estate. DeFi is meshing into the fabrics of traditional finance and will soon govern how transactions take place. More and more institutions are starting to adopt and recognize the advantages of crypto-economic systems.
Beyond the DeFi native assets like liquidity pool (LP) and governance tokens, DeFi will create unique mechanisms for value transfer with new assets flowing in, such as data tokens, social tokens, non-fungible tokens, and many more. In this series, we will explore the interactions between some of these new token primitives entering the DeFi ecosystem.
Let’s start with non-fungible tokens or NFTs, which are gaining a lot of traction with the new generation of crypto investors and enthusiasts.
The NFT market generated over $350 million in sales over the past month.
NFT is a fairly technical term but is gaining wide recognition with the artists’ and the collectors’ community globally. Apps like NBA Topshot, bands like Kings of Leon launching an album as NFTs, and artists like Grimes selling $6M worth of digital art, are all creating a movement leading to mainstream awareness.
Fungibility is the ability to replace or be replaced by another identical item; therefore non-fungible assets are mutually exclusive and non-interchangeable. This makes them ideal for representing ownership or rights to the holder for any record, art, collectible, real-estate, certificate, essentially anything unique and of value.
Many DeFi protocols today use non-fungibles for their functionality of representing specific contract terms to the holders of the token. For example, in BarnBridge, which is a derivatives protocol for hedging yield sensitivity and market price, all the senior tranche tokens with lower yield and lower risk profile are issued as NFTs. These NFTs provide you the ability to sell your tokens before their maturity date at a discount to someone who is willing to wait until the end to claim the principal plus the guaranteed reward.
In another DeFi protocol yInsure, which provides smart contract cover, each insurance contract is represented as an NFT which can also be traded on a secondary market like Rarible. These examples make it clear that NFTs present breakthrough features that go beyond the digital collectibles industry. There are other decentralized financial use cases that completely revolve around NFTs and make them even more important.
Loan Collateral
Traditional financial institutions like Bank of America have been providing lending services with art as collateral. According to BoA, art is a “powerful capital financial asset that may be considered as part of your overall wealth management strategy such as using your collection as collateral to gain liquidity for other financial opportunities.” With the constant innovation in the NFT market, it is inevitable that we see this concept extended to the DeFi world.
Even though it is easy to imagine NFT as collateral, the implementation is still difficult in a decentralized trustless manner. As there is no requirement for KYC or credit checks on self custody solutions and decentralized lending platforms, most platforms rely on over-collateralized loans to be able to liquidate the collateral in case of massive price movements or non-payments. In standardized DeFi lending and borrowing platforms, the value of supplied collateral can be easily measured by integrating price oracles, which is not always the case with NFTs, which has limited quantitative data on user-defined value.
The valuation of these NFT collectibles is more qualitative and the liquidity is also low. There is a requirement for a decentralized form of valuation with NFT lending which is currently achieved by tracking the transaction history of the token and/or reputation of the creator. The interest rates are correspondingly adjusted to minimize risks. There are still challenges with issuing loans against NFTs as most marketplaces allow anyone to create and trade collectibles. Imagine a scenario where a bad actor with multiple addresses buys and sells an NFT (that they created) a number of times, to create a trading track record and price point. This will give the NFT a false valuation but can still meet the requirements for some of the NFT lending platforms, thus risking the lender’s funds. To counter these challenges, protocols are finding new mechanisms with NFT price prediction markets or inbuilt automated trust analyzers.
The NFT lending markets are still serving a limited number of individuals but the mechanisms that will be developed in the process could be further used for making new distributed models for credit scoring and decentralized trust. With greater adoption of the concept of fractional ownership, we will see a boost in the usage of NFTs as collateral in DeFi.
Creator Economy
Another upside of NFTs on DeFi markets is establishing a new economy for creators, where they have complete ownership of the content creation and distribution. In this economy, they can even leverage abstract concepts like ‘reputation’ that are essentially non-fungible in nature. For example, a Twitter influencer’s reputation lies in what they regularly put in 140 characters. NFT & DeFi provide the ability to build applications that can assign a tangible value to these abstract concepts. For example, opening those individual tweet characters to be tokenized and freely traded in the wild. How would this work in theory? Let’s say you are an influencer you can tokenize each character of your tweet like N0, N1, N2… N139 and sell it on an NFT platform and let the owner of each character have the choice to place any random single character, backed by proving ownership of NFT. You automate sending out a combined Tweet through your account with all the NFTs included. While this may be an extreme example, the possibilities for creativity and monetization with tokenized random digital bits are endless. From tweets to curated pixels on a digital artboard, designing new game scenarios, multiverses, and virtual worlds… any creation can be tokenized and traded in the world of DeFi.
The applications are not limited to individual creations but can be extended further to other business areas like digital marketing by giving companies new ways to create unique advertisements, like creating a new version of the 1 Million Dollar project. With most people spending hours immersed in digital worlds, NFTs are a great way to accrue and move value, creating digital economies that are built on DeFi blocks.
Gamification of Finance
Another area gaining popularity is the gamification of finance which is beneficial for making DeFi transactions more intuitive for retail users. Aavegotchis are DeFi-staked NFT collectibles and a good example of gamified economics. The valuation of an Aavegotchi comes both from its intrinsic value and from its rarity score. Each Aavegotchi NFT manages an escrow contract address that holds their Aave that generate yield via Aave’s LendingPool, which increases the number of aTokens held in the wallet. Intrinsic value is the denominated value of Aavegotchi’s staked collateral, or the DeFi side of the platform. Rarity score is determined by calculating the rareness of each Aavegotchi’s traits and equipped wearables within the Aavegotchi universe, which is the gamified side.
However, gamified experiential learning is only realistic when the transactions are economically viable for the users. Some of the other ideas that bring thousands of creators exchanging millions of digital bits, we need blockchain networks that have the bandwidth to support the sizable transactions stream. With the price of gas on Ethereum currently, it is impractical to play around with the new protocols on the mainnet. This gives an opportunity for faster blockchains to create entirely new NFT + DeFi ecosystems.
NFTs + DeFi on Conflux Network
Conflux Network offers a high throughput rate of 3000+ TPS and low transaction fees, making it future-ready for building the DApp ecosystem to base DeFi and NFT markets.
Since mainnet launch, there have been more than 3.1M transactions on the network, costing a total gas fee of around $11 combined!
This is a proven solution to the scalability trilemma and will be a benchmark for establishing financial ecosystems to build on the distributed web.
Some of the early NFT products are already live on-chain like the NFT authentication and trade platform T-Space and the first DeFi + NFT role-playing game ConDragon. Gaming platform MoonGaming is creating a platform for issuing, selling, mining, and trading NFTs on the network, which will leverage the low fees and high throughput of the Conflux Network.
If you are interested in building DeFi + NFT products — like an NFT Index or an NFT lending protocol — we invite you to apply for a Conflux Ecosystem Grant. To learn more about the program and apply, please visit our website.
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